Notes on Exploration and Exploitation

What is the principle of informativeness in incentive design?

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The principle of informativeness states that the principle has to rely upon informative

information, which are based on accurate performance measure, in order to determine

the right incentives to the different tasks and balance the trade-off between the

benefits borne by extra effort provided and the costs of the risk borne by the agent.

Informative information allows to skim the random variables that affect performance

and that will, consequently determine the performance pay of agents.

An example is given by BP, where the performance pay was based on real randomness

since the workers’ performance was greatly affected by the year variations on crude

oil prices. Therefore, BP decided to introduce the “self-help” in performance pay. A 3

QUESTIONS & NOTES CH 6 - WARGLIEN

method that distinguished the measures for actual earning and the one for oil price, in

order to give a better indication of what people in the firm actually did.

What is the multitasking problem? Why, if one task has more accurate

- measures than another, this may induce a “distorted mix” of activity by the

agent?

The multitasking problem is the issue related to the provision of incentives when the

agent has to spend attention and effort over more tasks. The solution to solve this

problem is to give an appropriate balance of incentives among tasks, in order to

equally incentivize the agent to provide equal effort to the diverse tasks he has to

purse. Otherwise, if the incentives are stronger on one activity over another, the agent

will by tempt to provide effort only on the best measured activity, undersupplying the

other even is both activities are important for the principal. Therefore, when the agent

cares about how time is divided among tasks (doing more of one will still increase the

costs of doing more of another), unless the incentives are appropriately balances, the

agent will overemphasize the better-rewarded activity scarifying the other.

Do men and women differ in their preferences for competition? How does it

- impact on economic issues?

Yes, they do. An experiment over 24 people, equally divided b/w men and women, has

shown that women tend to underestimate their abilities and to shy away from

competition. They result more risk-averse than men. On the other side, men

overestimate their abilities and they are largely affected by biases, implying a

misallocation of talents. The experiment focused on how the different groups reacted

to two diverse incentives – piece rated vs tournaments – applied to a gender-neutral

task such as adding up sets of 5 two-digits numbers in 5 minutes.

The piece rate rewarded individually, independently by the others’ performance.

Whereas, the tournament rewarded only the winner of the group, giving a 4 times

higher pay than the payoffs of the piece rate, therefore, each group member had the

100/4 = 25 % to win.

At the end, members had chosen their personal reward. The result was that too many

men entered in the tournaments compared to women. 4 women out of 12 entered in

the tournament compared to the 9 men to entered.

In conclusion, it can be stated that tournaments aren’t perfect incentives, despite the

advantage of costs saving in acquiring information about employees, through the use

of selective effect. They don’t allocate talents effectively.

What are alternatives to monetary rewards?

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The non-monetary rewards are more about the intrinsic motivation. The first is

organizational design, which is crucial in determining motivation. The organizational

structure should be organic and allow cross-functional communication in order to

share important information and knowledge among different departments. Moreover, if

teams are small, the performance measure will be detailer since people mutually

check their behavior. Further, small groups eliminate the free-riding problem, because

rewards are more narrowly shared. 4

QUESTIONS & NOTES CH 6 - WARGLIEN front-and-back

Organizational design is connected to the model. The manufacturing

and other support unit for production are thought as the back of the organization,

whereas, marketing and sale are the front, where the organization is abler in gaining

information about costumer’s desires and needs. The aim is to create a tight

communication among them, in order to increase the organizational core

competences.

Reputation is another form of non-monetary rewards and intrinsic motivation. The

latter increases the personal value in the internal labor market of each agent, if these

behave correctly. Indeed, reputation means trust and reliability, it affects positively,

moreover, the position of the organization.

At last, but not for importance there is the PARC model, which employs the “high

commitment human resource management.” It is tied to the organizational design and

it requires a culture that emphasises strong collaboration and cooperation among

team members. The organization ensures employment, transparency of information

and high socialization and training for employees in other to make more enjoyable the

work. What are the typical traits of the competitive model of supply chain

- management?

In the competitive model of supply chain management, there are multiple suppliers

and the focus is on price, therefore, suppliers are in competition for delivering the

cheapest product to the buyer. Moreover, contracts are specified and have short-term

horizon. Suppliers are perfect substitute, because they have to deliver standardized

components, information asymmetry is fully exploited buy the buyer to keep prices

low. The main disadvantage is the lack of quality and cooperation.

What are the purchase reverse auctions?

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A reverse auction is a type of auction in which sellers bid for the prices at which they

are willing to sell their goods and services. In a regular auction, a seller puts up an

item and buyers place bids until the close of the auction, at which time the item is sold

to the highest bid. In a reverse auction, the buyer puts up a request for a

required good or service. Sellers then place bids for the amount they are willing to

be paid for the good or service, and at the end of the auction the seller with the lowest

amount wins.

What is the bullwhip effect? Provide at least two causes for such an effect.

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The idea of the bullwhip effect is that demand oscillations increase has they move

backward to the supply chain starting from the final consumer. It is the unexpected

distortion of the supply chain due to demand variations, it implies some cost and has a

negative effect over the business’ performance such as inventory and service level

deterioration, late responds and increase cost of material and manpower. The main

causes of the bullwhip effect are forecast error, over reaction to backlogs, poor

communication among value chain activities and wrong strategic amplification of

inventories when resources are scare.

What is the difference between friendly and hostile acquisitions?

-

Acquisitions occurs when a firm buys another (target). The latter can be friendly or

hostile takeover. The first one occurs when there is the consensus of both parties. 5

QUESTIONS & NOTES CH 6 - WARGLIEN

Whereas, in the second one the target firm disagrees over the takeover, so, the

acquiring firm buys slowly the target’s shares until it has bought it all.

Why do the target firm shareholders often get most of the value created by an

- acquisition? Provide two reasons.

Acquisitions do create value, but most or all of it accrues to the target firm. Firstly,

acquisitions occur in an active competition where the target firms are in short supply

with respect to buyers. So, managers of the target company have the duty towards

their shareholders to increase the value of the firm, thus, they exploit the asymmetry

of information on their behalf. Generally, the evaluation of a target firm is subjective,

because it might represent a possibility of increasing the entire value generated

through the synergies and complements among the two firms. Nevertheless, the

uninformed buyers don’t know the real value of the target. Moreover, the

unsophisticated buyers will be subjected to the winner’s curse, which is the tendency,

in certain auctions, of unsophisticated bidders to overestimate the real value of the

item. In other words, they will pay more than the actual value, therefore, the value

created by the acquisition will accrue only to the target and not to the acquiring firm.

Indeed, the sophisticated bidders learn to avoid the winner’s curse by pushing

downwards their bids.

- What are the typical problems of post-acquisition policies?

The main issue faced by firm after a takeover is to integrate differences, combine

complementarities, but in the first place, realize them. Generally, firms have three

methods for integrate differences and find a balance among the different

organizational designs. The first, is to keep firms separated to let them free to design

the most appropriate structure for themselves. However, it might reduce

communication and collaboration opportunities, due to opposite cultures. The second

method is to choose the best organizational design of one of them and impose it to the

other. The last, instead, pursues the “best-of-each” approach, finding the best features

in each other’s design and institute it across both firms. These last methods have the

advantage to minimize confusion and give a clear structure to follow and adapt to.

Nevertheless, people might be resistant to change, due to organizational inertia, which

might slow down the refreeze process after that the change has occurred.

Define economies of scale and at least 2 causes of economies of scale

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The economy of scale is the cost advantage that enterprises obtain due to large size,

output and scale operations. It arises due to the inverse function between quantity

and per-unit fixed cost: the greater the quantity produced the lower will be the fixed

costs, since they will be more spread over a larger amount of outputs. One reason of

economies of scale is a geometric cause, because the value of a cube increases much

faster than its surface. Therefore, the capacity of a firm increases faster than the fixed

costs due to incrementing its surface (raw material to produce a larger plant).

Moreover, indivisibilities and play an important from for such economies, since

capacity cannot be fragmented into small pieces, but it goes only for large ones. A

final cause is the great gains that come from division of labor. The latter allows people

to specialize in a certain task and increase their performance become abler and faster.

Define the experience curve and explain why these can have different speed in

- different industries. 6

QUESTIONS & NOTES CH 6 - WARGLIEN

The experience curve describe how much a firm has learnt and at what pace. It relates

experience with efficiency, making them a