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MBA 540, Summer II

 

Final Exam

1. The CEO of the oil company justified the merger with the department store by stating, “This is a great merger. First the products are unrelated. Thus, our company’s earnings volatility is likely to decrease. Second, our management team has proved that we are better managers that the former management team of the department store, and thus we are likely to discover new ways to create and capture value within the department store.” Evaluate this rationale.

I think this merger will be very costly for the oil company and probably will not have any success. It does not matter how good management team is, economic will dictate other very obviously reasons for failure of this merger. The oil company’s management team may be good in their industry; it is not obvious that they will have an advantage in competing in an unrelated industry. They are more likely to be able to exploit any special talents they have in a related business.

This diversification occurs for two completely unrelated products. It can be quite expensive (high transaction cost) to develop common personnel, communication, information, and operating system. Net benefits are likely to be greater in related rather than unrelated diversification. If there is little interaction on either the production or demand side of the businesses, it is hard to envision where economies of scope might arise and by definition the two businesses would not produce complementary products.

It is true that diversification can reduce earnings volatility. It is the poor reason to diversify. The problem with using this as a justification for diversification is that this reduction in volatility need not increase a firm’s value. Shareholders can diversify within their own investment portfolios at low cost. It is easy for investors to purchase shares of both a department store company and oil company. Through this diversification investors reduce return on volatility on their overall portfolios. There is no reason for investors to pay a premium for a company simply to reduce return volatility, since they can achieve this same objective by purchasing stock in the two separate companies. At the same time cost of integrating diverse businesses within the same firm will be significant.

This type of diversification will not create value.

 

 

2. What is the relation between a dominant strategy and Nash equilibrium?

Dominant strategies are when it is optimal for firm to choose that strategy no matter what its rival does. I think that almost all dominant strategies are Nash equilibria; but not all Nash equilibria are dominant strategies. Nash equilibrium strategies are strategies that are individually optimal given the strategy of the other party. Sometime Nash equilibria are not necessarily the outcomes that maximize the joint payoff of the players. The power of a Nash

equilibrium to predict the outcome in strategic situation stems from the fact that Nash equilibria are self – enforcing: they are stable outcomes. When dominant strategies exist, there are strong private incentives to choose them, regardless of what the other player does. With a Nash equilibrium, your best choice generally is contingent on what you expect your rival to do.

 

3. In Chapter 9, an example of coordination problems in the market for HDTV’s was given. Show the game in strategic form using hypothetical payoffs of your choice. Use the arrow technique to identify the equilibria.

 

4. Is it worthwhile for shareholders to seek to completely eliminate incentive problems with managers and directors through means such as monitoring? Why or why not?

I think the answer is NO. It is optimal to incur out-of-pocket expenses to reduce agency problems only up to the point where the marginal reduction in the residual loss is equal to the marginal increase in out-of-pocket expenses. A firm might want to stop employees from taking company pencils home for personal use. However, the costs of completely eliminating this behavior are likely to be extremely high to justify.

Monitoring cost it is an agency cost that arises when shareholders take steps to ensure that management is acting in the best interest of the owners, i.e., that managers are maximizing the wealth of shareholders. It is very costly to control contracting problems. It generally will not pay for either party to incur sufficient costs to ensure that the agent (agent performs some service on the principal behalf) will follow the wishes of the principal completely (at some point marginal cost exceeds the marginal benefits of additional expenditures to increase compliance).

5. How might the softer elements of corporate culture help increase productivity in an organization? Provide two examples.

Softer elements in a firm’s corporate culture include things as slogans, role models, corporate stories, and social gatherings. These features are important in communicating the objectives of the firm to employees and other stakeholders. They can also serve to convey to employees the architecture of the firm (what decision rights employees have, what will receive positive evaluations and rewards). Also, these features can be used to enhance employee expectations that other employees will behave in particular ways. Sometimes these expectations are important in fostering cooperation among employees. It is easy to give examples of how managers might use the softer elements to meet these objectives. For example, it’s the case of Mary Kay Cosmetics in our book. Or we can find softer elements in the Home Depot corporate site in internet (page The Home Depot: Fact Check). And I like their slogan “You can do it we can help”.

 

6. Continental Airlines assigns flight attendants to routes based on attendant seniority. Why does Continental use this procedure instead of having the supervisor of the attendants assign the flights?

I think that this practice cuts down on the influence costs that would arise if the flight attendants had a scheduling supervisor who they could lobby for preferred routes.

 

7. Why do you think that U.S. firms have reorganized their international divisions from a country focus to matrix organizations focusing on both country and product?

Grouping all the activities within a country under one manager is likely to promote the use of specific knowledge about that country in decision making. The country manager might use specific knowledge about consumer preferences in the design of particular products; knowledge about local taxes and regulation can be very important. Country managers can be provided strong incentives for making them responsible for profit and loss within their given territory. The drawback of organizing solely around country is it does little to promote coordination and information sharing within product lines across country borders. In the past when market areas were relatively defined by country boundaries (due to taxes, tariffs and regulation), the advantages of country organization were more likely to have been larger than the costs. As country barriers break down it is more important to coordinate decisions within a product line. For example, a multinational buyer does not want to have to negotiate with 100 country managers over product price. Also to the extent that tastes are becoming more uniform across countries, there are stronger reasons to exploit economies of scale in production. Given it is important to promote coordination and information use both within a product line and a given country, a matrix organization appears to make sense to many companies at the present time.

 

8. Does the market for unskilled service employees (e.g., fast – food restaurants) during the summer month fit the assumptions of the competitive model? Describe the likely impact in this market of an increase in the minimum wage.

The labor market is competitive. I think that the market for unskilled service employees is competitive also. It is just labor market. Increase in the minimum wage will cause a raise in

unemployment. Employers will try to keep cost low. Thus, they will cut the hours for unskilled employees or will lay them off.

 

 

 

Source:

Managerial Economics and Organizational Architecture, by Brickley, Smith and Zimmerman; McGraw-Hill Irwin publisher, 5 th edition, 2009; ISBN-10: 007337582-9 or ISBN-13: 978-007337582-3.