Boeing vs. Airbus, revisited

Since we talked about Boeing and Airbus in class, I figured it would be helpful to point you towards a working paper about the race to develop the superjumbo jet and the failed attempt at preemption on Boeing's part. You will notice here that Airbus succeeded because, to use the terminology from your textbook reading, it built a cart with legs and didn't believe that Boeing's wheeled cart was going to stay where it was. (Unfortunately, Airbus' cart broke a few years later, but the original scenario is still relevant.)

A Word on Ethics...

As you guys saw in class, the idea of business ethics is a particularly messy one, where conventional wisdom may not always provide the "right" answer. Below is a classic example, courtesy of wikipedia:

Brent Spar or Brent E, was an oil storage and tanker loading buoy in the Brent oilfield, operated by Shell UK. With the completion of a pipeline connection to the oil terminal at Sullom Voe in Shetland, the storage facility had continued in use but was considered to be of no further value as of 1991. Brent Spar became an issue of public concern in 1995, when the British government announced its support for Shell’s application for disposal in deep Atlantic waters at North Fenni Ridge (approximately 250 km from the west coast of Scotland, at a depth of around 2.5 km).

Greenpeace organised a worldwide, high-profile media campaign against this plan. Although Greenpeace never called for a boycott of Shell service stations thousands of people stopped buying their petrol at Shell. Shell's sales went down by 70%. Greenpeace activists occupied the Brent Spar for more than three weeks. In the face of public and political opposition in northern Europe (including some physical attacks and an arson attack on a service station in Germany), Shell abandoned its plans to dispose of Brent Spar at sea - whilst continuing to stand by its claim that this was the safest option, both from an environmental and an industrial health and safety perspective. Greenpeace’s own reputation also suffered during the campaign, when it had to acknowledge that sampling errors had led to an over-estimate of more than one hundredfold of the oil remaining in Brent Spar’s storage tanks. Following Shell’s decision to pursue only on-shore disposal options - as favoured by Greenpeace and its supporters - Brent Spar was given temporary moorings in a Norwegian fjord. In January 1998 Shell announced its decision to re-use much of the main steel structure in the construction of a new harbour facilities near Stavanger.

My advice to the world, when thinking about ethical issues? Make sure you've done your homework before you get your pants all in a twist about what is "right"- it could make everyone better off.

Asset Specificity Example

I think the concept of asset specificity is best illustrated with an example similar to the one I gave at the end of section. Imagine you have a buyer and a seller for parts that go into making a car. The specifications for the parts are very specific, so the parts made can only go into one model of car, and only this supplier can make the parts. Now imagine that the buyer and seller enter into a contract where the seller will provide this part at $100 each. After the parts are made, the seller realizes that the parts are critical to the functioning of the car, and it says that, regardless of the contract terms, it's not going to let the parts go for less then $150 each. Now the buyer is in a bind since it can't just turn around and buy them from someone else. The "holdup" could also go the other way, with the buyer saying wait, I'm going to only pay you $75 each, since I know that once these parts are made you can't sell them to anyone else. See the problem? This could theoretically be avoided if the buyer's and seller's assets were contained within the same firm.

Jodi's Demsetz Summary

Demsetz argues that Coase’s theory of the firm is still incomplete, and that more attention needs to be given to information costs. (Information costs are one presumably important component of transaction costs.)

In order to have a cogent theory of the firm, we need to take away the traditional assumption of costless information.

Moral Hazard, Shirking and Opportunism:

Demsetz points out that another issue involved with organizations is that of aligning incentives. In section, we briefly discussed the issue of post-contractual opportunistic behavior, or "holdup". The general model assumes a buyer and a seller that make a contract in some state of uncertainty, so that they don't know perfectly what the world is going to be like when it comes time for work to be done. When the true state of the world is revealed, the buyer and seller tend to renegotiate, even though they already had a contract. This is because there are certain items that cannot be contracted on, and contracts are not perfectly enforceable. This renegotiation is costly from a logistical perspective, and could also be costly for the party that doesn't have a lot of bargaining power. The theory is that these holdup problems can be mitigated with internal organization (according to Klein Crawford Alchian).

Given these problems, why do we have markets? Demsetz argues that markets offer high-powered incentives that cannot always be recreated within a firm.



(Obviously preliminary, again stay tuned!)

Some Incentives Reading...

A student in the other class asked me to recommend some articles on compensation systems and incentives, so I figured I would also put the list here. Most of these articles should be available online through the HOLLIS catalog.

Holmstrom, Bengt and Paul Milgrom. 1991. “Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design.” Journal of Law Economics and Organizations 7: 24-52

Baker, George. 1992. “Incentive Contracts and Performance Measurement.” Journal of Political Economy 100:3.

Lazear, Edward and Sherwin Rosen. 1981. “Rank-Order Tournaments as Optimum Labor Contracts.” Journal of Political Economy 89:5 841-64.

Prendergast, Canice. 1999. “The Provision of Incentives in Firms.” Journal of Economic Literature 37:1 7-63.

Oyer, Paul. 1998. “Fiscal Year Ends and Non-Linear Incentive Contracts: The Effect on Business Seasonality.” Quarterly Journal of Economics. CXIII, 149-185.

Healy, Paul M. “The Effect of Bonus Schemes on Accounting Decisions.” Journal of Accounting and Economics 7 (1985): 85-107.

Courty, Pascal and Gerald Marschke, “M. “An Empirical Investigation of Gaming Responses to Explicit Performance Incentives,” Journal of Labor Economics forthcoming.

Roy, Donald. 1952. “Quota Restriction and Goldbricking in a Machine Shop” The American Journal of Sociology, 57:5 427-442.

You could also look at the articles that these reference for further resources.

Another Way to Find Articles...

Some of you have expressed having problems with accessing materials on reserve. While not everything is available directly online through the Harvard Library system, many of the academic journal pieces can be found rather easily.

1. Go to hollis.harvard.edu.
2. Click on "e-research (articles)" at the bottom left.
3. Scroll down and click on "Find E-Journals". (Note: For those of you writing research papers and such, the "Find E-Resources" link is also helpful to you. For economics-related topics, the two most useful sources here are EconLit, JSTOR and Lexis-Nexis.)
4. You can then search for the title of the journal with the desired article and go from there. You can also search for the article directly through EconLit or JSTOR, mentioned above.

It is probably useful to play around with these resources to familiarize yourselves with how they work.