Williamson's Managerial Discretion Model (4).pptx

economics

1. international institute of professional studies, DAVV Name–Shivangi Umredkar Roll Number – IN2K22-104 Class- 2nd Yr MBA[MS 5 yrs ] Section – B Subject – Managerial Economics

2. Williamson's Managerial Discretion Model

3. AGENDA Introduction Key Concepts The Model Graphical Representation of the Williamson’s Model Future Research Conclusion

4. INTRODUCTION Williamson's Managerial Discretion Model, developed by economist Oliver E. Williamson, focuses on understanding how managers make decisions within organizations. Key components include bounded rationality (limitations in decision-makers' rationality), opportunism (self-interest), and specific assets (unique resources tied to transactions). The model recognizes that managers have discretion in decision-making due to uncertainties and adaptability. It is applied to analyze governance structures and contractual relationships, offering insights into organizational challenges and strategies for efficiency. ​ key concepts in the Managerial Discretion Model Bounded Rationality Opportunism Specific Assets 4

5. Key concepts

6. Explanation of key concepts in the Managerial Discretion Model Oliver E. Williamson's Managerial Discretion Model is a framework within the field of organizational economics that seeks to understand how managers make decisions within organizations. The model is particularly concerned with the challenges and constraints that managers face in their decision-making processes. Bounded Rationality: Definition: Limited decision-making capability due to cognitive constraints. Implication: Managers simplify decisions based on incomplete information. Significance: Understanding helps design decision-making processes that accommodate cognitive limitations, improving organizational adaptability. Opportunism : Definition: Self-interested actions that may conflict with organizational goals. Implication: Recognizing the need for aligning individual and organizational interests. Significance: Prompts the design of governance structures and contracts to mitigate risks and foster cooperation. Specific Assets: Definition: Specialized resources tied to specific transactions or relationships. Implication: Dependency on these assets influences decision-making and behavior. Significance: Emphasizes the importance of considering relationship-specific investments, informing strategic choices in organizational decision-making.

7. The model > SIMPLIFIED MODEL OF WILLIAMSON’S MANAGERIAL DISCRETION > Williamson’s Utility Function The demand curve faced by the firm is downward sloping Cost of Production Concept of Profit in the Williamson’s Model

8. Simplified Model of Williamson’s Managerial Discretion 8 Under Willaimson’s model, the objective is the maximisation of the utility function subject to the minimum profit constraint. The minimum profit should be such that it is sufficient to pay satisfactory profit to shareholders and pay for necessary investments. Here we are taking a simple case where there is no management slack, i.e. M=0. Objective Max U = f (S, 𝐼𝐷) Subject to π ≥ π0 + T As there is no management slack, so the discretionary investment absorbs all the discretionary profit. Thus the managerial utility function can be written as- U = f [S, ( π – π0 + T)] Here, we are also assuming that there is no lump sum tax, i.e. Ť=0, so that T=t π. Thus, U = f [S, (1 – t) π – π0 ] Where (1-t)π – π0 is the discretionary profit πD.

9. Williamson’s Utility Function The managerial utility function encompasses measurable salary and non-quantifiable variables like status and job security. Williamson's utility maximization model combines staff number and manager salary as 'monetary expenditure on staff' in the utility function 𝑈 = 𝑓1(𝑆, 𝑀, 𝐼𝐷), where 𝑈 is utility 𝑆 is expenditure on staff, 𝑀 is management slack 𝐼𝐷 is discretionary investment These variables represent unquantifiable concepts such as power and dominance. Despite the positive relationship between decision variables (𝑆, 𝑀, 𝐼𝐷) and utility, the firm chooses values within the constraints 𝑆≥0 and 𝐼𝐷≥0. Williamson also introduces the law of diminishing marginal utility, implying that incremental changes in 𝑆, 𝑀, and 𝐼𝐷 yield smaller utility increments to the manager THE demand curve faced by the firm is downward sloping Under Williamson’s model, the downward-sloping demand curve is represented by Q = 𝑓2(P, S, Ɛ) and P = 𝑓3(Q, S, Ɛ), where Q is output, P is price, S is staff expenditure, and Ɛ reflects autonomous changes in demand. The negative relationship between price and quantity (\(𝜕𝑃/𝜕𝑄 < 0\)) indicates that as prices rise, quantity decreases and vice versa. The positive relationships (\(𝜕𝑃/𝜕𝑆 > 0\) and \(𝜕𝑃/𝜕Ɛ > 0\)) signify that an increase in staff spending or shifts in demand parameters cause an upward shift in the demand curve, allowing for higher prices. Any changes in demand-shift parameters, like income or shifting tastes, contribute to this effect

10. Cost of Production Total production cost (\(C\)) is a function of output (\(Q\)), expressed as \(C = 𝑓4 (Q)\). As output increases, total cost rises (\(𝜕𝐶/𝜕𝑄 > 0\)), depicting a positive correlation. Concept of Profit in the Williamson’s Model: The various concepts of profit used in the Williamson model need to be understood clearly before moving to the main model. Williamson has put forth four main concepts of profits. These are actual profit, discretionary profit, reported profit and minimum profit. ( i ) Actual profit (π): The actual profit is defined as the revenue from sales less the production costs and the staff expenditure. π = R – C – S Where, R is revenue, C is the cost of production and S is the staff expenditure. (ii) Reported Profit (πR): This is the profit reported to the tax authorities. Reported profit (πR) is the difference between actual profits and supplementary or nonessential managerial emoluments as represented by the management slack. It is the actual profit minus the managerial emoluments (M), which are tax-deductible. So, πR = π – M = R – C – S – M

11. (iii) Minimum Profit (π0): Minimum profit (π0) is the number of profits (after tax) which is required to be paid as an acceptable dividend to the shareholders of the firm. Suppose the shareholders do not get reasonable dividends. In that case, they may sell their shares and thereby expose the firm to the risk of being taken over by others, or alternatively, they will vote for a change of top management. This is mathematically expressed as: πR ≥ π0 + T The tax function is of the form T = Ť + t. πR .Where, t is the marginal tax rate or unit profit tax and Ť is the lump-sum tax. (iv) Discretionary profit (πD): Discretionary profit is the amount of profit left after subtracting from the actual profit (π), the minimum profit requirement (π0) and the tax (T). It can be expressed as: πD = π – π0 – T (v) Discretionary Investment (ID): Discretionary investment is the amount left from the reported profit after subtracting the minimum profit (π0) and the tax (T). It can be expressed as: ID = πR – π0 – T The difference between reported profits (πR) and actual profits (π) arises due to management slack and discretionary profits. It can be written as πD = ID + Amount of management slack. Thus, if management slack is zero, then πR = π and πD = ID

12. Graphical Representation of the Williamson’s Model

13. The graphical representation of the equilibrium of the firm requires the construction of the indifference curves map of managers and the profit curve. An indifference map is a family of indifference curves. An indifference curve is a curve which shows different combinations of two goods yielding the same level of satisfaction to the consumer. These are the two variables that determine the utility function of the managers. The indifference curve is shown in the figure where staff expenditure (S) is measured on the x-axis and discretionary profit (πD) on the y-axis. Each indifference curve shows various combinations of staff expenditure (S) and discretionary profit (πD), which give the same level of satisfaction to the managers. Consider the Figure below: TITLE

14. It is assumed that the indifference curves of managers are of well behaved: Indifference curves are downward sloping. They are convex to the origin, implying a diminishing marginal rate of substitution of staff expenditure and discretionary profit. Two indifference families of indifference curves can never intersect each other. The higher the indifference curve higher is the level of satisfaction. The indifference curves do not intersect the axes. The non-intersection of indifference curves with the axes is crucial. As staff expenditure and discretionary profit positively impact manager utility, the model assumes positive values for both. the model excludes the corner solutions, such as points A, B, C, D etc., where discretionary profit (πD) would be zero in the final equilibrium of the firm. TITLE

15. The profit function and then the equilibrium analysis of the firm. The relationship between S, staff expenditure, and πD, discretionary profit, is determined by the profit function. The profit function explains the relationship between profit and output. Thus, the profit function is a function of the price of the product, expenditure on staff and the demand shift parameter π = ƒ(Q) = f(P, S, Ɛ) Where, π is profit, Q is output P is price S is expenditure on staff Ɛ demand-shift parameter reflecting autonomous changes in demand The profit function which explains the relationship between π0 and S is shown below in the Figure below: TITLE

16. Future Research Potential areas for future research in managerial discretion: Behavioral Dynamics: Explore the psychological aspects influencing managerial discretion and decision-making within the model. 2.Technology Integration: Investigate how emerging technologies impact managerial discretion and its role in organizational economics. 3.Cross-Industry Analysis: Extend the model's applicability by examining its effectiveness across diverse industries. 4.Global Context: Assess the model in the context of international business, considering cultural and regulatory variations.

17. SUMMARY Managerial Autonomy: Williamson's Managerial Discretion Model underscores the significance of managerial autonomy in organizational economics. Decision-Making Framework: The model provides a robust framework for understanding decision-making processes within firms. Adaptability: Highlight the model's adaptability to evolving organizational structures and economic landscapes.

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