Issue 2

Volume 2 JOURNAL OF ECONOMICS & MANAGEMENT STRATEGY
March 1993

Power in Profit-Maximizing Organizations

Julio J. Rotemberg
I study how profit-maximizing organizations make decisions. Members of organizations tend to have incompatible preferences over decisions, but willingness to pay for decisions plays a very limited role in actual decision making. A sizable empirical literature documents that people who provide critical services, are hard to replace, or deal effectively with external shocks are powerful; they have disproportionate influence over decisions. This can be profit maximizing because the right to shape the firm through its decisions renders the firm more attractive as an employer. Thus, the relative costliness of employees' departures should affect their relative power.

Advertising as Information: Matching Products to Buyers

Kyle Bagwell and Garey Ramey
We consider communication of quality via cheap talk and dissipative advertising expenditures, when consumers have heterogeneous tastes for quality, and price information must be acquired through costly search. For search pods, cheap talk communicates quality when fixed costs are roughly constant across quality levels, while if fixed costs vary greatly with quality, then firms having the higher fixed-cost quality level use dissipative advertising. For experience goods, quality can be communicated by cheap talk in a range where low-quality firms have greater fixed costs, and low-quality firms use dissipative advertising if their fixed costs are greater still.

Rent Division, Restructuring, and Managerial Risk Taking: A Strategic Bargaining Model

Thomas H. Noe and Michael J. Rebello
This paper demonstrates that, when the manager of a poorly performing firm generates firm-specific rents, strategic considerations associated with anticipated future restructuring may lead to the adoption of risky operating policies. Furthermore, this bias toward risky policies may be exacerbated by increases in managerial entrenchment. This is the case even when the manager does not have an ownership stake in the firm. On the other hand, a manager of a firm that is performing well will prefer safer policies. These results are driven by endogenously determined management-borne costs of financial distress, and obtain under both restructuring regimes that enforce the priority of creditor claims as well as restructuring regimes that induce deviations from absolute priority.

Dynamic R&D Competition, Research Line Diversity, and Intellectual Property Rights

Jay Pil Choi
This paper develops a simple model of sequential innovations with a diversity of research lines. Competitive strategies of firms for R&D are analyzed at each stage in a sequence of innovations. We compare two alternative regimes of enforcing patent law, as a mechanism to provide adequate incentives for R&D at each stage. The regime that protects the research line gives monopoly rights to an entire line of research, hence limiting the utilization of the previous knowledge and retarding subsequent innovations. The other regime protects the product, which facilitates the use of previous knowledge at the expense of providing inadequate protection to the ideas embodied in the product, and results in underinvestment in the first stage.

Task Assignment and Agency Structures

Yukiko Hirao
This paper considers an agency model in which a principal delegates an agent authority to choose investment projects. The performance of the project depends stochastically on the agent's evaluation and operating efforts. The paper examines the conditions under which the principal prefers to assign production to a second agent. It is shown that the tasks will be assigned to two agents of the agent chooses an unobservable operating effort. The tasks will be assigned to one agent if the agent's evaluation and operating efforts are both unobservable and if disutilities of efforts are large relative to the profit from the risky project.