9781118041581

12 percent more than his or her counterpart (for a third-year wage of about $63,000)

if the division achieved 150 percent or more of its profit goal.

At its introduction, nearly all of the division’s 20,000 employees (and four of the

five affected labor unions) adopted the plan. The enthusiasm was in part due to the

fact that the first-year profit goal was set at a modest level, and partial-year sales results

almost guaranteed beating it. The salary incentives also seemed to affect workers’

behavior, prompting many to suggest ways to cut costs and enhance revenues.

Nonessential programs became candidates for termination. Some workers said the

plan would change their viewpoints: from fixation on their particular jobs to the big

picture of company performance.

In Chapters 12 and 13, we considered decision making under uncertainty and

the value of information solely from the individual manager’s point of view.

Dealing with risk and acquiring better information are equally relevant in deci-

sions involving multiple decision makers, whether they operate within markets,

across organizations, or within the same organization. Particularly important

examples involve asymmetric information—situations in which one party knows

more than another about key economic facts. As we shall see, the presence of

asymmetric information has a number of implications. First, managers must

be careful to draw correct inferences from the behavior of others. Second,

asymmetric information can lead to market failures, that is, can impede prof-

itable transactions between buyers and sellers. Third, it can create incentive

problems. One party may undertake behavior that is not in the best interest of

another party with which it interacts.

The first section of this chapter considers the effects of asymmetric infor-

mation, and the second explores how firms can best organize themselves to

deal with asymmetric information.

ASYMMETRIC INFORMATION

In situations characterized by asymmetric information, one party knows more

than another about key economic facts. The presence of asymmetric information

can lead to adverse selectionand moral hazard,each of which we take up in turn.

Adverse Selection

As noted in Chapter 13, managers must make accurate probability assessments

in order to make well-informed decisions. But as the next example shows, these

assessments must take into account the likely behavior of other decision makers.

A BENEFITS PROGRAM After considerable planning, a company’s human

resources department has introduced a premium medical insurance program

582 Chapter 14 Asymmetric Information and Organizational Design

c14AsymmetricInformationandOrganizationalDesign.qxd 9/26/11 11:03 AM Page 582