Q1; the firm mind; the author had separated it into 1. owner mind(ch3) 2. manager mind (ch4). Your answers show that the student didn’t even touch the book :(

Q1)The separation of ownership and control has profoundly changed the organization of industries. Looking at it at the firm level, how has it changed (1) the mind and (2) the body of the firm?

Q2) Now looking at it at the market level, tell a story of how it may produce merger waves or chaos?

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The task is to summarize what is written in the book as answers for the two questions.

Q1; the firm mind; the author had separated it into 1. owner mind(ch3) 2. manager mind (ch4). Your answers show that the student didn’t even touch the book 🙁

The same thing for Q2. the author had separate it into 4 main topics

Too big, Too complex, Too fragile, Too similar each in a different chapter, you didn’t summarize any you just talked about the chios from the internet

I reviewed the book for really quick and here are the answers

Q1 : The mind of the firm: is summary of:

1. The mind of the owner ch3

2. mind of manager ch4

The body of the firm is the summary of

Too big ch5 2. Too complex ch6. 3. Too fragile ch7 4. Too similar ch8

Q2; is the summary of ch9, ch10, and ch11

I have just summarized the Mind of owner (this is just a very rough draft) but it should include all the important information about the subject just to give you an example:

The Owner mind:

Owners may suffer the separation anxieties as a result of being separated from controlling their own firms. Two ways to come over this separation anxieties. First, by hiring “distancing institutions” where it comes as an intermediate link between the owners and the managers such as the Board of directors (BOD). The BOD works in the best interests of the owners. However, sometimes owners would hire mutual-fund managers to make sure the BOD acts to their best interest. Figure p23

Second, Willful Blindness; the best way to describe the willful blindless case is when the owner owns a few shares in a big index. Owners and shareholders measure the manager’s competence by accounting profit, market share. However, those measures are not accurate, for example, profit can be derived by shifting in the consumer’s preferences, labor strikes, wars, pandemics, or market bubbles.



INDUSTRIAL ORGANIZATION MINDS, BODIES, and EPIDEMICS by Li Way Lee June 2019 1 TABLE OF CONTENTS Acknowledgments Chapter 1: Introduction Part I – The Minds of a Firm Chapter 2: Two Minds Chapter 3: The Owner’s Mind Chapter 4: The Manager’s Mind Part II – The Firm’s Body: The 4 Toos Chapter 5: Too Big Chapter 6: Too Complex Chapter 7: Too Fragile Chapter 8: Too Similar Part III – Epidemics Chapter 9: Waves Chapter 10: Bubbles Chapter 11: Chaos 2 Part IV – Antibodies Chapter 12: Raiders Chapter 13: Trustbusters Chapter 14: Creative Destructors Part V – Conclusion Chapter 15: Good Luck Index 3 Acknowledgements The book began to take shape one day in 2017, when I received an email from a Jay Grenda offering “free assistance with research.” He said that he was a singer, an economics major, and had worked as an editor of a newsletter at a non-profit. I was intrigued. I had been writing a bunch of notes on industrial organization since 2010, and I wanted to see if they could hang together and turn into a book or something like that. So I asked Jay to give it a shot. He went to work right away. Two months later, as I looked at what he had done, I realized that I had struck gold. In the meanwhile, Jay had gone to graduate school. Ever since Jay, I have been asking students for comments on drafts. Toward the end of a class, I would say to them: “tell me the good, the bad, the ugly of what you have read.” Now I have a big folder of them. I also asked them to suggest titles for the book. Heart-Attack Economics won strong support. I reluctantly passed it over because a couple of friends, upon hearing it, thought I was writing a book in medicine. To my students I say from the bottom of my heart: Thank you!!! In no particular order, they are: Asma Alhazmi; John Breen, Sa-ad Iddrisu; MinJeong Kwon; Walt Ryley, Dibin Joy; Juan Fernandez; Badri A Jawad; Luke Antonczak; Robert Simpson; Matt Barbish; Alec Zatirka; Kevin Stadler, Thomas Wilk, Derek Jenkins, Joseph Janeski, and David Criss. My mentor John Tomer read two early drafts and offered counsel and encouragement. He also sent me in the direction of Editor Elizabeth Graber. How wise of him! Elizabeth commented on substance and design, and helped me pick a title. Meanwhile, Assistant Editor Sophia Siegler held my hand as we moved the project along. I am also grateful to my colleague John Sase and two anonymous reviewers for tips on rhetoric. If you find the book boring, blame me. But if you find the book too long, blame them. 4 The publisher Elsevier has given me permission to reuse parts of two of my articles. You will find the parts in the appendix of Chapter 2 and the body of Chapter 9. I appreciate the generosity. I shall acknowledge specifically when we reach these places in the book. 5 Chapter 1 Introduction Heart Attacks on Wall Street On September 15, 2008, the firm Lehman Brothers collapsed and passed out. Within a few hours, other firms started to sputter and pass out. There seemed to be some sort of deadly contagion going on. Caballero (2010) compared it to a contagion of “sudden financial arrest.” In any case, the government quickly stepped in and put the unconscious firms on life support. They became known as the Too-Big-to-Fails. Going through the wreckage, Scherer (2010) conducted a forensic analysis of six of those firms: J.P. Morgan Chase, Citigroup, Bank of America, Wells Fargo, Goldman Sachs, and Morgan Stanley. He found that those firms had grown by serial mergers. From 1985 to 2008, they were involved in 192 mergers. Any firm that grows in this manner at this pace will become big and complex. Akerlof and Shiller (2015, p. 28) describe how Goldman Sachs grew from $50 million to $28 billion in capital between 1970 and 2005 (I added the italics): “Whereas in the old days Goldman had been overwhelmingly about the underwriting, now it was into many, many different businesses…Goldman Sachs has become an empire.” Banks were not the only casualties of contagious heart attacks; General Motors and Chrysler also succumbed. That did not surprise me. General Motors and Chrysler had tried mightily to become banks by acquiring financial services and products. For at least twenty years before 2008, I had GM cars, GM auto insurances, GM mortgages, GM home insurances, GM Master Cards, and GMAC checking and saving accounts. You name it; I had it. I was a most faithful member of “The GM Family.” 6 Deaths at Heart-Attack Grill A few years later, I came across an article about a restaurant in Las Vegas: Heart Attack Grill. I learned that two spokespersons of the restaurant had died recently. That article hit home and provided much inspiration for the book. Here is part of the article (Polis, 2013): For the past year and a half, Alleman would stand outside of the restaurant and try to encourage people to come inside. Owner Jon Basso didn’t actually pay him for this, but would occasionally give him some free food. “I told him if you keep eating like this, it’s going to kill ya,” Basso told the Las Vegas Sun The Heart Attack Grill is known for its over-the-top burger creations such as the quadruple bypass burger, which holds the Guinness World Record for “most calorific burger.”… Alleman died of a heart attack. The other spokesperson died of complications from pneumonia. Multiple Minds How do we explain those deaths on Wall Street and at Heart-Attack Grill? Would it not have been in the bankers’ and patrons’ self-interest to stay away from those bankruptcies and quadruple bypass burgers? Yes, if we should assume that everyone has a singular, well-defined self-interest. Then we could conclude that those bankers and patrons are irrational. End of story. But I am not a fan of that story. I prefer stories that explain how their “irrational” behaviors come about in the first place. Fortunately, there are many such stories. What follows is a summary version. A person has several selves pursuing different interests while bargaining and making compromises among themselves. As Shiller (2005, p. 169) puts it, there is “a pool of conflicting ideas coexisting in the human mind.” Things are fine when the selves stay at the bargaining table. Things go wrong when bargaining breaks down, with one self exercising dominion over the others. 7 Take, for example, saving for old age. People don’t do it seriously (Thaler and Benartzi 2004; Akerlof and Shiller 2009, chapter 10). The “present self” says: I smoke, eat fast food, drive over speed limits, stay up late, and do not save; I have only so much energy and attention and money; I can’t worry for that “future self.” The idea of multiple minds is not new. In The Theory of Moral Sentiments, Adam Smith saw multiple minds. The first sentence in the first paragraph of the first chapter of that book reads as follows: How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it, except the pleasure of seeing it. The “principles in his nature” represent multiple selves. Later in the book, which predates The Wealth of Nations by almost two decades, he suggested that in a good society the rich are led by “an invisible hand” to share wealth with the poor. In the book he also introduced “the impartial spectator,” which suggests multiple selves as well. Therefore, it is no accident that he would reintroduce “the invisible hand” in The Wealth of Nations. Behavioral economists today see a person’s brain as the dormitory of two or more selves. Schelling (1984) sees the Jekyll self and the Hyde self. Lynne (2006) sees the egoistic self and the empathetic self. Thaler (2015) see the planner self and the doer self. Akerlof and Shiller (2015) see the good-taste self and the bad-taste self. (They call their bad-taste selves “monkeys on the shoulders,” who make them eat sweets and fatty food.) The list of multiple selves is long (Lee 2018). Between Adam Smith and modern-day behavioral economists stand Berle and Means. In The Modern Corporation and Private Property, they find two minds in the modern corporation (ibid., p.300): The owner of a private business receives any profits made and performs the functions not only of risk-taking but of ultimate management as well….In the modern corporation, with its separation 8 of ownership and control, these two functions of risk and control are, in the main, performed by two different groups of people. Berle and Means sowed the seed for the “agency problem” in the field of corporate governance. The Book in a Nutshell In this book I take the reader on a custom tour of industrial organization. We start with a visit to the inside of a firm, with the agency problem at the top of our agenda. We meet the owner and the manager. We look deeply into their mindsets. They, in separate persons or not, are constantly judging each other. The owner judges the manager by the firm’s dominance. The manager is fully aware of that judgment heuristic and pursues dominance to impress the owner. Then we move outside the firm, to observe its body. Several features catch our attention: size, complexity, fragility, and its similarity to other firms. Next we tour communities of firms and consumers, or what we call “markets.” We watch waves of mergers, chaos, and bubbles. We also witness battles between managers and creatures that act like antibodies in blood stream: raiders, trustbusters, and creative destructors When all told, the book is my story of how I learned to worry about industrial organization, with hope. References Akerlof, George A. and Robert J. Shiller. Animal Spirits. Princeton, New Jersey: Princeton University Press, 2009. Akerlof, George A. and Robert J. Shiller. Phishing for Phools. Princeton, New Jersey: Princeton University Press, 2015. 9 Berle, Adolf A., and Gardiner C. Means. The Modern Corporation and Private Property. First edition by The Macmillan Company, New York, 1932. Revised edition by Harcourt, Brace & World, Inc., New York, 1967. Caballero, Ricardo J. “Sudden Financial Arrest.” IMF Economic Review, 58 (1), 2010, pp. 6-36. Lee, Li Way. Behavioral Economics and Bioethics. London: Palgrave Macmillan, 2018. Lynne, Gary D. “On the Economics of Subselves: Toward a Metaeconomics.” In Morris Altman, editor, Handbook of Contemporary Behavioral Economics, New York: M.E, Sharpe, 2006, pp. 99-122. Polis, Carey. “John Alleman Dead: Heart Attack Grill Unofficial Spokesman Dies from Heart Attack.” The Huffington Post, February 12, 2013. Schelling, Thomas C. Choice and Consequence. Cambridge, MA: Harvard University Press, 1984. Scherer, F. M. “A Perplexed Economist Confronts ‘Too Big to Fail’.” Faculty Research Working Papers Series, RWP10-007, Harvard Kennedy School, 2010; also in The European Journal of Comparative Economics, 7(2), December 2010, pp. 267-284. Shiller, Robert. Irrational Exuberance, 2nd edition. Princeton, New Jersey: Princeton University Press, 2005. Thaler, Richard. Misbehaving. New York: W. W. Norton, 2015. Thaler, Richard, and Shlomo Benartzi. “Save More TomorrowTM: Using Behavioral Economics to Increase Employee Saving.” Journal of Political Economy, 112 (S1), February 2004, pp. 164-87. 10 PART I The Minds of a Firm Chapter 2 Two Minds Chapter 3 The Owner’s Mind Chapter 4 The Manager’s Mind 11 Chapter 2 Two Minds The Roofers The four roofers on my neighbor’s house have been working hard. I have been watching them. The work looks simple: Tear off old shingles, get bags of new shingles on the roof, nail down new shingles, do trims and gutters, and clean up. But this is the third week into the job now. There have been a snow storm, an ice storm, and several rain storms. Today, they showed up later than usual. They might have run out of new shingles on the roof top, so they had to wait for the delivery truck with that big, long crane. A truck just came. I wonder how they have been able to deal with all these problems. How do they develop contingency plans, reach agreement on them, monitor compliance, and enforce agreement? Also, how many contingency plans do they make? These are the questions that Ronald Coase asked in “The Nature of the Firm.” (He watched workers at auto assembly plants.) His answer is amazingly simple: Stuff happens, and people who work together just have to deal with it. There is always need to manage and control. People may choose to manage and control as problems arise or to develop plans for them ahead of time. Either way, collective actions must be agreed to, individual actions monitored and infractions punished. The bottom line is that people who work together have to spend resources on managing their relations. How do the roofers do it? I can think of three ways. 1. Co-op They can work everything out by forming a co-op. A co-op is a network in which each roofer is linked to all other roofers. Figure 2.1 shows how: roofer A roofer B 12 roofer C roofer D Figure 2.1: A co-op There are 6 links, each containing 2 relations. So there are 12 relations, the maximum in this “complete network.” The roofers spend resources on the management of each of these relations. They also take all risks, like inclement weather and bounced checks. 2. A “Small” Firm Here, the four roofers bring in someone to manage relations and take risks. Call that someone “the owner-manager.” Let’s say you are that someone. Figure 2.2 shows the new organization, “a small firm.” roofer B roofer A owner-manager (you) roofer D roofer C Figure 2.2: A small firm 13 In your small firm, we note three features: a. The firm is a star network with one center. b. At the center of the network is the owner-manager. c. There are 5 persons connected by 4 “links.” Each link runs two ways, as the relation is managed by both the employee and the owner-manager. So there are 2 relations in each link and a total of 8 relations in the firm. Exactly how do you make a living as the owner-manager of this roofing company? You offer each roofer an “employment contract.” The contract pays a fixed wage, and each roofer deals with you and you only. There is no change in the nature of work. You assure them that if anything out of the ordinary comes up, let you know and you will deal with it. Of course, you will design the employment contract so they all prefer it to what they have now in the co-op. Let’s count again how many relations in the firm you and the 4 roofers must manage. There are 4 links, each containing 2 relations. So there are 8 relations to manage. That is 4 fewer than 12, the number in the co-op. This saving is your income as the owner-manager. It is “profit.” You may think of profit as the “network efficiency” that you achieve by reducing the number of relations that must be managed. Another source of profit is what you may call “management acumen.” Under your management, the suppliers get paid more timely, the roofers are happier, and the roof gets done sooner. 3. A “Big” Firm You don’t have to manage a firm in order to own it. Ownership and control can be separated. You find someone to be the manager, while you remain as the owner. This allows you to kick back a little. You pay the manager a salary just as you pay each of the four roofers a salary. 14 You like this idea, so you hire Jones as the manager, and you become the owner. Figure 2.3 shows the reorganized roofing company. Now you own a “big firm.” roofer A roofer B owner (you) manager (Jones) roofer C roofer D Figure 2.3: A big firm Note four architectural features: a. b. c. d. The firm is a star with one center. The owner and the manager are separate persons. At the center of the star is the manager. There are a total of 6 persons connected by 5 “links.” Each link runs two ways, as the relation is managed by both sides. The “peripheral” persons are the four roofers and the owner. So there are 10 relations in the firm now. Still, that represents a saving of 2 relations from the time when the 4 roofers worked as a co-op. And that saving is the source of both manager Jones’s salary and your income. The Separation of the Owner’s Mind and the Manager’s Mind As Berle and Means (1932) see it, every firm has to perform two functions: risk-taking and management. In the “small firm,” the two functions are 15 performed by you. So when we look into your head, we see two minds: the owner’s mind and the manager’s mind. Figure 2.4: The owner-manager (you) The day when Jones shows up at work is the day when the two minds get separated. Jones picks up the manager’s mind, while you retain the owner’s mind. In other words, the degree of separation of ownership and control goes up by one. This has consequences. The most serious is that coordination between the owner and the manager becomes more difficult. manager (Jones) owner (you) Figure 2.5: The separation of ownership and control 16 The separation of ownership and control reminds me of the Alien Hand Syndrome. In this syndrome, a person’s two hands lose coordination, so one hand does not quite know what the other hand is doing. In a big firm, the owner and the manager are the two hands of the firm. Conclusion In the aftermath of the Great Recession, John Bogle (2009) said: But the larger cause was our failure to recognize the sea change in the nature of capitalism that was occurring right before our eyes. That change was the growth of giant business corporations and giant financial institutions controlled not by their owners in the “ownership society” of yore, but by agents of the owners, which created an “agency society.” The managers of our public corporations came to place their interest ahead of the interests of their company’s owners…. John Bogle was the owner-manager of the Vanguard Group of Mutual Funds in its early days. Appendix: Coase’s Explanation of the Firm (adapted from Lee 1987.) When Ronald Coase was a college student, he wondered why we needed firms when the prevailing wisdom was that prices could make the world go round and round. He looked in vain for a satisfactory answer in his books. So he boarded a ship in England and found his way to Detroit, Michigan. It was in the early 1930’s. He got himself into car assembly plants and watched how people worked together. In 1937, he reported what he had learned in “The Nature of the Firm.” 17 Coase’s explanation of the firm is so simple that it can be boiled down to 6 words: Firms are better at managing relations. The explanation is extraordinary because everybody else thought the essence of a firm is production, not management. For that same reason, though, economists did not want to take his explanation seriously. Coase (1972) mused 35 years later: “What is curious about the treatment of the problems of industrial organization in economics is that it does not now exist.” Then, 16 more years later, Coase (1988, p.62) again reviewed the impact of “The Nature of the Firm” and found the article to be “much cited but little used.” Macey (2008, p.5), alarmed by economists’ willful blindness to Coase’s wisdom, issues a warning: “(I)f Coase is right… then everything is up for grabs – or up for negotiation – including the issue of what the basic objectives and purpose of the corporation should be…” In this appendix, I revisit Coase’s theory of the firm. I show that profit comes about from management, not production. It follows that the manager – not the owner – collects profit. “A firm,” according to Coase (1937, p. 339), “consists of the system of relationships which comes into existence when the direction of resources is dependent on an entrepreneur.” Firms are an alternative resource-allocation mechanism to the price mechanism. Why do firms exist in the midst of the price mechanism? Coase’s explanation is simple: some of us think that we are better at allocating resources than the price mechanism. Let’s c …
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