Ebook Positional Wages, Market Wages and Firm Size
This paper addresses the entrepreneurial problem of determining endogenously the optimal size of a firm in a competitive market environment, when the production possibilities interact with the labor organization and the governance of the firm. It has been observed by Rajan and Zingales (2001) that at the root of most enterprizes generating economic surplus is an entrepreneur with a unique critical resource such as an idea, good customer relationships, a new tool, or superior management technique. We represent that unique resource by two concepts: a production outcome function specifying the various production possibilities from which to select one, and the firms governance, specifying the management of transactions and agency relations in the firm when realizing the chosen production technology. The firms governance (or rather the entrepreneurs governance) specifies roles or positions within the firm and the agency relations connecting these roles and positions. The governance is adapted to the technology and to the size of the firm. The interaction between these two concepts, the technology and the governance, determines the productivity of positions and of coalitions of positions for workers.
We follow the seminal paper of Alchian and Demsetz (1972) who state that production is in principle a collective effort, see also Hart and Moore (1990) and Ichiishi (1993). Therefore we use a cooperative game theoretic model in which coalitions or teams of workers can generate a production outcome when they are coordinated by their managers. The technology is a set of production outcome functions, each adapted to the products or services supplied, and to the amounts supplied, but invariant for the characteristic degree of complementarity or substitution between the various positions within the firm. A choice of production affects the organization and the governance of the firm.
The firms governance is described by three elements. First, a network of principal0agent relations between well defined labor positions in the firm is defined. The top0position in the firm, that is the one having no principal and is occupied by the CEO, chooses the size of the organization and the governance that maximizes the profit of the firm. The front0positions in the firm, which have no agent within the firm, generate the added value of the firm by producing services and selling these on a product market. These front0positions enter the firms production function as inputs.
Second, the network of principal agent relations is supposed to be a hierarchy in which each agent at some level (except the lowest level) is a principal for agents at a consecutive level. Such a principal is called a manager or coordinator who translates, monitors, and adapts the various tasks and responsabilities of its subordinates in order to let them comply with the overall mission of the firm. We assume this mission to be given by the top principal, who is aiming at profit maximization . Increasing the number of levels broadens the productive base of the organization but also increases the level0dependent agency costs. These costs are increasing in the number of hierarchical levels. Examples of such costs are the translation of the central strategic mission to each operational level, or the agency costs involved in the processing and control of level0dependent budgets and information, implying a loss of control of a coordinator over the behavior of its direct subordinates, see, e.g. Williamson (1967). These agency costs are expressed by a discount factor between 0 and 1, which indicates the percentage loss of output for each level involved.
In order to distribute the value added by the firm among the various positions in the firm, we introduce a distribution function which is characterized by principles used in labor negotiations. Finally, a pay system is determined by a distribution function which distributes the value added of the firm between the profit for the owner position and the different wages for the employee positions in the firm. Since the wages and profit are assigned to the positions in the firm, and not directly to the emloyees who occupy these positions, we refer to these as positional wages and positional profit.
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