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[adverse selection] [agency] [agenda] [asymmetrical information] [bezzle] [chinese wall] [(due) diligence] [ethics] [incentive compatibility] [moral hazard] [responsibility] [stakeholder] [transparency]

These notions are covered in Business and Organization courses offered by Veryard Projects and Antelope Projects.



Adverse Selection

An unfair distribution of value or risk, or biased sample, typically caused by asymmetrical information.

Example: if an insurance company offers a health policy without requiring a medical test, then this will attract customers who are likely to fail a medical test or perhaps those who have already failed a medical test because customers who can pass a medical test can get a cheaper policy elsewhere. The policy-holders will then not form a representative sample of the population, but will have a disproportionate number of unhealthy people.

Example: suppose that a dodgy builder charges £5000 to fix your chimney badly, and a professional builder charges £10,000 to fix it properly. Suppose that you cannot tell the difference (in advance) between the dodgy builder and the professional builder. Then you have no reason to pay the higher price, and the dodgy builders will drive the professionals out of business. (Economists refer to this phenomenon as the market for lemons.)

Note that adverse selection does not always involve asymmetrical information. The unhealthy insurance customer may not know that he is unhealthy; and the dodgy builder may simply not appreciate the difference between the professional builder and himself.


Agency

A relationship between an agent and a principal. For example, the directors of a company are the agents of the shareholders.

In agency theory, economists study the costs, risks and inefficiencies of this relationship.


Agenda

The set of topics and issues that an organization is prepared to address.

Control over the agenda confers and confirms political power. True empowerment demands access to the agenda.


Asymmetrical Information

Differential access to information, which may lead to adverse selection and/or moral hazard.
 
The agent (supplier) often knows more about the performance of a task than the principal (customer).  Is this solution complete, or will the customer need to buy more bits before it works properly?
Conversely, in the financial services industry, the customer often knows more about the risk than the finance company. Do I really intend to pay back this loan?

Am I likely to be able to keep up the payments?

Do I have undeclared health problems?

...?

Insider trading Do I want to buy this stock from someone who knows more about it than I do?

Do I want to sell this stock to someone who knows more about it than I do?


Bezzle

The economist J.K Gailbraith used the term "bezzle" to denote the amount of money siphoned (or "embezzled") from the system.

In good times, he remarked, the bezzle rises sharply, because everyone feels good and nobody notices. "In [economic] depression, all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks." [Galbraith, The Great Crash 1929]
  

Further Material Bezzle (html)


Chinese Wall

A structure intended to reduce asymmetrical information and moral hazard. Sometimes just a notional boundary, with little real effect - for symbolic purposes only.

For example, financial institutions are supposed to have Chinese Walls, to prevent various patterns of inappropriate behaviour, including Insider Trading and Insider Recommendations. Among other things, the Chinese Wall protects investment analysts from commercial pressure from other parts of the same organization. Recently, there has been much criticism of financial analysts (especially in America) who recommend the purchase of stocks simply because their colleagues have a commercial interest in promoting that stock.


(Due) Diligence

Usually refers to an inauthentic procedural form of responsibility, in which managers mime attention to something important, going through the motions with just enough energy and attention to evade liability and blame.

This is therefore one of the many management terms whose meaning in practice is almost the exact opposite to its literal meaning.


Ethics

To start with, you can think of Ethics very simply as the study of value.

As one of the Foundations of Business, it provides a philosophy of value, which is complementary to the science of value provided by Economics, and helps to motivate a deeper and more reflective study of business.
  

Course Material Ethics (pdf)
Further Material Ethics (html)


Incentive Compatibility

Common interest between contracting partners. Where there is no common interest, this is incentive incompatibility.

An example of incentive incompatibility is found in telecoms and internet service provision. Under certain circumstances, the service provider may benefit from a congested network, since by increasing the duration of transactions it increases the charges that can be billed to consumers. This gives little incentive to the service provider to improve the network and eliminate the congestion.

In contrast, incentive compatibility in this case would mean that both service provider and consumer share the costs of congestion, and would both benefit from eliminating congestion.

Regulators seek to achieve incentive compatibility, because it reduces conflicts of interest (and possible disputes) between supplier and consumer. For example, London taxi fares are supposedly designed to encourage the taxi driver to get you to your destination as quickly as possible (the sooner to pick up another passenger and earn more money), rather than to sit in traffic clocking up unnecessary fares.


Moral Hazard

The temptation to obtain unfair advantage - especially from asymmetrical or subjective information. Inappropriate influence. In some industries, the regulator is concerned to prevent moral hazard.


Responsibility

Responsibility means that one agent is answerable or accountable to another agent for a given state of affairs.


Stakeholder

A person or community that possesses intentions and attributes value to things.  A person or community that is regarded as having a legitimate interest or "stake" in something - for example a system or project.

Traditional business ethics defined the purpose of a business solely in terms of satisfying the interests of the shareholders.  But some businessmen wanted to recognize the legitimate interests of other groups of people; they started to use the term "stakeholder" rather than "shareholder".  The similarity of the two words is deliberate: it draws attention to the substitution of a broader concept for a narrow one.

Thus use of the term stakeholder was originally to be inclusive rather than exclusive. It leads people to argue that companies should be run for the benefit of a range of stakeholders, including employees, customers, suppliers and neighbours, and not merely for the benefit of shareholders. Similarly, housing estates should be run for the benefit of the tenants, not just the landlords; schools for the benefit of pupils and parents, not just the convenience of teachers; and so on.  Some politicians talk about a stakeholder society. To label a person or community as a stakeholder is to legitimize action intended for their benefit.

To the businessman who takes the concept of stakeholder seriously, what is important is not just the specific set of people who are named as stakeholders, but the ongoing mission to identify and include people who might otherwise be excluded. Similarly in politics, the stakeholder agenda indicates a desire to recognize the interests of the people who might otherwise be left out or disadvantaged.

However, some managers and analysts seem to regard the concept of stakeholder as exclusive. There is a closed list of stakeholders, drawn up at the start of a project, who may be consulted at various stages of the project. If you're not identified as a stakeholder, then your opinion doesn't matter.  (I deplore the exclusive use of the stakeholder concept.)

The stakeholder agenda therefore entails a renewed attention on the processes associated with stakeholdership.  Who looks after the stakeholder's interests, and how? Who legitimates new stakeholders?


Transparency

An ideal state in which business transactions and decision processes (including pricing and procurement) are supposedly explicit and open, with unmediated access to the relevant information.



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