Post on 16-Dec-2015
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Structure of Organizations Structure of Organizations for Production of Public for Production of Public and Private Goodsand Private Goods
Shyam Sunder, Yale UniversityShyam Sunder, Yale University
American Accounting Association’s American Accounting Association’s International Visiting LecturerInternational Visiting Lecturer
Bogazici University, IstambulBogazici University, Istambul
October 9, 2000October 9, 2000
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Compare Public and Compare Public and Private Good Private Good OrganizationsOrganizations
Private good organizations produce Private good organizations produce and sell goods for a price to and sell goods for a price to customerscustomers
Customers can impose discipline Customers can impose discipline on themon them
Shareholders control manager by Shareholders control manager by offering them net income based offering them net income based compensationcompensation
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Public Good OrganizationsPublic Good Organizations
Public good organizations have Public good organizations have beneficieries, not customersbeneficieries, not customers
Weaker or no customer disciplineWeaker or no customer discipline Efficient production of public goods Efficient production of public goods
is very difficultis very difficult Solution is bureaucracySolution is bureaucracy
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OutlineOutline
Organizations as a set of contractsOrganizations as a set of contracts Accounting as a contract implemetAccounting as a contract implemet
ation mechanismation mechanism Compare resource flows, managemCompare resource flows, managem
ent structure, decisions, and accouent structure, decisions, and accounting in organizationsnting in organizations
Examples and implicationsExamples and implications
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Faculty Teaching by Faculty Teaching by SubjectSubject
Subject AreaSubject Area
AuditingAuditing
FinancialFinancial
Manageral/CostManageral/Cost
MAS/SystemsMAS/Systems
TaxationTaxation
GovernmentGovernment
ResearchResearch
All current Teaching All current Teaching
(In percent)(In percent)
1111
4444
2121
55
1010
11
33
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Calls for ReformsCalls for Reforms
Arthur Andersen: Sound Financial Arthur Andersen: Sound Financial Reporting in Public Sector: A Reporting in Public Sector: A Prerequisite to Fiscal ResponsibilityPrerequisite to Fiscal Responsibility
Coopers & Lybrand: Financial Reporting Coopers & Lybrand: Financial Reporting Practices of American Cities: A Public Practices of American Cities: A Public ReportReport
Touche Ross: Public Financial Reporting Touche Ross: Public Financial Reporting by Local Governmentsby Local Governments
Robert N. Anthony: Tell It Like It isRobert N. Anthony: Tell It Like It is
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Four Characteristics of Four Characteristics of BureaucracyBureaucracy
Fixed wageFixed wage Impersonal rulesImpersonal rulesTenure in jobTenure in jobPromotion from insidePromotion from inside
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Cries in the WildernessCries in the Wilderness
Bolton: Don’t Put Government Bolton: Don’t Put Government Financial Accounting in a Strait Financial Accounting in a Strait JacketJacket
Drebin: Is Accounting that is Good Drebin: Is Accounting that is Good for General Motors Good for for General Motors Good for Detroit?Detroit?
Mautz: Should Government Mautz: Should Government Emulate Business?Emulate Business?
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Legitimate Reasons for Legitimate Reasons for Different AccountingDifferent Accounting
Imposing business practices can cause considerable harm
Bureaucracy is an efficient solution to a difficult problem
Efficient production of public goods is a lot more difficult
Example: Besselman, Arora and Larkey Study of Defense Department
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Lack of Theory of Lack of Theory of Organizations to Produce Organizations to Produce Public GoodsPublic Goods
Management curricula linked to Management curricula linked to economicseconomics..
Absence of economic theory of public Absence of economic theory of public good organizationsgood organizations
Economics and management courses Economics and management courses emphasize private goods only.emphasize private goods only.
Contract theory of organizations can help Contract theory of organizations can help An example of a lack of theory driving out An example of a lack of theory driving out
teaching and practiceteaching and practice
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A Framework for Contract A Framework for Contract Theory of OrganizationsTheory of Organizations
Chester Barnard, President, Bell Chester Barnard, President, Bell Telephone Company of New Telephone Company of New JerseyJersey•Functions of the ExecutiveFunctions of the Executive 19371937
Herbert A. Simon, Herbert A. Simon, Administrative Behavior, 1946
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Figure 1
Resource Flows in Private-Good Organization
Employees
Shareholders
Creditors
Customers
VendorsGovernment
Managers
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Figure 1
Resource Flows in Private-Good Organization
Employees
Shareholders
Creditors
Customers
VendorsGovernment
Managers
Public
Goo
dsTax
es
Goo
ds a
nd
Serv
ices
Cas
h
Compensation
Skills
SkillsCompensation
Res
idua
lR
ight
s
Equ
ity C
apita
l
Interest
Loan
Capita
l
CashGoods and Services
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Necessary ConditionsNecessary Conditions
1) Individual Condition: Each 1) Individual Condition: Each participants expects to receive at participants expects to receive at least the opportunity cost of least the opportunity cost of contributions he/she makes to the contributions he/she makes to the organizationorganization
2) Aggregate Condition: Contributions 2) Aggregate Condition: Contributions of all participants can produce enough of all participants can produce enough output to meet the expectations of alloutput to meet the expectations of all
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Functions of AccountingFunctions of Accounting
Measures resource contributions
Determines inducementsCompares contributions to
inducements
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Special Problems in Special Problems in Control of ManagersControl of Managers
At the procedural hub of the contractsAt the procedural hub of the contracts Control resources, have informationControl resources, have information Monitor and negotiate with othersMonitor and negotiate with others Difficult to measure their contributionsDifficult to measure their contributions Can appropriate resources and Can appropriate resources and
informationinformation Misappropriation difficult to detectMisappropriation difficult to detect Devising a scheme to induce managers to Devising a scheme to induce managers to
contribute what is expected of hercontribute what is expected of her
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What are public and private What are public and private goods?goods?
Pure public goods satisfy two Pure public goods satisfy two conditions:conditions:
Zero marginal cost of serving an Zero marginal cost of serving an additional useradditional user
Nonexcludability: those who do not Nonexcludability: those who do not pay still benefit.pay still benefit.
Examples: National defense for Examples: National defense for citizens of U.S. Public radio in citycitizens of U.S. Public radio in city
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Pure private goods do not Pure private goods do not satisfy either conditionsatisfy either condition
Examples: a cup of coffee, Examples: a cup of coffee, car, suitcar, suit
Most goods and services lie Most goods and services lie in between the two in between the two extremes of pure public and extremes of pure public and pure private goodspure private goods
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Comparing Private and Comparing Private and Public Good OrganizationsPublic Good Organizations
Resource flowsResidual ClaimsProduct Market DisciplineDecision Making
•Product•Investment
Accounting and Control
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Resource FlowsResource Flows
Unreciprocated outflow to beneficiaries
No quid pro quoNeed unreciprocated inflow (tax, gifts)Captial versus revenue account cash
flows In Public good organizations, capital
flows are “revenue” contributions
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Figure 1
Resource Flows in Private-Good Organization
Employees
Shareholders
Creditors
Beneficiaries
VendorsGovernment
Managers
Public
Goo
dsTax
es
Goo
ds a
nd
Serv
ices
Cas
h
Compensation
Skills
SkillsCompensation
Fin
anci
alR
esou
rces
Interest
Loan
Capita
l
Goods and Services
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Figure 1
Resource Flows in Private-Good Organization
Employees
Shareholders
Creditors
Customers
VendorsGovernment
Managers
Public
Goo
dsTax
es
Goo
ds a
nd
Serv
ices
Cas
h
Compensation
Skills
SkillsCompensation
Res
idua
lR
ight
s
Equ
ity C
apita
l
Interest
Loan
Capita
l
CashGoods and Services
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Residual Claims
An economizing device in private good organizations
Reduce the number of contracting relationships
Residual claimant given control (susceptible to others' non-performance)
All agents can protect their interests directly
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Stock Market Stock Market Consequences of Residual Consequences of Residual ClaimsClaims
Trading in residual claims (stock market)
Creates incentives to gather and produce information
A large information industry existsCapitalizability of residual claims
induces interest in longer term resource flows
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Public Goods Public Goods OrganizationsOrganizations
No tradeable residual claimsWeaker incentives to search
for informationWeaker concern for the
longer run (e.g., Social Security debates)
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Defining Managers’ Defining Managers’ ContractsContracts
Private Good Organizations make it self-enforcing: link compensation to the residual (accounting and audit)
No product market discipline No link of managerial compensation to residual
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Product Market DisciplineProduct Market Discipline
Customers in PGOs negotiate terms
No transaction if not satisfiedCan withhold revenuesResidual-based contract for managers possible
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Public Good Organizations’ Public Good Organizations’ BeneficiariesBeneficiaries
Cannot withhold resources directly
Would continue to consume resources of poorer quality
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Private Good Contract in Private Good Contract in Public Good OrganizationPublic Good Organization
DysfunctionalSimple for managers to maximize
the residual by cutting the quality or quantity
This makes the organization becomes redundant
Efficient structure for private goods is not efficient for public goods
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Redistribution of Decision Redistribution of Decision RightsRights
This Problem in public good organizations is addressed by Redistribution of decision making responsibilities
Managerial contract delinked from residual
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Product Decision RightsProduct Decision Rights
Managers have information, expertise, and decision rights in private good
In public goods, the governing body specifies what is produced, quantity, quality, and who gets them, because it pays for them
Residual generation is irrelevant because the net residual is negative
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Product Decision Rights in Product Decision Rights in Public Good OrganizationsPublic Good Organizations
The informational advantage managers in private goods is left unused in public goods
Managers not offered incentives to look for newer types of public goods
They may do so to seek promotion and power, retain jobs
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Investment/Production Investment/Production Decision RightsDecision Rights
Managers choose residual maximizing quantity, quality using their information
Delegation of quantity decisions possible through linkage between residual and remuneration
Investment decisions are derived decisions from the quantity decisions
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Investment/Production Investment/Production Decision Rights in Public Decision Rights in Public Goods Orgs.Goods Orgs.
In public goods, governing bodies make quantity and quality decisions,
And therefore, the capital investment decisions
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Accounting and ControlsAccounting and Controls
Differences between internal control and financial reporting
Differences often misinterpreted as prima facie evidence of poorly designed or poorly run public-good organizations
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Accounting and Control Accounting and Control DifferencesDifferences
EntitiesEntitiesFundsFundsConsolidationConsolidationAssets/DepreciationAssets/DepreciationRevenue (cash versus accrual)Revenue (cash versus accrual)BudgetsBudgets
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Entities, Funds and Entities, Funds and ConsolidationConsolidation
Restrictions on use of funds to make each fund a separate entity
Governing bodies direct funds to implement their production decisions
Beneficiaries cannot discipline the managers
Segregation of funds is a device to implement the contract
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Detail in Public Good Detail in Public Good Financial ReportsFinancial Reports
Even small public good organizaations have fat financial reports
Why do they not aggregate?
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Reports Reflect the Reports Reflect the Decision StructureDecision Structure
Governing boards make product/investment decisions
Public good org. reports comparable to middle management reports
Each fund serves a different constituency
If funds cannot be commingled, why consolidate?
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Fixed Assets and Fixed Assets and DepreciationDepreciation
Private‑good: Record and value of long‑term assets at acquisition cost
Expense as cost of production over lifeUse of standard formulas Statistical inaccuracy vs. objectivityValuation of individual assets and the
residual rights for transactionsUseful for traders
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Public Good OrganizationsPublic Good Organizations
Residual rights not tradedSale of fixed assets infrequentUniqueness of many assets (Mount
Rushmore)Dominant market positionNonmonetary disclosure of assetsNot sure if some assets are liabilities
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Depreciation in Private Depreciation in Private Good OrganizationsGood Organizations
Three functions:Estimating the residual surplus
• Information value of residual surplus • Important statistic for all (viability,
renegotiation)Charging depreciation to the cost of
production for pricing decisions Induce managers to goal congruence
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In Public Good In Public Good OrganizationsOrganizations
none of the above three reasons applicable
No residual claimantPublic goods are not soldProduction investment
decisions made by governing bodies
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Accruals and Accruals and Revenue/Expense Revenue/Expense RecognitionRecognition
In Private good organizations, realization principle represents the quid pro quo with the customers
No quid pro quo for transactions in public-good organizations
In absence of quid pro quo, applying accrual principle is chasing form, not substance
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Budgets, Appropriations Budgets, Appropriations and Encumbrancesand Encumbrances
Governing bodies of public-good organizations appropriate funds for specific items
The budget is an authorization to spend
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Which one is the Which one is the Independent Variable?Independent Variable?
Legal charterLegal charter Interal Revenue Service Interal Revenue Service
Rules on tax statusRules on tax statusEconomic characteristics of Economic characteristics of
organization’s outputorganization’s output
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Considered Polar Cases Considered Polar Cases OnlyOnly
Pure public and pure private Pure public and pure private goods are two polar casesgoods are two polar cases
Most goods, and organizations Most goods, and organizations that produce them lie in betweenthat produce them lie in between
Rich spectrum of opportunities for Rich spectrum of opportunities for study of organizations, economics study of organizations, economics and accounting controlsand accounting controls
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Bureaucracy As A Dirty Bureaucracy As A Dirty WordWord
Bureaucracy is the oldest form of Bureaucracy is the oldest form of managementmanagement
Does not receive a fair shake in pressDoes not receive a fair shake in press Perhaps overused in welfare statePerhaps overused in welfare state But it is necessary for many functionsBut it is necessary for many functions Lack of understanding leads to Lack of understanding leads to
misguided attempts at reform that misguided attempts at reform that can backfirecan backfire
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Unequal RaceUnequal Race
Efficient production of public goods Efficient production of public goods is more difficult than private goods is more difficult than private goods (lack of customer discipline on (lack of customer discipline on managers)managers)
Always room for improvement in Always room for improvement in current practicescurrent practices