Deck 14: Asymmetric Information and Organizational Design

Question 1

Centralized decision making is favored over decentralized decision making:

A) when there are no principal-agent problems.
B) when decisions need to be made on a case-by-case basis.
C) when coordinated decisions are essential.
D) when information that is relevant to the decision is dispersed.
E) when the firm has a flat organizational structure.

Answer 1

C

Question 2

A used car salesperson offers a warranty on any car sold in the lot. This is known as:

A) signaling.
B) risk aversion.
C) self-selection.
D) screening.
E) adverse selection.

Answer 2

A

Question 3

Which of the following is an example of asymmetric information leading to a "lemons" market?

A) A marketing manager is uncertainty about the volume of sales in the next quarter.
B) An employee does not know the rate of inflation in the coming year and so cannot ascertain his real wage.
C) The seller of a used laptop knows more about its true condition than the buyer.
D) A firm's manager has motives that sometimes conflict with the interests of shareholders.
E) A trader, who has access to inside information, profits by trading on that information.

Answer 3

C

Question 4

Which of the following is an example of signaling?

A) A buyer who makes a large raise in bid at an auction to discourage other bidders.
B) A doctor who performs a large number of in-office tests and is paid per test.
C) An elderly couple who elect a generous medical insurance policy.
D) A board of directors that is trying to refine the compensation system for its CEO.
E) A pitcher (about to sign with a new team) who is aware of a nagging elbow pain.

Question 5

Which of the following is an example of a principal-agent problem?

A) A buyer who makes a large raise in bid at an auction to discourage other bidders.
B) A doctor who performs a large number of in-office tests and is paid per test.
C) An elderly couple who elect a generous medical insurance policy.
D) A board of directors that is trying to refine the compensation system for its CEO.
E) A pitcher (about to sign with a new team) who is aware of a nagging elbow pain.

Question 6

Which of the following is a method of signaling used by firms in the presence of asymmetric information?

A) Bundling products together for sale
B) Outsourcing the production of goods and services
C) Offering discounts on the price of goods
D) Offering fixed-wage contracts to employees
E) Building a reputation

Question 7

In a "lemons" market:

A) both the buyer and the seller have perfect information.
B) regulators intercede to control quality.
C) different quality goods sell at different prices.
D) asymmetric information leads to the sale of low-quality goods.
E) only the buyer has access to complete information.

Question 8

Which of the following must be true for a firm to efficiently employ centralized decision-making?

A) The decision-relevant information must be dispersed.
B) The employer and the employees must have compatible interests and objectives.
C) A very low degree of coordination is required between the various departments.
D) The organization structure must informal.
E) There must be significant principal-agent problems.

Question 9

Which of the following is a method used to overcome the problem of asymmetric information?

A) Creating an informal organizational structure
B) Pooling risks
C) Self-selection
D) Signaling
E) Outsourcing

Question 10

Moral hazard occurs when:

A) the principal purposely misleads the agent to obtain higher profits.
B) limited information causes uncertainty for the agent.
C) an agent pursues his own interests to the detriment of the principal.
D) self-selection is not possible
E) an agent has incomplete information when acting on behalf of the principal.

Question 11

Some employers permit telecommuting where employees work from home and contact the office through electronic methods. Which of the following identifies a problem that the employer may face?

A) Telecommuting could lead to the problem of self-selection.
B) The employer encounters new problems posed by moral hazard.
C) Telecommuting could contribute to an informal organizational structure.
D) The cost of hiring and retaining employees will increase.
E) Telecommuting can blur the boundaries of the firm.

Question 12

Adverse selection occurs in a market when:

A) one party has better information about pertinent risks.
B) both parties have an incentive to cheat on a contract.
C) the agent acts against the interests of the principal.
D) one party is unable to perform the contract as specified.
E) the cost of signaling is prohibitive.

Question 13

Which of the following contributes to principal-agent problems in large modern firms?

A) The dispersion of information among many decision makers
B) The consolidation of management and ownership in a single entity
C) The specialization of labor.
D) The agreement between managers of different departments to increase profits at any cost
E) The use of in-house production rather than outsourcing.

Question 14

The use of teams in an organization is:

A) an example of diffusion of responsibility.
B) is representative of centralized decision making.
C) representative of a hierarchical organizational structure.
D) can lead to difficulties in reaching a consensus.
E) an example of adverse selection.

Question 15

Which of the following is an example of self selection?

A) A buyer who makes a large raise in bid at an auction to discourage other bidders.
B) A doctor who performs a large number of in-office tests and is paid per test.
C) An elderly couple who elect a generous medical insurance policy.
D) A CEO who takes certain self-interested actions that diminish overall shareholder value.
E) A pitcher (about to sign with a new team) who is aware of a nagging elbow pain.

Question 16

Which of the following leads to adverse selection in a market?

A) Signaling
B) Externalities
C) Uncertainty
D) Asymmetric information
E) Moral hazard

Question 17

Which of the following is an example of asymmetric information?

A) A buyer who makes a large raise in bid at an auction to discourage other bidders.
B) A doctor who performs a large number of in-office tests and is paid per test.
C) An elderly couple who elect a generous medical insurance policy.
D) A board of directors that is trying to refine the compensation system for its CEO.
E) A pitcher (about to sign with a new team) who is aware of a nagging elbow pain.

Question 18

Which of the following is an example of moral hazard?

A) A buyer who makes a large raise in bid at an auction to discourage other bidders.
B) A doctor who performs a large number of in-office tests and is paid per test.
C) An elderly couple who elect a generous medical insurance policy.
D) A board of directors that is trying to refine the compensation system for its CEO.
E) A pitcher (about to sign with a new team) who is aware of a nagging elbow pain.

Question 19

The strategy of purchasing suppliers in order to have a reliable supply chain is known as:

A) in-house production.
B) outsourcing.
C) benchmarking.
D) vertical integration.
E) product lifecycle management.

Question 20

Which of the following is most likely to be true of a firm organized along functional lines?

A) There will be optimal coordination of information and decisions.
B) The firm will face decreasing returns to scale.
C) Information required for decisions will be generic and therefore easy to use.
D) Functional managers may not act in accordance with the firm's larger objectives.
E) Decision making in the organization will be highly centralized.

Question 21

Compare and contrast adverse selection and moral hazard.

Question 22

What factors typically lead a firm to centralize decision making? What causes it to decentralize?

Question 23

A strain of bird flu has broken out in a Southeast Asian country, killing flocks of chickens and sickening scores of rural dwellers. Raising and selling chickens (both live and butchered) to local townspeople is the main livelihood of many rural farmers.
(a) Does the chance of chicken flu in healthy looking chickens pose problems for transactions between farmers and local buyers? Explain.

Question 24

Assume that a worker works 60 hours a week. He contributes an additional $90,000 to the firm's revenue and his personal disutility from the job is $35,000. If he is paid $58,000 per year, what is the net profit from this employment relationship?

A) $32,000
B) $35,000
C) $55,000
D) $34,000
E) $23,000

Question 25

According to the saleswoman, the used car you are thinking of buying was owned by an elderly lady who only drove it to church and always traded in for a new vehicle every two years. Is this car likely to be a good buy?

Question 26

Across its facilities, a financial firm pays its back-office clerical workers in two different ways: (i) a set wage per hours worked (hours are flexible and can vary between 40 hours and 50 hours per week) or (ii) compensation according to the quantity (number of tasks) and the quality of work completed. Which method would you recommend? Explain briefly.

Question 27

Which of the following is not a mechanism used to address the principal-agent issue in the management of large corporations?

A) Enforcing managerial duties externally
B) Empowering shareholders
C) Strengthening corporate governance
D) Enforcing of disclosure requirements
E) Setting up a corporate lobbying group

Question 28

In 2000, Amtrak, the intercity passenger train service in the U.S., discontinued its customer satisfaction guarantee program (a full price refund if the rail trip was not to the customer's satisfaction). Instead of 1 passenger in 1,000 claiming the guarantee, the rate was 4 in 1,000; many claims were due to delays caused by weather or due to congested tracks used by other freight rail companies. Critically assess the pros and cons of Amtrak's guarantee program.

Question 29

A manager at a firm wants to increase the effort put in by his team. Which of the following measures should he adopt?

A) He should increase the average size of the teams.
B) He should pay the workers fixed wages.
C) He should increase the workers' share in company profits.
D) He should centralize the firm's decision making process.
E) He should use aggregate performance measures to evaluate the workers.

Question 30

A large health insurance plan pays for 90% of the cost of emergency room and other hospital visits but only 20% of the cost of an individual's purchases of prescription drugs. How might this affect the individual's health-care decisions? Why might the result lead to high health-care spending?

Question 31

Which of the following is a problem in evaluating a team's performance?

A) Some of the members may free ride on the work done by the others.
B) It is more difficult to measure team output than individual output.
C) Team decision making is inevitably marked by interpersonal conflicts.
D) Work is more efficient when it is done by individuals than when it is done by a team.
E) It is difficult to set realistic goals to gauge a team's performance.

Question 32

What is meant by self-selection in the insurance market?

Question 33

The Federal Reserve System has suggested that some very large banks in the US are "too big to fail." If the Fed adopts such a policy stance, what problem will it probably face as it seeks to cope with troubled banks?

Question 34

Describe how reputation and warranties alleviate the problem of adverse selection.

Question 35

A large firm's automotive division receives parts from the firm's parts division at a price of $450 each. Each part is produced at a marginal cost of $400 and the final product is sold for $5,000 each. Which of the following statements is true?

A) The firm is maximizing profits at the current price of the parts and the final product.
B) The parts unit should sell the parts to the automotive division at a price of zero.
C) The firm should outsource the production of the parts to another firm to maximize profit.
D) Since the final product is sold at a price of $5,000, the parts unit can increase the price of the parts sold to the automotive division.
E) The automotive division should pay $400 for each part to maximize profits.

Question 36

Which of the following is not a major impediment to shareholder control of large corporations?

A) The top management of the firm usually controls the voting and proxy process.
B) Shareholders seeking to change management recover their costs only if they are successful.
C) No one shareholder owns a substantial percentage of the corporation's stock.
D) Most shareholders in large firms engage in rational apathy.
E) Shareholders of large corporations are protected by limited liability.

Question 37

Give an example of the "lemons" market and how the problem of information asymmetry can be overcome in the market.

Question 38

You have decided to purchase a new car and are making arrangements for payment. The salesperson suggests that you consider purchasing an extended warranty. In fact, it seems that the salesperson is even more eager to sell the extended warranty than to sell the new car. What economic issues should you consider before you buy the warranty? Explain.

Question 39

What are the problems that a manager may face while evaluating the performance of employees who work together as a team?

Question 40

Which factors typically lead a firm to produce an item in-house? What causes a firm to outsource production?

Question 41

What are the major mechanisms to address the principal-agent problems of large, publicly held corporations? How are they intended to correct the problems? How effective are they?

Question 42

The German electronics company Siemens has a two-tier system of corporate governance: a management board and a separate supervisory board. For major company decisions, management must build a consensus with the supervisory board. What are the advantages and disadvantages of this corporate structure?