Milton Harris

Organization Design

This paper attempts to explain organization structure based on optimal coordination of interactions among activities. The main idea is that each manager is capable of detecting and coordinating interactions only within his limited area of expertise. Only the CEO can coordinate company wide interactions. The optimal design of the organization trades off the costs and benefits of various configurations of managers. Our results consist of classifying the characteristics of activities and managerial costs that lead to the matrix organization, the functional hierarchy, the divisional hierarchy, or a fiat hierarchy. We also investigate the effect of changing the costs of various managers on the nature of the optimal organization, including the extent of centralization.

A Theory of Wage Dynamics

A dynamic, equilibrium model of long term (implicit) labour contracts under incomplete but symmetric information is developed. Workers are assumed to be risk averse and of unknown ability or productivity. Risk neutral firms learn, as do workers, about each workers productivity by observing the workers output over time. It is shown that equilibrium contracts provide for wages which never decline with age and increase only when the workers market value increases above his current wage. In addition to characterizing the equilibrium wage contract, we also derive some of its implications for the behaviour of aggregate wages across various groups of workers. These implications explain some findings in the recent empirical literature on age-earnings profiles. In particular our model can explain why earnings may be positively related to experience even after controlling for productivity, as some empirical studies have indicated.

Corporate control contests and capital structure

Abstract This paper explores the determinants of corporate takeover methods (proxy fights versus tender offers) and their outcomes and price effects. We focus on the effect of leverage on the takeover method and outcome. The model predicts, for example, that the targets stock price appreciates less following a successful proxy contest than in a successful tender offer. In addition, we obtain several other results on price effects and on the capital structure changes that accompany contests for corporate control. Some of our results are compared with the existing empirical evidence.

Corporate governance: Voting rights and majority rules

Abstract In this paper, we derive conditions under which the simple majority voting rule for electing controlling management and one share-one vote constitute a socially optimal corporate governance rule. We also show that other majority rules and/or multiple classes of shares are not socially optimal. Finally we show that an entrepreneur would choose to issue two securities, one with only cash flow claims and no votes and one with only votes and no cash flow claims, if this were allowed. This scheme, regardless of the majority rule adopted, is not socially optimal.

Resource Allocation under Asymmetric Information

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The design of securities

Abstract This paper investigates the determinants of security design. We consider the assignment of both cash flows and voting rights, focusing on corporate control. We postulate that a conflict of interest exists between contestants for control and outside investors. The conflict arises because private benefits of control give contestants an incentive to acquire control even when this reduces firm value. Security design is a tool for resolving these conflicts and maximizing firm value. Our main result is that a single voting security is optimal.

On the Duration of Agreements

A model of optimal contracts between two infinitely-lived parties, a borrower and lender, is presented and analyzed. The objective is to explain the phenomenon of finite-length, multi-period contracts. It is shown how costly information acquisition can account for multi- period contracts which are of bounded length. Comparative-statics results on how contract length responds to exogenous parameters, such as the cost of information acquisition, are also derived. Copyright 1987 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Capital budgeting and delegation1

As part of our ongoing research into capital budgeting processes as responses to decentralized information and incentive problems, we focus in this paper on when a level of a managerial hierarchy will delegate the allocation of capital across projects and time to the level below it. In our model, delegation is a way to save on costly investigation of proposed projects. Therefore, it is more extensive the larger are the costs of such investigations. This delegation takes advantage of the fact that the lower-level managers preferences are assumed to be similar (though not identical) to those of the higher level.

Allocation Mechanisms, Asymmetric Information and the ‘Revelation Principle’

The purpose of this chapter is to explain a new approach for predicting both the allocation of resources and the resource allocation mechanism in certain environments in which agents are asymmetrically informed prior to any trading.1 We illustrate this approach by applying it to a simple pure-exchange environment in which an information asymmetry is present.

Higher Capital Requirements, Safer Banks? Macroprudential Regulation in a Competitive Financial System

In this paper we propose a general equilibrium framework to analyze the effectiveness of bank capital regulations when the banking sector faces competition from unregulated investors. In our model an implicit bail-out guarantee for banks may generate excessive incentives to invest in high risk, negative NPV projects. When competition from unregulated investors is low, the banking sector has a natural incentive to first fund positive NPV projects and to only engage in risk-shifting when the banking sector’s funding capacity exceeds the supply of positive NPV projects. This “natural pecking order” of bank investment allows regulation in the form of simple equity-capital ratio requirements to be effective. However, when banks face sufficiently strong competition from unregulated investors, they weakly prefer to focus on the funding of high-risk issuers, since government-insured banks have a natural comparative advantage in that market. This “reverse pecking order” of bank investment renders simple capital regulation to be ineffective and may even cause equity injections to be locally counterproductive. However, we show that contingency of capital regulation on credit ratings can restore the natural pecking order of bank investment and thereby increase the efficiency of capital requirements. ∗Previous versions of this paper circulated under the titles ”Optimal Rating-Contingent Regulation” and ”Regulating Banks’ Risk Taking with External Risk Assessments.” We are grateful to Sam Lee for a thoughtful discussion of an earlier draft of this paper. In addition, we thank seminar participants at the Federal Reserve Bank of New York and at the Federal Reserve Board of Governors. †University of Chicago, Booth School of Business, e-mail: milt@chicagobooth.edu. Professor Harris thanks the Center for Research in Security Prices at the University of Chicago Booth School of Business for financial support. ‡University of Pennsylvania, The Wharton School, email: opp@wharton.upenn.edu. Research support from the Rodney White Center for Financial Research and the Wharton School Dean’s Research Fund is gratefully acknowledged. §University of California, Berkeley (Haas), email: mopp@haas.berkeley.edu.