Chapter 4 Employees may not act in the best interest of the company because of the self-interest. In order to eliminate this problem, firms have to design an incentive and reward system that is based on objective judgments to make employees act in the best interest of the firm. When human and physical capital are highly complementary within a given application, a firm should give the authority to the managers whose decisions will have the greatest impact on the performance of that activity. When a physical capital will affect the whole company, then the firm should centralize the decision over this physical capital. This chapter also mentions the “make or buy” decision for the firm. Whether a firm should rely on market or internal organization for some inputs depends on the trade off between technical efficiency and agency efficiency. Another factor that a firm needs to consider when making the “make or buy” decision is that down stream firms could maximize profits by eliminating profit-share to upper stream firms. Tapered integration refers to a mixture of vertical integration and market exchange regarding to “make or buy” decision. In addition, firms can franchise to make advantage of franchisees’ superior knowledge of local market. Also, they can undertake strategic alliances or joint ventures, implicit contracts, and long-term market relationship instead of vertical integration.

Volkswagen’s appalling clean diesel scandal This scandal is that Volkswagen had been installing elaborate software that would control cars’ pollution when being tested. Yet, cars would produce hazardous emissions when not being tested. The economic damage is easy to get over while reputation damage is hard to get over. Winterkorn, the former CEO of VW wanted to help rebuild company’ reputation by his resignation. Even Winterkorn may not involve in decision-making process