1. Structure of Organizations for Production of Public and Private Goods
Shyam Sunder
Faculty Research Seminar
Yale School of Management
April 18, 2018
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Production of Public and Private Goods

2. Compare Public and Private Good Producing Organizations
Private good organizations produce and sell goods and services for a price to customers
Customers can impose discipline on them by denying revenue
Shareholders control manager-employees by offering them residual-based compensation
Public-good organizations serve their beneficiaries, not paying customers
Weaker or no customer discipline
It makes the task of establishing managerial control to promote efficient production of public goods a more difficult challenge
Bureaucracy as a solution
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3. Production of Public and Private Goods
Overview
Barnard, Simon: Organization as a set of contracts
Accounting and control as a contract implemetation mechanism
Examine organizations by economic nature of their output, not legal form
Compare resource flows, management structure, decisions, and accounting and control in public and private good-producing organizations
Unit of analysis: decision makers, not organization as a whole
Examples and implications
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4. Accounting Teaching by Subject
Subject Area
Auditing
Financial
Managerial/Cost
MAS/Systems
Taxation
Government
Research
All current Teaching
(In percent) 11 44 21 5 10 1 3
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5. Production of Public and Private Goods
Calls for Reforms
Arthur Andersen: Sound Financial Reporting in Public Sector: A Prerequisite to Fiscal Responsibility
Coopers & Lybrand: Financial Reporting Practices of American Cities: A Public Report
Touche Ross: Public Financial Reporting by Local Governments
Robert N. Anthony: Tell It Like It is
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6. Production of Public and Private Goods
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7. Cries in the Wilderness
Bolton: Don’t Put Government Financial Accounting in a Strait Jacket
Drebin: Is Accounting that is Good for General Motors Good for Detroit?
Mautz: Should Government Emulate Business?
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8. Legitimate Reasons for Different Accounting and Management Structure
Imposing business practices can cause considerable harm
Bureaucracy is an efficient solution to a difficult problem
Efficient production of public goods is more difficult
Example: Besselman, Arora and Larkey Study of Defense Department’s procurement policies
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9. Lack of Theory of Organizations to Produce Public Goods
Management curricula rooted in private good economics
Under-development of economic theory of public good organizations
Economics and management courses mostly emphasize private goods
Contract theory of organizations can help
An example of a lack of theory driving out teaching and even practice
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10. A Framework for Contract Theory of Organizations
Chester Barnard, President, Bell Telephone Company of New Jersey: Functions of the Executive 1936
Herbert A. Simon, Administrative Behavior (1946) and “A Comparison of Organisation Theories,” (RES )
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11. Production of Public and Private Goods
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12. Production of Public and Private Goods
Necessary Conditions
1) Individual Condition: Each participants expects to receive at least the opportunity cost of contributions he/she makes to the organization
2) Aggregate Condition: Contributions of all participants can produce enough output to meet the expectations of all
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13. Functions of Accounting for Participants
Measures resource contributions
Determines inducements
Compares contributions to inducements
(Two other functions relate to potential participants)
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14. Special Problems in Control of Managers
At the procedural hub of the contracts
Control resources and information
Monitor and negotiate with others
Difficult to measure their contributions/inputs
Can appropriate resources and information
Misappropriation difficult to detect
Devising a scheme to induce managers to contribute what is expected of them
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15. What are public and private goods?
Pure public goods satisfy two conditions:
Non-rivalrous consumption: zero marginal cost of serving an additional user
Non-excludability: those who do not pay still benefit.
Examples: National defense for citizens of U.S.; city streets and lighting, public safety
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16. Pure private goods do not satisfy either condition
Examples: a cup of coffee, car, suit
Most goods and services lie in between the two extremes of pure public and pure private goods
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17. Comparing Private and Public Good Organizations
Resource flows
Residual Claims
Product Market Discipline
Decision Making
Product
Investment
Accounting and Control
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18. Production of Public and Private Goods
1. Resource Flows
Unreciprocated outflow to beneficiaries
No quid pro quo
Need unreciprocated inflow (taxes, gifts)
Capital versus revenue account cash flows
In Public good organizations, capital flows are “revenue” contributions
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19. Production of Public and Private Goods
Public Good Organizations
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20. Production of Public and Private Goods
Private Good Organizations
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21. Production of Public and Private Goods
2. Residual Claimants
An economizing device in private good organizations
Reduces the number of contracting relationships
Residual claimant given control (because susceptible to others' non-performance)
Other agents can protect their interests more directly
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22. Stock Market Consequences of Residual Claims
Trading in residual claims (stock market)
Creates private incentives to gather and produce information
A large information industry exists
Capitalizability of residual claims induces shareholder interest in longer-term resource flows
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23. In Contrast: Public-Goods Organizations
No tradeable residual claims (its NPV is negative)
Weaker incentives to search for information
Weaker concern for the longer run (e.g., Social Security debates)
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24. Defining Managers’ Contracts
Private Good Organizations make it self-enforcing: by linking managerial compensation to the residual (subject to controls and audit)
No product market discipline  No link between managerial compensation and the residual
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25. 3. Product Market Discipline
Customers of private good organizations negotiate terms
In most cases, they directly observe the quality and quantity of what they get
No transaction if not satisfied
Customer can easily withhold revenue with little effort
Residual-based contract for managers is possible in this case
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26. Public Good Organizations Have Beneficiaries, Not Customers
They cannot withhold resources directly (not so easily)
Much higher cost of imposing discipline on managers
May not know of the quality/quantity of benefits until too late
Have only costly recourse when offered substandard benefits (complain, vote)
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27. Private Good Contract in Public Good Organization
Dysfunctional
Would be simple for managers to increase the residual by cutting the quality or quantity of public services (this would make the organization redundant)
Efficient structure for production of private goods is not efficient for public goods
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28. 4. Redistribution of Decision Rights
This Problem in public good organizations is addressed by redistribution of decision making responsibilities
Managerial contract is delinked from the residual
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29. 4.1 Product Decision Rights
Managers have information, expertise, and decision rights in private good organizations
In public good orgs., the governing body specifies what is produced, quantity, quality, and who gets them, because it pays for them
Positive residual generation is irrelevant because the net residual is negative
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30. Product Decision Rights in Public-Good Organizations
The informational advantage of managers in private goods is left unused in public goods (Hayek dec.)
Managers not offered incentives to look for newer types of public goods
They may still do so to seek promotion and power, retain their jobs (RedCross)
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31. 4.2 Investment/Production Decision Rights
Managers choose residual maximizing quantity, quality of private goods using their information
Delegation of quantity decisions possible through linkage between residual and remuneration
Investment decisions are derived decisions from the quantity decisions; delegated to managers with oversight rights
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32. Investment/Production Decision Rights in Public-Goods Orgs.
In public goods, governing bodies make quantity and quality decisions
Governing bodies have to provide funds for investment (no internal generation of funds)
And therefore, they must also make the capital investment decisions
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33. 5. Accounting and Controls
Differences between internal control and financial reporting
Often misinterpreted as prima facie evidence of poorly designed or poorly managed public-good organizations
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34. Accounting and Control Differences
Entities and Funds
Consolidation
Fixed assets/depreciation
Revenue (cash versus accrual)
Budgets
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35. Production of Public and Private Goods
5.1. Entities and Funds
External 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 from governing body
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36. 5.2 Detail in Public Good Financial Reports (No Consolidation)
Even small public good organizations have lengthy financial reports
Why do they not aggregate?
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37. Reports Reflect the Decision Structure
Governing boards make product/investment decisions
Reports of public-good organization comparable to middle management reports
Each fund serves a different constituency
If funds cannot be commingled, consolidated reports do not serve the needs of various constituents
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38. 5.3 Fixed Assets and Depreciation
Private‑goods: Record long‑term assets at acquisition cost
Expense as cost of production over life
Use of standard formulas (e.g., linear depn.)
Statistical inaccuracy vs. objectivity
Valuation of individual assets and the residual rights for transactions
Useful for security traders
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39. Public-Good Organizations
Residual rights not traded
Sale of fixed assets infrequent
Uniqueness of many assets (Mount Rushmore; Lincoln Memorial)
Dominant market position
Nonmonetary disclosure of assets
Not sure if some assets are liabilities
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40. Depreciation in Private Good Organizations
Three functions:
Estimating the residual surplus
Information value of residual surplus for valuation and trading
Important statistic for all (viability of firm, contract renegotiation)
Charging depreciation to the cost of production for pricing decisions
Induce goal congruence in managers
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41. In Public Good Organizations
none of the above three reasons is applicable
Residual has negative value, not traded
Public goods are not sold; no pricing
Production/investment decisions made by the governing bodies
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42. 5.4 Accruals and Revenue/Expense Recognition
In Private good organizations, realization principle reflects the customer quid pro quo
No quid pro quo for transactions in public-good organizations
In absence of quid pro quo, applying accrual principle would be chasing the form, not the substance of transactions
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43. 5.5 Budgets, Appropriations and Encumbrances
Governing bodies of public-good organizations appropriate funds for specific items
The budget is an authorization to spend
Public good organizations permit little managerial discretion on spending
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44. Which one is the Independent Variable?
Legal charter
Internal Revenue Service Rules on tax status
Economic characteristics of organization’s output
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45. Considered Polar Cases Only
Pure public and pure private goods are two polar cases
Most goods, and organizations that produce them lie in between (partially rivalrous, excludable, common pool, and club goods) not considered here
Rich spectrum of opportunities for study of organizations, economics and accounting controls
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46. Characteristics of Bureaucracy (Weber)
Pre-specified duties
Fixed hierarchy
Fixed wages
Impersonal rules
Tenure in job
Promotion from inside by technical criteria (e.g., degree x from recognized college)
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47. Bureaucracy As An Epithet
Bureaucracy is the oldest form of management
Does not receive a fair shake in press
Perhaps overused in welfare state
But it is necessary for many functions
Lack of understanding leads to misguided attempts at reform that often backfire
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48. Production of Public and Private Goods
Unequal Race
Efficient production of public goods is more difficult than private goods (lack of customer discipline on managers)
Always room for improvement in current practices
An integrated economic theory of management and structure for production of private vs. public goods may help direct more attention to teaching and research in this significant segment of national economy and help fulfill our motto of serving business and society
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49. Production of Public and Private Goods
Thank You
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