Role of Knowledge and Decision Making in Large Firms

July 10, 2012 by  Filed under: Management 

Large firms, with the presence in multiple lines of business, have complex processes to manage and maintain the limited resources (time, money and skills). For ease of control and to allow the cascading of decision making, large firms have multiple teams aligned with a line of business. Each team can then have their own inputs and outputs defined and managed. Team production is the key reason that firms exist. Team output then depends on the input resources, the productivity of the team resources and the right decision making capabilities and knowledge of the team leaders.

Human resources are the biggest asset of a firm. For a firm to be productive, the firm has to efficiently use the input resources and produce output goods and/or services at a competitive rate. The productivity of the individual resources forms a key component of the final output. The individual resource needs the right tools and skills to perform the job efficiently. To a firm the tools and the resources are costs. Forecasting and managing these costs is an important role of the firm’s management. Team production has advantages but it also has a variety of organizational problems. The free rider problem (the incentive to shirk in team production) and the principle-agent problem are quite common in a firm. Teams try to avoid the free-rider problem by using the team loyalty (pressure from other team members) and through monitoring. This monitoring again adds to the cost. In general agency problem arise because of information asymmetries. Difference among employees’ risk tolerance, working horizons and desired levels of job perks generate agency costs. These agency costs decline the firm value.

All resources or assets are part of decision rights with respect to how they can or cannot be used. Decision rights over the firm’s assets are assigned to various people within the firm who are then held accountable for the results. If decision management rights are delegated, decision control rights are usually retained, thereby decreasing the span of control. Individuals of firms have decision rights with respect to resources that they own, the right to use the resources, the right to sell the resources and the right to the sale proceeds. Since knowledge is costly to acquire, store and process, individual decision-making capacities are limited. Knowledge is needed for decision making. Knowledge may reside with an individual or in the process or in a combination of processes. To harness the right information at the right time for decision making is the most important aspect for the management. Special process and systems are established and maintained to obtain the required knowledge. All these again add to the bottom line cost. Ideally, knowledge and decision rights are linked but they may not always reside with the same individual. The other challenge is the need to transfer the knowledge across the organization or to the individual to make the right decision.

Major firms have multiple systems to manage the knowledge, cost, decision rights etc. The most common of the systems are: i) A system that manages and measures performance. ii) A system that manages and measures costs. iii) A system that manages and assigns decision rights. All these systems have to work in unison and have to be in sync to achieve the desired results and effectiveness. A few components of these systems are measurable and hence can be monitored more efficiently. E.g the cost of raw materials, hours of labor needed to produce a good etc. Financial measures are more objective and less subject to managerial discretion. Non financial indicators mostly relate to strategic factors. And provide information for decision making. The challenge to managers arises when there are multiple financial and non financial measures. Managers then have to specify the weights for respective measures to arrive at the right output. All these extra measure again add cost to the bottom line of a firm.

Large organizations have hierarchies with higher level managers supervising lower level employees. Decision management included the components of the decision process in which the manager initiates or implements a decision. Decision control includes the components of the decision process whereby managers either ratify or monitor decisions. Accounting systems play a decisive role in monitoring the costs and revenues and are extensively used in decision control. Accounting systems are designed to eliminate or reduce the agency costs, including theft and embezzlement. Senior management usually has a substantial control of the information generated by the accounting system. Internal accounting procedures, such as standard costs, budgeting and cost allocations help reduce agency problem. The cost of having and maintaining the accounting system should always be less than the benefits.

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