What happens to spending when the decider does not pay?

Taken from http://www.realclearhealth.com/articles/2017/03/27/the_root_cause_of_health_care_dysfunction_110514.html.

Let's predict

What would happen to GPAs if college funding increases when graduation and retention rates increase?

What would happen to the mix of majors offered if college funding increases when job placements and salaries of graduates increase?

What would happen to GAPs if college funding increases when job placements and salaries of graduates increase?

What would happen to the mix of majors offered if college funding increases when job placements and salaries of graduates increase?

States Challenge Public Universities to Prove They Are Worth Their Funding
by: Melissa Korn
Mar 13, 2017
Click here to view the full article on WSJ.com

TOPICS: Education, Public Funding

SUMMARY: States such as Kentucky, Wisconsin and Arkansas have adopted, or are considering, funding models for higher education that allocate money based on outcomes like student graduation and retention rates.

CLASSROOM APPLICATION: Students can discuss and evaluate whether states should tie their funding of public institutions to the institutions' educational outcomes.

QUESTIONS: 
1. (Introductory) Why are states shifting toward basing higher education funding on educational outcomes?

2. (Advanced) Just as salespeople are compensated by commission based on sales, should public university receive state funding based on educational outcomes such as job placements and salaries of their graduates?

3. (Advanced) If colleges and universities are funded according to educational outcomes, how could these institutions game the funding system? What type of funding system could encourage colleges and universities to push for appropriate educational outcomes without gaming the system?

Reviewed By: James Dearden, Lehigh University

How incentives work in socialist countries

How NOT to motivate physicians: lessons from Cuba

Cuba penalizes physicians for "not meeting quotas" on infant mortality.  How do they respond?

• When pregnancies are deemed risky, doctors have to coerce women to undergo abortion in spite of their wishes. 
•  On top of this, forced sterilization in some cases are an actually documented policy tool. These restrictions do reduce mortality, but they feel like a heavy price for the people. 
•  ...doctors ... lie about the statistics. One thing that is done by the regime is to categorize “infant deaths” as “late fetal deaths” – its basically extending the definition in order to conceal a poorer performance.

What happens when you adjust the infant mortality statistics?

• ...Cuba moves from having an average infant mortality rate ... to having the worst average infant mortality in that dataset – above that of most European and North American countries.

Incentives matter

http://www.bbc.com/news/blogs-news-from-elsewhere-38208914 reports that visits to nursing homes in China increase when the home pays people to visit.

Startups and organizational design

This article describes the need for a change in organizational design that startups face when they grow. Here is a money quote:

"the company needs more structure for communications and decision-making".

The article talks about the need for good information flows and clear decision rights.

Disparate examples of game theory and the rational actor paradigm in action

Business World. Donald Trump and Vladimir Putin's Troublemakers
by: Holman W. Jenkins, Jr.
Nov 05, 2016
Click here to view the full article on WSJ.com

TOPICS: Economic Incentives

SUMMARY: The Kremlin has a stake in promoting email leaks that suggest America is as kleptocratic as Russia. This week's Business World column is about two incentive problems. First, "Dictators can be-but aren't necessarily-trapped into ever-increasing repression by fear of retribution over the means they used to gain power." Second, "The U.S. Army loads more checklist requirements on junior officers and their units than they can possibly comply with, leaving junior officers little choice but to become practiced at deciding which requirements to meet and which to lie about."

CLASSROOM APPLICATION: Students can evaluate the effect of pressures (i.e., incentives) that lead to unethical behavior, such as ever-increasing repression by dictators and lying and cheating by employees.

QUESTIONS: 
1. (Advanced) The column notes "tit-for-tat strategies." Describe these strategies. In games such as the prisoner's dilemma, how can the use of tit-for-tat strategies promote behavior that increases the payoffs of the players involved in the game?

2. (Introductory) What causes dictators to ever-increasingly repress their citizens?

3. (Advanced) Why does setting impossible standards for employees to meet result in unethical actions like lying and cheating by employees?

Reviewed By: James Dearden, Lehigh University

Contract thery uses the Rational Actor Paradigm to determine optimal contracts when information is costly and asymmetric

Nobel Prize in Economics Awarded to Oliver Hart and Bengt Holmström for Work on Contract Theory
by: Charles Duxbury and Mike Bird
Oct 11, 2016
Click here to view the full article on WSJ.com
Click here to view the video on WSJ.com 

TOPICS: Contracts

SUMMARY: The 2016 Nobel Prize in Economic Sciences was awarded jointly to Oliver Hart of Harvard and Bengt Holmström of MIT for their contributions to contract theory.

CLASSROOM APPLICATION: The article informs students about this year's Nobel Prize recipients and offers brief statements about the theory of contracts. Instructors can use the article to inspire students to investigate the economics issues involved in contracts.

QUESTIONS: 
1. (Advanced) Why are contracts and a well-functioning legal system to enforce them important to the functioning of an economy? Research question. Distinguish a "complete contract" from an "incomplete contract."

2. (Advanced) What are the incentive issues in the design of contracts for executive compensation?

3. (Introductory) What is an example of a pitfall in the design of a contract for example between a buyer and supplier?

4. (Advanced) What is the incentive problem created by a government bailing out a failed bank?

Reviewed By: James Dearden, Lehigh University

Who benefits when Delta Lloyd’s executive board rejects a takeover bid

http://www.wsj.com/articles/delta-lloyd-rejects-nn-groups-takeover-bid-1475820920

Questions:

1. Did Delta Lloyd reject the bid or did the executive board of Delta Lloyd reject the bid?
2. Prior to the bid, did the buyers and sellers in the stock market believe that Delta Lloyd's "capital position [and] opportunity to improve further capital generation and dividends” warranted a 30% increase in the market value of Delta Lloyd?
3. Whose opinion of the value of a company is more accurate, the buyers and sellers in the stock market or the executive board? 
4. Did the offer help or hurt shareholders relative to their position before the bid?
5. Could the shareholders benefit from the executive board's decision to reject the bid? If so, how?
6. Could the members of the executive board benefit from the decision to reject? If so, how?

Maybe this is why the rational actor paradigm sometimes fails

http://www.independent.co.uk/news/world/australasia/psychopaths-ceos-study-statistics-one-in-five-psychopathic-traits-a7251251.html?platform=hootsuite

Limitations of the Rational Actor Paradigm?

https://www.washingtonpost.com/news/wonk/wp/2016/03/15/why-we-should-give-up-trying-to-make-people-less-sexist/ dicusses how biases exist and how the difficulty in removing them. It talks about problems and solutions when making employment decisions and during negotiations.

Why Organizations Fail

Taken from https://dl.dropboxusercontent.com/u/2021568/GRPublishedJELFinal.pdf

Why do organizations fail?

“Organizations fail due to incentive problems (agents do not want to act in the organization’s interests) and bounded rationality problems (agents do not have the necessary information to do so)” (https://dl.dropboxusercontent.com/u/2021568/GRPublishedJELFinal.pdf, p. 137).

“Agents fail to act together because they do not want to (an incentive problem) or they do not know how to (a bounded-rationality problem). Incentive problems arise due to the presence of asymmetric information or imperfect commitment, which lead agents to act according to their own biases or preferences rather than in the interest of the organization (e.g., Holmstrom 1979; Shavell 1979). Bounded-rationality problems arise due to agents’ cognitive limitations and finite time, which means that even if they want to, agents cannot compute the solution to every problem, nor can they make themselves precisely understood by others (e.g., Simon 1955; Marshack and Radner 1972; Arrow 1974)” (https://dl.dropboxusercontent.com/u/2021568/GRPublishedJELFinal.pdf, p. 138-9) .

What creates incentive problems?

https://dl.dropboxusercontent.com/u/2021568/GRPublishedJELFinal.pdf identifies 4 reasons that employees (agents) and owners have different interests.

1. Short-Termism (p.141)
2. Decentralized Authority and Coordination Failures (p. 147).
3. Communication failures (p.155)
4. Inability to Adapt to Change Due to Organizational Rigidities (p. 163)

What problems occur in the absence of incentive conflicts?

https://dl.dropboxusercontent.com/u/2021568/GRPublishedJELFinal.pdf identifies 2 failures in the absence of incentive conflicts.

1. Hierarchy and the Allocation of Talent (p. 175)
   “organizational failures arise when those giving directions lack the required talent” (p. 176)
2. Coarse Communication and Code Incompatibility (p. 179)

What conclusions do the authors draw?

https://dl.dropboxusercontent.com/u/2021568/GRPublishedJELFinal.pdf draw 6 conclusions.

1. “One general thread throughout our survey concerns the danger of high-powered incentives attached to objectively measured outcomes. … high-powered incentives drive individuals to seek high-probability payoffs in the short term at the expense of exposing the organization to low-probability, catastrophic failures (section 2) and also drive individual effort away from cooperation among team members (section 3)” (p. 183).
2. “The general response suggested by the literature to multitasking failures has three components” )p. 183).
1. “rely on low-powered incentives and on incentives linked to inputs, rather than outputs (Prendergast 2002)” (0. 183).
2. “ the firm is a “subeconomy” and can use a broad set of tools—including decision rights, task assignments, relational contracts, culture, and hierarchies—to solve the motivation and coordination problems it faces” (p. 183).
3. “ to avoid multitask issues, organizations can rely variously on: selecting the “right” type of agents, such as agents who are intrinsically motivated by the aims of the organization (Prendergast 2007, 2008); developing an identity (Akerlof and Kranton 2005; and Bénabou and Tirole 2011); and creating a sense of mission (Dewatripont, Jewitt, and Tirole 1999)” (p. 183).
3. “Another critical source of failures is miscommunication (section 4) …  Truthful communication requires aligned incentives within the organization, for which not only monetary incentives, but also intrinsic motivation in the form of identity or mission, is desirable” (p. 183).
4. “Our survey also suggests that managers must be mindful of the long-term consequences of their decisions (section 5). …  our analysis illustrates how short-term efficiency gains must be weighted against the constraints they place on future cooperation and change” (pp. 183-4).
5. “Finally, organizations must resolve coordination failures in the presence of bounded rationality (section 6)” (p. 184).
6. “A broad message of organizational economics is that organizations exist when there are contractual imperfections and other limitations on collective action that make markets even less effective than organizations. Our models highlight a variety of such imperfections and show how they are responsible for the (mostly inevitable) trade-offs we identify inside organizations” (p. 184).

Luck v. skill

http://www.wsj.com/articles/SB10001424052970204556804574261942466979118

What determines the drugs your doctor prescribes for you?

Even Cheap Meals Influence Doctors' Drug Prescriptions, Study Suggests
by: Peter Loftus
Jun 21, 2016
Click here to view the full article on WSJ.com

TOPICS: Moral Hazard, Statistics

SUMMARY: Doctors who received a single free meal from a drug company were more likely to prescribe the drug the company was promoting than doctors who received no such meals, according to a study.

CLASSROOM APPLICATION: Students can critically evaluate the study examining the relationship between industry-sponsored meals and physician prescriptions. In particular, instructors can stress the difference between a correlations between meals and prescriptions and the causal effect of meals on prescriptions. Students can also discuss whether

QUESTIONS: 
1. (Introductory) The study reports, "Receipt of industry-sponsored meals was associated with an increased rate of prescribing the brand-name medication that was being promoted. The findings represent an association, not a cause-and-effect relationship." Does this statistical association between meals and prescription decisions imply that the meals influence doctors' drug prescriptions?

2. (Advanced) Is it possible that pharmaceutical reps promote (i.e., detail) drugs that are most effective? If so, could the detailing improve economic efficiency by its promotion of effective drugs?

3. (Advanced) What types of studies should be done to determine (1) whether pharmaceutical detailing has a causal effect on the prescriptions physicians write, and (2) whether detailing improves economic efficiency by providing information about pharmaceuticals?

Reviewed By: James Dearden, Lehigh University

The Rational Actor Paradigm at work

https://www.bloomberg.com/view/articles/2016-05-17/here-s-why-the-tsa-is-so-terrible

"Career-minded TSA officials have no incentive to admit their methods are inefficient, while the security staff serving eight-hour shifts have little reason to speed things up" (Qz.com).

Incentives in ObamaCare

http://time.com/4292290/how-obamacare-is-fueling-americas-opioid-epidemic/?xid=homepage

Bad luck or bad decisions?

https://bgr.com/2016/02/18/apple-product-failures-all-time-lisa-pippin-newton/

What do you get when you pay people to lie?

Exactly how does a dealer report inflated sales? 

1. To whom does the report go?
2. What are the consequences of false reports? true reports?
3. If the allegations are true, did Fiat Chrysler employees anticipate being able to keep the lies secret forever? If not, why did they encourage the dealers to lie? Note: a lie in this month's sales increases the probability the Fiat Chrysler will need another lie next month if the goal is to show continuous growth in sales.

U.S. Dealer Sues Fiat Chrysler Over Sales Reporting
by: Jeff Bennett and Eric Sylvers
Jan 15, 2016
Click here to view the full article on WSJ.com

TOPICS: Moral Hazard

SUMMARY: An Illinois dealer sued Fiat Chrysler, accusing the fastest-growing of the major auto makers of manipulating new-vehicle sales reporting in the U.S.

CLASSROOM APPLICATION: Instructors can use the article as a basis to examine the incentive of automobile manufacturers to inflate sales records and produce continually-growing sales. They can also present the incentives that manufacturers could provide to auto dealers to inflate their sales records.

QUESTIONS: 
1. (Introductory) Describe the rationale for an automobile manufacturer to provide incentives for their dealers to inflate new-vehicle sales.

2. (Introductory) Describe a method that an automobile manufacturer can use to hide payments to automobile dealers for inflating sales records.

3. (Advanced) Why would news of the Illinois dealership's suit of Fiat Chrysler negatively affect the price of the company's shares?

4. (Advanced) Define "moral hazard." Is the Fiat case described in the article an example of possible moral hazard with hidden information?

Reviewed By: James Dearden, Lehigh University

Transplant centers respond to incentives

http://managerialecon.blogspot.com/2015/12/repost-why-are-so-many-donated-kidneys.html

When did return on investment begin to measure success?

http://qz.com/569738/the-dupont-invention-that-forever-changed-how-things-work-in-the-corporate-world/

What determines whether or not a doctor prescribes a stent?

Inappropriate Stent Procedures Decline, Study Shows
by: Ron Winslow
Nov 10, 2015
Click here to view the full article on WSJ.com

TOPICS: Health Economics

SUMMARY: A new study suggests cardiologists have curbed overuse of a flagship procedure for treating heart disease that has been cited as a high-profile example of waste in the U.S. health care system.

CLASSROOM APPLICATION: The article offers two interesting economic issues associated with stent implant decisions. First, "upcoding" may explain the reason for the measured reduction, but not an actual reduction, in unnecessary stent implants. The incentive issue is whether doctors are implanting stents for financial gains, despite the possibility that the costs of doing so outweigh the benefits. "But concern arose about a decade ago that many cardiologists were implanting the devices in patients with stable disease and few if any symptoms." Second, "Several studies, including a large trial called Courage, challenged whether the benefits of stents in such patients outweighed the risks and questioned the economic cost to patients and the health system. By some estimates, one in six stent procedures was inappropriate, sparking criticism of cardiologists and prompting calls to rein in use of the devices."

QUESTIONS: 
1. (Introductory) Do physicians have an incentive to overuse certain medical procedures like stent implantation?

2. (Advanced) What is "upcoding"? What is the incentive of a doctor ordering a stent implant on a patient to upcode?

3. (Advanced) How would an economist measure whether upcoding is a response to a change in medical policy or reimbursements for procedures?

Reviewed By: James Dearden, Lehigh University