What Are Hybrid Forms and How Can They Be Modeled?

8 October 2007 at 2:39 am 24 comments

| Nicolai Foss |

Many scholars have argued that hierarchies are increasingly infused by market mechanisms (e.g., here and here), and that elements of authority can increasingly be witnessed in market transactions. This has been referred to as the “swollen middle hypothesis.” A major step forward in the understanding of such hybrid governance is Williamson’s seminal 1991 paper in the ASQ, “Comparative Economic Organization: The Analysis of Discrete Structural Alternatives,” and Holmström and Milgrom’s equally important 1994 paper in the AER, “The Firm as an Incentive System.”

However, it is quite arguable that the theoretical understanding of hybrid governance is still deficient. For a long time, Anna Grandori has argued that the literature over-emphasizes the “discreteness” of hybrids; the space of possible combinations of governance mechanisms is much larger than Williamson (or Holmström and Milgrom) portrays it (e.g., here and here). There are neither strong theoretical, nor empirical reasons for ascribing the strong complementarities to governance mechanisms that Williamson does.

In a recent paper (that won the Glueck Best Paper Award for the BPS Division at this year’s Academy of Management meeting), “Both Market and Hierarchy: An Incentive-Systems Theory of Hybrid Governance Forms,” two O&M favorites, Rick Makadok and Russ Coff, develop a similar point. They point out that in extant thinking on hybrid forms, the dimensions or attributes of governance structures (in Holmstrom and Milgrom: authority, ownership, and incentives) move together simultaneously. Forms that are intermediate in this sense do exist — as witness joint ventures –, but most hybrid forms do not fall neatly in the middle in terms of the relevant dimensions. They are market-like on some dimensions and hierarchy-like on other dimensions. The problem is how to model this more complex picture of hybrids.

Russ and Rich begin from the Holmström and Milgrom (1994) model which they modify in one small, but crucially important way: They assume that there may be positive externalities between costly-to-measure tasks and less-costly-to measure tasks. For example, if an employee becomes more productive (which may not be costly to measure) by cooperating with others (which may be costly to measure), providing high powered rewards for the task that is not costly to measure may spur costly-to-measure cooperation. This possibility is ruled out by Holmström and Milgrom and it is this feature that makes them conclude that the firm must be characterized by authority, ownership on the part of the principal, and low-powered performance rewards.

Intuitively, the Makadok and Coff modification allows for the possibility of high-powered rewards in hierarchies, that is, a true hybrid form. This is generalized, so that their model can explain the combinations of authority (strong-weak), ownership (principal owns asset – agent owns asset), and rewards (weak-strong) that are ruled out by the Holmström and Milgrom model (and Williamson’s approach as well).

The paper is highly recommended. Mail Rich (Rich_Makadok@bus.emory.edu) or Russ (Russ_Coff@bus.emory.edu) for a copy!

Entry filed under: - Foss -, Recommended Reading, Strategic Management, Theory of the Firm. Tags: .

Terence Hutchison (1912-2007) Foss & Klein Chapter on “Organizational Governance”

24 Comments Add your own

  • 1. Joe Mahoney  |  8 October 2007 at 8:28 am

    Over time,the Makadok and Coff paper (which may still be under review at a journal) looks promising to take its place alongside Lippman and Rumelt (1982) as the most influential modelling paper(s) in the Strategy field.

  • 2. Rich Makadok  |  8 October 2007 at 10:10 am

    Joe, as always, you are way too kind…
    But nevertheless, the check is in the mail. ;-)

    Cheers,
    Rich

  • 3. Nicolai Foss  |  8 October 2007 at 10:21 am

    Joe (and Rich),

    I agree that this is an important paper. And it is indeed like the Lippman and Rumelt paper in that it takes an established model and introduces a “small” change (not that the modelling effort is necessarily easy or banal!), and derives new and non-trivial implications.

    I think there is a potential methodological lesson in this: Detractors of economics often criticize the econ journals for publishing papers with “just” a small modification of some previous model. I think papers such as Lippman & Rumelt or Makadok & Coff show much “leverage” we can often get out of those small modifications.

    Mine 25 øre.

  • 4. Peter Klein  |  8 October 2007 at 10:39 am

    I too think it’s a terrific paper. But we are not usually so “gushy” here at O&M, so let me suggest a potential weakness and ask for Rich and Russ’s reaction.

    To what extent does the model, like the Holmström and Milgrom model on which it’s based, depend on assumptions about contractual completeness? Specifically, in an incomplete-contracting framework, ownership is inextricably linked with at least one form of authority (residual rights of control). If we introduce the Grossman-Hart-Moore notion of ownership (or, if we want to get down and dirty, the Barzel-Foss notion), are ownership and authority still fully separable — i.e., are all eight combinations of the ownership, authority, and rewards pairs equally feasible?

    Having raised this point, will I still get my check?

  • 5. Russ Coff  |  8 October 2007 at 11:45 am

    Hi Peter. We’ll just send a smaller check ;-)

    I would agree with your point in general. That is, the right to authority may flow with ownership. However, owners routinely choose to delegate authority. Often this is done in an effort to get individuals (or org units) to behave in a more entrepreneurial or “market-like” fashion. This is why this is such a critical dimension on which to define hybrids.

    I believe Nicolai’s work raises the question of whether owners can delegate authority credibly over time. I agree with him on this count. In our classes, we often talk about radical governance forms in which substantial autonomy is granted and tremendous innovation results. However, in most cases, success is fleeting. They seem to depend on an individual’s charismatic leadership to assure managers that the autonomy won’t be yanked away (something that is exogenous to our model).

    However, that refers to the more “exciting” radical forms. In smaller doses, authority may be credibly delegated and it can be stable over a longer period of time.

    This gets us to your last issue. I absolutely believe that there are discrete governance forms (though that is not reflected formally in our model). We believe that there are some regions of “governance space” that are not viable and some combinations that are more stable than others. I don’t think we know fully where those stable points are because new hybrids emerge every day. This is an empirical question that we hope will be explored further.

    This is a cool discussion and thanks for your comments!

  • 6. Rich Makadok  |  8 October 2007 at 12:01 pm

    Hi, Peter.

    Thanks very much for your kind words about the paper. Unfortunately, there is only one check. (This is how I teach my students the true meaning of “first-mover advantage” in a classroom exercise.)

    Regarding your inquiry about the meaning of ownership, I will simply defer to Holmstrom & Milgrom’s (1994) answer to this question. Since we did not change their definition of ownership, their answer should presumably apply to our model as well. In the paragraph overlapping pages 975-976, they argue that their notion of ownership is sort of a “reduced form” of the results from the Grossman/Hart/Moore model. If you see a problem with this answer provided by Holmstrom & Milgrom, then we would likely inherit that problem from them.

    However, in general, I think that arguments in the literature that attempt to inextricably link the ownership and authority dimensions often wind up implicitly making the same underlying assumptions about the lack of cross-task synergies that Holmstrom & Milgrom make explicitly.

    For example, our apologies to Nicolai for being unaware of his Org Sci paper about the spaghetti organization when we wrote this manuscript — an omission we will undoubtedly correct on the next revision cycle. In that paper, Nicolai makes the argument that ownership and authority are inextricably linked because the owner cannot credibly commit to not exercise authority in the future. But to me, this argument begs the question of WHY the owner might want to exercise authority in the future. IF the agent’s personal goals are not synergistic with, or are counter-synergistic with, his official job duties, then it is perfectly understandable why — and perfectly reasonable to assume that — the principal might want to exercise authority later, because in that case, there is a serious danger that the agent might take advantage of his autonomy. BUT ON THE OTHER HAND, if the agent’s personal goals ARE synergistic with his official job duties, then there is no reason to believe that the agent would ever take advantage of his autonomy, because the pursuit of his personal goals goes hand-in-hand with the fulfillment of his official job duties. In that case, the principal really should never have any serious motivation to exercise authority later — i.e., granting autonomy should truly be in the principal’s best interests. So, it strikes me that Nicolai’s argument implicitly makes the same underlying assumption about the absence of cross-task synergies that Holmstrom & Milgrom do, but Nicolai makes this assumption implicitly (perhaps even being unaware of doing so), while H&M’s adherence to formal modeling techniques force them to make this assumption explicitly.

    In other words, once we explicitly admit the possibility of cross-task synergies, I suspect that arguments that attempt to inextricably tie ownership to authority might simply evaporate. What do you think?

    Thanks again,
    Rich

  • 7. Rich Makadok  |  8 October 2007 at 12:05 pm

    Well, after posting a reply simultaneously with my co-author, I now see that we seem to disagree on this point. I guess I’ll have to put a “stop-payment” on his check.
    — Rich

  • 8. twofish  |  9 October 2007 at 12:05 am

    Rich: I believe Nicolai’s work raises the question of whether owners can delegate authority credibly over time.

    One way that an owner can credibly delegate authority is it the authority is delegated on the basis of some technical skill. For example, I have authority delegated to me as a C++ programmer, and the basis of that authority is that I know how to program in C++ and the CEO doesn’t.

    “Owning a technical skill” is one way that power gets distributed. This can be also been seen within the interaction of a the “owners” of a large public corporation and the management. The management has much more authority than the shareholders because the manager has skills and knowledge that the shareholders do not.

    Also owners can credibly not exercise authority through rules and conventions or because of the owner does not possess a necessary social network. This can be seen in the role of the Queen of England and also in the role of the Communist Party of China with respect to state owned enterprises.

  • 9. twofish  |  9 October 2007 at 12:11 am

    The other point is that I think that it is not the case that market mechanisms are a new thing in hierarchical organization. They have always been there, but the trouble is that they usually not obvious to outsiders or even insiders because they form the “informal economy” of a corporation whose existence is officially denied. The tension between how things are supposed to work and how things actually do work is the topic of a lot of humor “Dilbert” and “the Office.”

    Reading about the Soviet-era economy is amusing because a lot of the stories seem like things that happen on a day to day basis in your large Fortune 500 company.

  • 10. Nicolai Foss  |  9 October 2007 at 3:14 am

    Folks! Thanks for the nice words about my humble Org Science piece. For those who are sufficiently interested in the issue of ownership, authority, managerial opportunism, etc. I have a large-N follow-up study: Foss, Kirsten, Nicolai J. Foss, and Xosé H. Vazquez. 2006. ”Tying the Manager’s Hand: Constraining Opportunistic Managerial Intervention,” Cambridge Journal of Economics, 30: 797-818. We initially submitted the paper to AMJ, but were rejected, and the paper ended up in a journal with which it makes a somewhat problematic fit.

  • 11. Rich Makadok  |  9 October 2007 at 6:19 am

    But Nicolai, am I correct?

    Does the problem of credible delegation go away when the agent’s personal goals are synergistic with his official job duties, thereby eliminating the principal’s motivation to intervene later (because the agent will be doing the right thing anyway)?

    It seems to me that credible delegation is only a problem when the principal has a clear motivation to intervene later. Or am I missing something here?

    — RJM

  • 12. links for 2007-10-09 at Jacob Christensen  |  9 October 2007 at 7:20 am

    [...] What Are Hybrid Forms and How Can They Be Modelled? « Organizations and Markets it is quite arguable that the theoretical understanding of hybrid governance is still deficient. For a long time, Anna Grandori has argued that the literature over-emphasizes the “discreteness” of hybrids; (tags: economics sociology research publicadministration) [...]

  • 13. Nicolai Foss  |  9 October 2007 at 9:28 am

    Rich,
    I think your argument depends on what exactly is meant by the agent’s “official job duties.”
    For example, in the case of a project-based organization, the agent that is charge of a project may have personal goals that are entirely congruent, even “synergistic,” with those of the project (appr. his “official job duties”)
    However, projects may be approved by management that later turn out to be mistakes, at least from the perspective of managers who may therefore be tempted to intervene, overruling agents (Baker, Gibbons, and Murphy) (for good or bad reason). Thus, the problem is not one of moral hazard on the part of the agent. It is rather one of implicit contracts (about delegation) between agents (employees) and principals (managers) being pushed out of their self-enforcing range by outside disturbances (á la Ben Klein).
    Perhaps I have misunderstood you?

  • 14. Joe Mahoney  |  9 October 2007 at 4:09 pm

    To go back to comment #4 by Peter Klein, my response would be that if we take the Grossman and Hart (1986) definition of ownership then the essence of ownership is having the residual rights of control. I take Oliver Hart’s position in his 1995 book on “Firms, Contracts and Financial Structure” and use the terms “power” “authority” and “residual rights of control” interchangeably. Bottom line: “Who has the last word on the use of resources/”

    I hasten to add, however, that since “residual rights of control” is NOT THE ONLY DEFINTION OF OWNERSHIP, I would NOT rush to the conclusion that ownership and authority are equivalent (if we go beyond the Grossman and Hart model). For example, another conceptualization of ownership may be having the residual rights of income.

    To rephrase Peter’s question then becomes: what are the patterns in relationships of “residual rights of income” (ownership) and “residual rights of control” (authority)?

    Of course in the Alchian and Demsetz (1972 AER) team production (nonseparabilities) case the “boss” has both residual rights of control AND receives the residual income (i.e., is the residual claimaint) — an elegant paper that links the two concepts of ownership.

    Howerver, as Coff and Makadok note, real-world organizational forms are far more complicated, and the Alchian and Demsetz model does not “scale-up” (to use Williamson’s terminology).

    Finally, the bottom line to Peter’s question is that EVEN FOR SIMPLE PHYSICAL ASSETS, the notions of ownership for residual income and for residual control are FUZZY. For example, do the directors of a firm have the residual control rights toaccept a takeover offer without soliciting competiting offers?

    Milgrom and Roberts in their 1992 book, ECONOMICS, ORGANIZATION, AND MANAGEMENT say it best:

    “… Ownerhship of something as complicated as a firm is a tenuous concept” (1992: 291).

    Given this state, we are far too complacent in organizational economics if we believe that the literature has it all figured out! There is much room for the next generation of scholars in organizational economics to bring greater clarity to understanding our institutions of capitalism. The Coff and Makadok paper is a contribution along these lines. I anticipate much more to follow from the young and the energetic.

  • 15. Twofish  |  9 October 2007 at 5:56 pm

    Something that needs to be mentioned is that the unit of analysis probably shouldn’t be the corporation since large corporations are basically federations of work groups that often behave in a quasi-market manner.

    One thing that makes the topic interesting is that within large corporations, there is always a tension between the goals of the organization and the goals of the agent, in that each presumably wants to maximize their personal profit.

  • 16. Rich Makadok  |  9 October 2007 at 6:31 pm

    Joe, thanks for adding this intellectual background as context for the discussion — the wise man, as always. (Might have to break that one-check rule after all…)

    Nicolai, please correct me if you think the following logic is flawed. I would think that if an approved project turns out to be a mistake, and the agent’s performance on the project is truly synergistic with the performance of the agent’s personal goals, then the agent should share the principal’s interest in curtailing, shutting down, or otherwise re-directing the project. Otherwise, the failure of the project would carry over to induce a failure of the agent’s personal goals. For example, being associated with a failed project for one principal may harm the agent’s ability to secure work for other principals. So, if the agent wanted to persevere with the project in its original form and the principal did not, then how much synergy could there really be between the agent’s performance on the project and the agent’s performance of personal activities? Again, please correct me if you think this logic is flawed Perhaps I am the one who is misunderstanding you.

    Twofish, we absolutely agree about the unit of analysis. In our model, the unit of analysis is the principal-agent dyad.

    Thanks again to all for the lively discussion — greatly appreciated.

    Cheers,
    Rich

  • 17. Nicolai Foss  |  10 October 2007 at 6:52 am

    Rich, I think you are right: With standard rationality assumptions, the agent should indeed realize that it is best to share the principal’s wish to shut down the project. And this seems to vindicate your original point.

  • 18. Peter Klein  |  10 October 2007 at 9:28 am

    Rich, thanks for pointing me to the relevant pages in H&M 94. After thinking about it some more, I may be even more confused, however. (Which explains why I try not to think about things too much.) Basically, H&M model the effects of ownership as a set of transferable returns (their lambda), without worrying about the details of the bargaining process. Authority is modeled as the intensity with which “private” tasks (those giving the agent a private, non-transferable benefit) are monitored. And, unless I missed it, lambda and this monitoring parameter (a_4 in your paper, for those following along at home) are chosen independently, right?

    Now, suppose that the set of possible personal tasks (i.e., uses of assets that give the agent a private benefit) is not fixed ex ante, but that new opportunities for opportunism (hey, that’s a cool expression) arise as new information is revealed. I.e., as in GHM, some states of the world can be realized that were not previously anticipated (and specified by contract). Whoever owns the asset can set the monitoring parameter for these new tasks. So ownership not only gives you more cash (a bigger lambda), but also the right to determine the new monitoring parameters ex post.

    Another possible source of inter-dependency is that the lambdas (in GHM) are functions of the nonverifiable ex ante investment decisions of the principal and agent. H&M take these investments as exogenous, right? What if these investments are functions of the a’s (the monitoring parameters specified by contract)? If I’m the agent, the greater my ability to exploit the assets for my own benefit (a_4), the greater my incentive to make ex ante specific investments that increase joint surplus, which affects the lambdas.

    What do you guys think?

  • 19. Twofish  |  10 October 2007 at 10:18 am

    I think a lot depends on what the “asset” in question is. In most of the high technology organizations I’ve been in, the major resource to be allocated is time. The major currency is reputation.

    Curiously exchanges of money is usually not an important factor at low levels in the hierarchy.

  • 20. twofish  |  10 October 2007 at 9:16 pm

    There seems to be the assumption that the “principal” and the “agent” are both individuals when in fact they may be “corporate” structures.

    What I’ve noticed is that the corporate hierarchy may be misleading implying that work is delegated in a top down way. What seems to be a more accurate description is that corporations consist of groups of people who form groups with other groups, which form larger and larger groups. One person is responsible for coordinating each level of group, which gives you the ability to draw a tree, but most social interactions take place between peers and the hierarchy serves something like a trellis on which to organize the daily interactions.

  • 21. twofish  |  10 October 2007 at 9:39 pm

    I’m trying to match all of these models with what happens in the office and I can’t seem to make the models fit.

    The basic thing is that about 80% of my communications is with peers or near-peers. Also within the set of communications with superiors, about 70% of that is reporting actions.

    The main role of the boss is as a broker. She negotiates between requests coming down with information going up, and also negotiates with peers for resources. I’m not sure how this fits into any of this discussion.

    Something else that needs to be mentioned is that in a firm every action is a negotiation, because the firm can fire you if they don’t like you, and you can quit if you don’t like them.

    Also, corporations tend to be far less hierarchical than academic organizations, I suspect its is because businesses exist in a context of a liquid labor market whereas academia doesn’t.

  • 22. Richard Makadok  |  16 June 2010 at 5:33 am

    Hi, Nicolai.

    An update: Russ Coff and I were just notified that our hybrid-governance paper, which was eventually published in the AMR special issue on formal theory, has won the 2009 AMR Best Paper Award.

    We would especially like to thank Mike Ryall, the special-issue co-editor who handled our paper, for his great assistance in helping us to navigate the review process.

    Cheers,
    Rich

  • 23. Richard Makadok  |  16 June 2010 at 5:35 am

    Note to self: Time to send Joe another check!
    — Rich

  • 24. Peter Klein  |  16 June 2010 at 9:52 am

    Wow, congratulations, guys! Maybe there is hope for AMR after all. . . .

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