Does Performance Cause Organizational Form?
| Peter Klein |
There is a large literature on the performance effects of organizational form. Obviously, for the strategist, getting organizational form right is important only if it leads to superior performance. Of course, the empirical literature recognizes that organizational form, governance, strategy, and other key decision variables are at least partly endogenous. Still, the causal arrows are usually thought to run from strategy to performance.
Ben Hermalin was at Missouri this week to present his paper, “Firm Value and Corporate Governance: Does the Former Determine the Latter?”, which argues that good governance can be the result, not the cause, of good performance. He constructs a model in which the benefits of getting governance right are, on the margin, increasing in the value of the firm’s investment opportunities. Better-performing firms have better opportunities and hence more to gain from designing governance structures that align managers’ incentives with owners. The model is based on an agency framework and applies specifically to managerial governance, but the general problem would seem to apply to a variety of organizational problems and contexts.
The model purports to explain some empirical regularities that do not fit with common theories of organizational governance. Why, for example, do firms leave money on the table by sticking with inefficient forms of governance? (This point is consistent with, but different from, the Demsetz-Lehn critique.) One problem with the model is that it assumes that the firm’s opportunity set is unobservable, so that empirical studies cannot simply include proxies for investment opportunities as control variables, making the positive correlation between governance and performance (as explained by the model) disappear.
More generally, though, I’m struck by how little we’ve learned about the benefits of organizational alignment since Masten, Meehan, and Snyder (1991). Even if organizational form matters for performance, how much does it matter, relative to the other causes of performance (resources and capabilities, industry characteristics, technical and allocative efficiency, etc.)? Getting organizational form right can be tricky; is it worth it?