| Peter Klein |
Bryan Hong, Lorenz Kueng, and Mu-Jeung Yang have two new NBER papers on strategy and organization using a seven-year panel of about 5,500 Canadian firms. The papers exploit the Workplace and Employee Survey administered annually by Statistics Canada. The data, the authors’ approach, and the results should be very interesting to O&M readers. Here are the links to the NBER versions; there may be ungated versions as well.
Business Strategy and the Management of Firms
NBER Working Paper No. 20846, January 2015
Business strategy can be defined as a firm’s plan to generate economic profits based on lower cost, better quality, or new products. The analysis of business strategy is thus at the intersection of market competition and a firm’s efforts to secure persistently superior performance via investments in better management and organization. We empirically analyze the interaction of firms’ business strategies and their managerial practices using a unique, detailed dataset on business strategy, internal firm organization, performance and innovation, which is representative of the entire Canadian economy. Our empirical results show that measures of business strategy are strongly correlated with firm performance, both in the cross-section and over time, and even after controlling for unobserved profit shocks exploiting intermediates utilization. Results are particularly striking for innovation, as firms with some priority in business strategies are significantly more likely to innovate than firms without any strategic priority. Furthermore, our analysis highlights that the relationship between strategy and management is driven by two key organizational trade-offs: employee initiative vs. coordination as well as exploration of novel business opportunities vs. exploitation of existing profit sources.
Estimating Management Practice Complementarity between Decentralization and Performance Pay
NBER Working Paper No. 20845, January 2015
The existence of complementarity across management practices has been proposed as one potential explanation for the persistence of firm-level productivity differences. However, thus far no conclusive population-level tests of the complementary joint adoption of management practices have been conducted. Using unique detailed data on internal organization, occupational composition, and firm performance for a nationally representative sample of firms in the Canadian economy, we exploit regional variation in income tax progression as an instrument for the adoption of performance pay. We find systematic evidence for the complementarity of performance pay and decentralization of decision-making from principals to employees. Furthermore, in response to the adoption of performance pay, we find a concentration of decision-making at the level of managerial employees, as opposed to a general movement towards more decentralization throughout the organization. Finally, we find that adoption of performance pay is related to other types of organizational restructuring, such as greater use of outsourcing, Total Quality Management, re-engineering, and a reduction in the number of layers in the hierarchy.
| Peter Klein |
Very sorry to report the passing of Henry Manne yesterday at the age of 86. Manne made seminal contributions to the literatures in corporate governance, securities regulation, higher education, and many other subjects. Here are past O&M posts on Manne and his contributions. I tried several times to get him to guest blog on O&M but couldn’t pull it off.
I got to know him fairly well in the last few years and he was a charming companion and correspondent — clever, witty, erudite, and a great social and cultural critic, especially of the strange world of academia, where he plied his trade for five decades but always as a slight outsider.
| Peter Klein |
We’ve addressed the widely held, but largely mistaken, view of creative artists and entrepreneurs as auteurs, isolated and misunderstood, fighting the establishment and bucking the conventional wisdom. In the more typical case, the creative genius is part of a collaborative team and takes full advantage of the division of labor. After all, is our ability to cooperate through voluntary exchange, in line with comparative advantage, that distinguishes us from the animals.
Christian Caryl’s New Yorker review of The Imitation Game makes a similar point about Alan Turing. The film’s portrayal of Turing (played by Benedict Cumberbatch) “conforms to the familiar stereotype of the otherworldly nerd: he’s the kind of guy who doesn’t even understand an invitation to lunch. This places him at odds not only with the other codebreakers in his unit, but also, equally predictably, positions him as a natural rebel.” In fact, Turing was funny and could be quite charming, and got along well with his colleagues and supervisors.
As Caryl points out, these distortions
point to a much broader and deeply regrettable pattern. [Director] Tyldum and [writer] Moore are determined to suggest maximum dramatic tension between their tragic outsider and a blinkered society. (“You will never understand the importance of what I am creating here,” [Turing] wails when Denniston’s minions try to destroy his machine.) But this not only fatally miscasts Turing as a character—it also completely destroys any coherent telling of what he and his colleagues were trying to do.
In reality, Turing was an entirely willing participant in a collective enterprise that featured a host of other outstanding intellects who happily coexisted to extraordinary effect. The actual Denniston, for example, was an experienced cryptanalyst and was among those who, in 1939, debriefed the three Polish experts who had already spent years figuring out how to attack the Enigma, the state-of-the-art cipher machine the German military used for virtually all of their communications. It was their work that provided the template for the machines Turing would later create to revolutionize the British signals intelligence effort. So Turing and his colleagues were encouraged in their work by a military leadership that actually had a pretty sound understanding of cryptological principles and operational security. . . .
The movie version, in short, represents a bizarre departure from the historical record. In fact, Bletchley Park—and not only Turing’s legendary Hut 8—was doing productive work from the very beginning of the war. Within a few years its motley assortment of codebreakers, linguists, stenographers, and communications experts were operating on a near-industrial scale. By the end of the war there were some 9,000 people working on the project, processing thousands of intercepts per day.
The rebel outsider makes for good storytelling, but in most human endeavors, including science, art, and entrepreneurship, it is well-organized groups, not auteurs, who make the biggest breakthroughs.
| Peter Klein |
It’s been another fine year for O&M, with over 100,000 unique visitors from Albania to Zimbabwe and about every country in-between. Our pageviews are down from 2006, the year we started this blog, but nowadays many people read our posts through Facebook or other syndication and sharing sites, so our actual reach is much larger.
Here are the most viewed posts written in the last year:
- What are “Transaction Costs” Anyway?
- Notes on Inequality
- Gary Becker: A Personal Appreciation
- It’s the Economics that Got Small
- Rich Makadok on Formal Modeling and Firm Strategy
- The Piketty Code
- Gary S. Becker, 1930-2014
- Is Human Capital Theory Compatible with the Strategy Literature?
- Cheating and Public Service
- The Soft Underbelly of Business Model Innovation
- More Skepticism of Behavioral Social Science
- Theories of the Firm
- The Theory of Mind in Agency Theory
- Academics and Social Media
- The New Empirical Economics of Management
Thanks to our readers and commentators for a great 2014. We are looking forward to 2015!
| Peter Klein |
Recent posts on strategy and game theory (here and here) generated quite a lot of discussion here and on social media. Avinash Dixit offers more grist for the mill in his December 2014 Journal of Economic Literature essay on Lawrence Freedman’s Strategy: A History (Oxford, 2013). (An ungated version is here.) Dixit’s essay contrasts the economist’s and the historian’s view of strategy — “strategy” being game theory for the former, a broader, interpretive, interdisciplinary exercise for the latter — but the discussion is highly relevant for strategic management. The management literature has traditionally taken a wide, flexible view of “strategy,” closer to the historian’s sense than the economist’s, though that is rapidly changing as game theory becomes more widespread in strategic management research and teaching.
Here’s an excerpt from Dixit’s opening, which gives you the flavor:
[Freedman] heads the preface with a memorable quote from Mike Tyson: “Everyone has a plan till they get punched in the mouth.” Later he quotes another fighter, the legendary German Field Marshal Helmuth Karl Bernhard Graf von Moltke: “no plan survived contact with the enemy” (p. 104). The game theorist will respond: “Those plans are not strategies. They are incomplete. They fail to specify any action at the node of the game tree where you get punched in the mouth or meet the enemy army, or in the ensuing subgame.” It would be extreme stupidity, or arrogance tantamount to stupidity, for a boxer not to recognize the possibility of getting punched in the mouth. And although avoiding battle may be an important aspect of military strategy in many situations (see pp. 47–9), every plan should include a provision for action if or when battle commences. Tyson, or Freedman, will probably counter that even if the boxer starts with a complete plan that specifies the action for this contingency, the punch will make him forget the plan and react hot-headedly. Modern game theorists exposed to behavioral ideas will admit some truth in this, and agree that the boxer’s System 2 calculations are likely to fly out of the ring when the punch lands and System 1 instincts will take over. But they will add that that makes it all the more important for the boxer to strategize better in advance—to take actions before getting punched, either to reduce the risk, or to arrange matters in such a way that the anger and instinct (or the prospects of such reactions) are put to more effective use, as with the strategy of brinkmanship. More generally, “the art of creating power” often entails strategic moves like commitments, threats and promises that game theorists have analyzed following Thomas Schelling (1960). And Freedman’s picture of “strategy as a System 2 process engaged in a tussle with System 1 thinking” (p. 605) looks remarkably like Schelling’s (1984, ch. 3) “intimate contest for self-command.”
I have a twofold purpose in constructing the above exchange. One is to highlight the difference between the perspectives of economists and historians in thinking about the same situation. The second is to argue that each has something to learn from the other, and a fuller understanding can result from their dialog. The two perspectives share a lot of middle ground, and have useful complementarities.
The thoughtful essay is well worth reading in its entirety.
| Peter Klein |
This review provides a critical survey of psychology-and-economics (“behavioral-economics”) research in contract theory. First, I introduce the theories of individual decision making most frequently used in behavioral contract theory, and formally illustrate some of their implications in contracting settings. Second, I provide a more comprehensive (but informal) survey of the psychology-and-economics work on classical contract-theoretic topics: moral hazard, screening, mechanism design, and incomplete contracts. I also summarize research on a new topic spawned by psychology and economics, exploitative contracting, that studies contracts designed primarily to take advantage of agent mistakes.
| Peter Klein |
Should academic work be classified primarily by discipline, or by problem? Within disciplines, do we start with theory versus application, micro versus macro, historical versus contemporary, or something else? Of course, there may be no single “optimal” classification scheme, but how we think about organizing research in our field says something about how we view the nature, contributions, and problems in the field.
There’s a very interesting discussion of this subject in the History of Economics Playground blog, focusing on the evolution of the Journal of Economic Literature codes used by economists (parts 1, 2, and 3). I particularly liked Beatrice Cherrier’s analysis of the AEA’s decision to drop “theory” as a separate category. The Machlup-Hutchison-Rothbard exchange helps establish the context.
[T]he seemingly administrative task of devising new categories threw AEA officials, in particular AER editor Bernard Haley and former AER interim editor Fritz Machlup, into heated debates over the nature and relationships of theoretical and empirical work.
Machlup campaigned for a separate “Abstract Economic Theory” top category. At the time of the revision, he was engaged in methodological work, striving to find a third way between Terence Hutchison’s “ultraempiricism,” and the “extreme a priorism” of his former mentor, Ludwig Von Mises (see Blaug, ch.4). He believed it was possible to differentiate between “fundamental (heuristic) hypotheses, which are not independently testable,” and “specific (factual) assumptions, which are supposed to correspond to observed facts or conditions.” The former was found in Keynes’s General Theory, and the latter in his Treatise on Money, Machlup explained. He thus proposed that empirical analysis be classified independently, under two categories: “Quantitative Research Techniques” and “Social Accounting, Measurements, and Numerical Hypotheses” (e.g., census data, expenditure surveys, input-output matrices, etc.). On the contrary, Haley wanted every category to cover the theoretical and empirical work related to a given subject matter. In his view, separating them was impossible, even meaningless: “Is there any theory that is not abstract? And, for that matter, is there any economic theory worth its salt that is not applied,” he teased Machlup. Also, he wanted to avoid the idea that “class 1 is theory, the rest are applied … How about monetary theory, international trade theory, business cycle theory?” He accordingly designed the top category to encompass price theory, but also statistical demand analysis, as well as “both theoretical and empirical studies of, e.g., the consumption function [and] economic growth models of the Harrod-Domar variety,” among other subjects. He eschewed any “theory” heading, which he replaced with titles such as “Price system; National Income Analysis.” His scheme eventually prevailed, but “theory” was reinstated in the title of the contentious category.