Another Cost of Selective Intervention: Convincing the Market

20 November 2006 at 3:45 pm Peter G. Klein Leave a comment

| Peter Klein |

Nicolai blogged recently on Williamson’s concept of the “impossibility of selective intervention.” Williamson asks why a large firm cannot do everything a collection of small firms can do and more. In princple, a set of projects could be combined into a single firm, with the firm’s management promising not to interfere with individual projects unless doing so would generate net gains. In this way, a firm could have responsibility an almost unlimited set of projects, each of which would be at least as profitable as it would be as a standalone entity. What, then, explains the limits to the firm?

Williamson’s answer has to do with the difficulties of making such a commitment credible. Project managers will not believe the firm’s promise not to interfere and will take value-reducing actions to protect their own returns and asset values. (Williamson identifies “asset malutilization” and “accounting contrivance” as specific problems; see Nicolai’s post for details.)

A story in today’s W$J on Blue Moon beer raises another issue. Even if central managers can convince division heads or project managers that they will not engage in opportunistic behavior, they may be unable to convince buyers, suppliers, or other market participants. Here’s an example: Blue Moon is a popular “craft,” or niche, beer that appeals to high-end, quality-conscious consumers. Such beers are typically produced locally, in small quantities, and marketed as “micro-brews.” The Journal piece explains how Blue Moon’s marketing department goes to great lengths to hide the fact that the beer is actually made by Molson Coors, North America’s third-largest brewer. A similar example is Chipotle, a restaurant chain popular with the young and trendy (and the not-so-young and even-less trendy — I love it!), which before going public was majority owned by McDonald’s. The fact that such niche products would be regarded, by their target demographic, as “tainted” were their parentage known, suggests that market participants do not believe that corporate parents can manage small subsidiaries without interference. The market, it seems, agrees with Williamson that selective intervention is a “myth.”