Fundamental Questions About Organizations

28 November 2007 at 3:25 pm 9 comments

| Peter Klein |

Our most popular tag here at O&M seems to be ephemera, but occasionally we write a “big think” post (e.g., this one). Today I’ll offer another. A colleague recently asked me to write down, for a research project we’re sketching out, some “fundamental questions about organizations.” He wanted my off-the-cuff response, not a carefully crafted set of ideas. Here’s what I came up with:

1. Does organizational form matter? How much does it really affect performance, however measured? Organizational form might not be that important because (a) its effects on performance are small relative to the performance effects of technical or allocative efficiency; (b) organizational form is easily changed and always chosen optimally to fit the circumstances; or (c) organizational form is merely a legal distinction without any economic significance.

To explore this, one would want:

  • Better ways of measuring or classifying organizational types. Are there just a few discrete types (proprietorship, partnership, cooperative, limited-liability company, publicly traded corporation), or are there important variations within types (e.g., M-form versus holding company)? Are Williamson’s markets, hierarchies, and hybrids discrete types? Maybe Coff and Makadok’s set of eight types is the right taxonomy. Or is organizational form best understood as a continuum?
  • Better techniques for measuring the effects of organizational form on performance in a cross-section of firms. There is a huge endogeneity problem. If underperforming firms of type A are converted to type B while strong performers remain as type A, then type B will look like a dog even if the conversion from A to B improves the performance of that particular organization. Are there good instruments for selection bias? Are there legal or other institutional differences across communities or states or regions that allow for natural experiments?
  • Good sources of longitudinal data, from which we can learn about births and deaths, transitions/reorganizations, spawning, and the like. Is organizational change easy or hard? Are there short-term performance losses followed by long-term performance gains? What kinds of firms get reorganized, and why? What would have happened to them (counterfactually) if they hadn’t reorganized?

2. Which theory best explains organizational choices and their effects — TCE, RBV, agency theory, or something else? E.g.,

  • Is asset specificity as important as Williamson thinks it is?
  • Is holdup the most important source of external or market transaction costs, or are measurement costs more important?
  • Is the RBV really a theory of firm-level returns, or simply an explanation for the returns to individual factors? (If Jay Barney reads this, he will recognize the use of the word “simply” as an inside joke.)
  • How do capabilities, routines, etc. affect performance?

3. How do agents learn about organizational form?

  • Do market participants generalize the experiences of a firm with a particular organizational type to other firms with similar organizational characteristics? E.g., do investors value firm structure itself, or simply individual firms, regardless of their structure?
  • Do firms cluster — geographically or in product space — by organizational type?

4. How is entrepreneurship related to the theory of the firm?

  • Can the establishment of a new organizational form, the transition to such a form, etc., be regarded as an entrepreneurial act?
  • Can theories of individual entrepreneurship be extended to group or team entrepreneurship, to account for entrepreneurial activity among partners, within the top management team, etc.?

Entry filed under: - Klein -, Entrepreneurship, Institutions, Strategic Management, Theory of the Firm.

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9 Comments Add your own

  • 1. Bart  |  29 November 2007 at 9:03 am

    Ad 4: Is there a link between uncertainty in TCE and entrepreneurial judgment over uncertainty?

    My practical business sense would say that there is; I consider competence as an important determinant to judgment; there is a lot of variance to entrepreneurial competence; so could entrepreneurial judgment then influence outcomes regarding the internalization/externlization of transactions (org form) based on the uncertainty to the transaction and competence of the person facing the entrepreneurial decision?
    Take a shot…

    P.s. Still owe you a repsons to the PE post, but couldn’t resisit mingling with this one…

  • 2. Bo  |  29 November 2007 at 10:35 am

    Perhaps you are already answering this in 1(c) but “to whom” does organization form matter? You seem to be driven by economic and/or theoretical rationales here rather than managerial/practical orientation. What is the theoretical basis for even asking this question? Organization form is either a (conscious) response to a set of circumstances (by managers with bounded rationality etc) or, more likely, the result of a series of (more or less unrelated) events taking place over time in an evolutionary manner. Either way, why would we expect this to be related to performance above and beyond the fact that “all variables in organizations are related to performance at some level”? You mention the causality issue yourself: certain types of performance may trigger certain types of organizational forms over time – or not..but to whom does the form really matter? To the employees? To the shareholders? To the external stakeholders? To society? or–to you as a scholar with nothing better to do than to look for relationships where none should be expected? :)

  • 3. Peter Klein  |  29 November 2007 at 3:04 pm

    Bo, you sure know how to hit a guy where it hurts.

    Bart, that’s an interesting question, one that hasn’t been explored much in my view. The Knightian view does seem to incorporate the idea that transaction cost econommizing is an ability that some entrepreneurs possess more than others, such that efficient organizational design represents an act of entrepreneurial judgment. This relates to Mayer and Argyres’s work on contract design as a firm capability.

    If you mean “how does the treatment of uncertainty in the TCE literature, as a co-determinant (with asset specificity) of organizational form, compare to the treatment of uncertainty in the entrepreneurship literature?” then the answer is more complicated, I think. TCE holds that, for given levels of asset specificity, uncertainty increases the likelihood of internal organization (vertical integration). The Knightian view says that the more assets the entrepreneur owns, the more he must exercise judgment in the deployment of those assets, for given levels of uncertainty. Perhaps one could say that the greater the uncertainty, the more likely that assets will tend to be concentrated in the hands of entrepreneurs with particularly good judgment, suggesting a positive correlation between uncertainty and firm size — but this doesn’t take asset specificity into account.

    That’s a roundabout way of saying gosh, hmmm, I don’t really know. Somebody needs to write a paper on this!

  • 4. srp  |  29 November 2007 at 7:53 pm

    It seems like all these questions are about legal ownership structures and the like. There’s nothing here about the aspects of organizational form (and practices) that have to with actually getting work done–developing products, identifying markets, turning inputs into outputs, etc.

    When I think about organizational form, the sorts of things that come to mind are functional vs. product vs. geography or formal vs. informal means of coordination. Whether the firm is a proprietorship or a partnership or a holding company or is vertically integrated is important, but only in the context of these other issues that jointly affect the ability of the firm to create and capture economic surplus. I suspect that the focus on legal ownership structures results primarily form data availability, not from relative importance.

  • 5. Peter Klein  |  30 November 2007 at 12:20 am

    Sure, let’s add these questions fo the list. My items were meant as conversation starters, not as a completed set. But I do think the arrangement of ownership and governance rights is critical, and inextricably linked to strategy and operations. Calling these “legal” seems to imply, as in the nexus-of-contracts tradition, that ownership and governance issues are purely formal and distinct from strategic and operational issues. Having just come back from a conference on buyouts and their effect on performance (on which I’ll blog shortly), I have to disagree strongly with the “boundaries-as-a-legal-fiction” approach!

  • 6. spostrel  |  30 November 2007 at 9:06 pm

    Boundaries are real and do affect strategic and operational issues; it’s just that only some of them are the legal ones having to do with ownership and contracts. There are also boundaries of communication, of loyalty, of shared use of assets, and so on. Some of these boundaries are coterminous with the legal boundaries of the firm, but many of them are not–they either lie entirely inside legal firms or cut across firm boundaries. And in a world of purposive decision makers, the legal and managerial boundaries are determined jointly. I object to the frequent separation, or false opposiiton, of these issues in much of the literature, so I was trying to head that off here.

  • 7. twofish  |  3 December 2007 at 2:20 am

    One way I think about organizational forms is using the Confucian methodological individualism. You start with the interactions between individuals and move out from that. At the same time another way you can view organizations is how do organizations interact with money and resources.

    The problem with the views of organizational forms in economics is that they view only the top level of organization, and don’t view the sub-levels of organization. The top level of organizational form matters because that is where the “internal organization” interacts with the market, but if you want to understand the interaction between organizations and entrepreneurship you have to go into the sub-levels of the organization.

  • 8. twofish  |  3 December 2007 at 2:23 am

    One way of talking about this is that if you want to sketch out a diagram of organizations, you can do so using a combination of “boxes” and “lines.” If you talk only in terms of organizational forms, then the diagram consists only of boxes, and that I think is insufficient to represent that the behaviors of individuals are.

  • 9. Peter Klein  |  3 December 2007 at 10:01 am

    Twofish, I certainly do think organizational economics has a lot to say about the relationships among subunits, between subunits and HQ, and among individuals within subunits. I should have said more about this in the original post. Actually I didn’t mention agency problems and collective-action problems at all — major omission! — so a better title would have been “Fundamental Questions About Organizational Boundaries.”

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