Archive for March, 2008

Maybe Sociology Is Worth Something After All

| Peter Klein |

This passage from yesterday’s WSJ front-pager on Sheraton’s attempt to upgrade its image should delight Brayden and the Boys:

[Sheraton’s Hoyt] Harper, whose father was a psychologist, says he takes an inclusive approach to negotiating with [franchisees]. Instead of issuing blanket instructions, he has brought in major Sheraton owners, such as Host, early on in the design process to get their input and help tweak the final plan. This means that Starwood must endure a lot of criticism from its hotel owners and that the owners must endure criticism from Starwood. “My sociology major was much more appropriate for this job than my business degree,” he says.

On a more serious note, the article contains interesting general information about the hotel industry and the dominant franchise model. It should have mentioned Francine Lafontaine’s work on franchising, particularly this recent paper (with Renata Kosova and Rozenn Perrigot) on the hotel industry and a chain’s choice to own or franchise particular units.

26 March 2008 at 4:26 pm 1 comment

A Picture Is Worth a Thousand Bullet Points

| Peter Klein |

An alert reader directs me to slide 241 of the slide pack for Dick Langlois’s Economics of Organization course. Click the image below for a look. Dick seems to be raising the point that Williamson’s TCE (as well as other theories of economic organization) pays insufficient attention to the processes by which firms reach their “optimal” organizational structures. TCE holds that firms try to minimize (or should minimize) the sum of production and transaction costs. But do firms actually do this? Do they make mistakes? Do they experiment and learn? Is the selection environment strong enough that inefficient organizational choices are quickly eliminated, or do inefficiencies persist? (The problem is particularly important for empirical literature on organizational form — see pp. 440-42 of this paper.) Or, can we assume, with Dr. Pangloss, that whatever is, is optimal?

oew_candide.jpgTo illustrate the point, Dick includes a photo of Williamson giving a seminar, with some additional background art — an etching from Candide — added to the frame. If you’re not paying attention you might think the etching is part of the original. I give Dick points for cleverness, but my anonymous correspondent finds the illustration a bit too subliminal. What do you think?

26 March 2008 at 11:17 am 4 comments

Intelligence Doping

| Peter Klein |

Posner and Becker weigh in on “intelligence doping,” using drugs to increase cognitive performance (see our earlier remarks here). Both argue, on utilitarian grounds, against regulating Provigil and similar stimulants. I bet they’d go for the new Snickers bar too.

26 March 2008 at 9:15 am Leave a comment

No Country for Old Probability Theorists

| Peter Klein |

I finally got around to seeing No Country for Old Men, which I enjoyed despite unrealistically high expectations (movies too suffer from the winner’s curse). Javier Bardem’s Anton Chigurh surely belongs with Darth Vader, Hannibal Lecter, Dr. Christian Szell, Nurse Ratched, and Max Cady on the list of all-time great movie villains. The movie is in one sense a meditation on the role of chance in human affairs, so naturally I started thinking about risk, uncertainty, choice, delegation, and other issues near and dear to our organizational hearts. 

Chigurh, the cold-blooded killer, likes to flip a coin before deciding whether to kill someone, forcing the victim to call the toss. This reminded me that risk and Knightian uncertainty aren’t mutually exclusive determinants of economic outcomes. Entrepreneurs choose to invest in risky projects, but project selection itself reflects the bearing of Knightian uncertainty. Richard von Mises gives the example of champagne bottles that burst while in storage with predictable frequencies. The champagne producer can quantify the risks associated with bottling and storage. But the choice of producing one variety or another, hiring one type of laborer or another, and even being in the champagne business at all, involves another kind of uncertainty, one that cannot be described with mathematical precision. The decision to enter the champagne business involves Knightian uncertainty, but once that decision has been made, some of the variation in outcome can be characterized as probabilistic risk. Think of it in terms of mixed strategies; the specific move is random, but the decision to play a mixed strategy is not. Likewise, Chigurh can hardly claim that his victims’ deaths are random. A coin flip determines their fate, but he chooses to flip the coin — and that choice cannot be explained by a known probability distribution. (more…)

25 March 2008 at 12:04 pm 10 comments

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. (more…)

21 March 2008 at 9:35 am 4 comments

Private Equity and Innovation

| Peter Klein |

LBOs do not reduce patent activity, and the quality of patents may actually increase following a “going-private” transaction, according to a new paper by Morten Sorensen, Per Strömberg, and Josh Lerner.

A long-standing controversy is whether LBOs relieve managers from short-term pressures of dispersed shareholders, or whether LBO funds themselves are driven by short-term profit motives and sacrifice long-term growth to boost short-term performance. We investigate 495 transactions with a focus on one form of long-term activities, namely investments in innovation as measured by patenting activity. We find no evidence that LBOs decrease these activities. Relying on standard measures of patent quality, we find that patents applied for by firms in private equity transactions are more cited (a proxy for economic importance), show no significant shifts in the fundamental nature of the research, and are more concentrated in the most important and prominent areas of companies’ innovative portfolios.

I very much like this kind of work even though I’m a patent skeptic (1, 2, 3, 4).

20 March 2008 at 2:45 pm 2 comments

Numbers Don’t Lie — Or Do They?

| Peter Klein |

Quantitative analysis leads to superior decision making, says Ian Ayres in Supercrunchers. Enthusiasts for expert systems are skeptical of “intuitive” reasoning. And most contemporary social scientists can’t conceive of a world without econometrics, sociometrics, psychometrics, and fill-in-the-blank-ometrics. Even management scholars are getting into the act. Of course, quantitative analysis is only as good as the assumptions that go into it. And economists such as Knight and Mises maintain that some kinds of human decision-making defy quantification and systematization and are fundamentally qualitative, or verstehende (explaining why some entrepreneurs earn profits while others make losses).

Wharton’s Gavin Cassar studies nascent entrepreneurs (defined here as firm founders) and finds, surprisingly, that those who use common accounting practices such as budgeting, sales forecasting, and financial planning are more likely to overestimate future performance than those who rely on qualitative, intuitive projections. “[T]hose individuals who adopt an inside view to forecasting, through the use of plans and financial projections, will exhibit greater ex-ante bias in their expectations. Consistent with inside view adoption causing over-optimism in expectations, I find that the preparation of projected financial statements results in more overly-optimistic venture sale forecasts.” In other words, quantitative analysis may exacerbate, rather than mitigate, cognitive bias. Worth a read (and see this summary in Knowledge@Wharton).

19 March 2008 at 9:44 pm 1 comment

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Nicolai J. Foss and Peter G. Klein, Organizing Entrepreneurial Judgment: A New Approach to the Firm (Cambridge University Press, 2012).
Peter G. Klein and Micheal E. Sykuta, eds., The Elgar Companion to Transaction Cost Economics (Edward Elgar, 2010).
Peter G. Klein, The Capitalist and the Entrepreneur: Essays on Organizations and Markets (Mises Institute, 2010).
Richard N. Langlois, The Dynamics of Industrial Capitalism: Schumpeter, Chandler, and the New Economy (Routledge, 2007).
Nicolai J. Foss, Strategy, Economic Organization, and the Knowledge Economy: The Coordination of Firms and Resources (Oxford University Press, 2005).
Raghu Garud, Arun Kumaraswamy, and Richard N. Langlois, eds., Managing in the Modular Age: Architectures, Networks and Organizations (Blackwell, 2003).
Nicolai J. Foss and Peter G. Klein, eds., Entrepreneurship and the Firm: Austrian Perspectives on Economic Organization (Elgar, 2002).
Nicolai J. Foss and Volker Mahnke, eds., Competence, Governance, and Entrepreneurship: Advances in Economic Strategy Research (Oxford, 2000).
Nicolai J. Foss and Paul L. Robertson, eds., Resources, Technology, and Strategy: Explorations in the Resource-based Perspective (Routledge, 2000).