Archive for October, 2009
Governing Firm-Specific Knowledge Assets
| Nicolai Foss |
In spite of book titles such as Competitive Advantage Through People, a whole subfield dedicated to linking human resources and firm-level performance outcomes (i.e., strategic HRM), and a general recognition that many knowledge-based competitive advantages are ultimately rooted in a web of complementary and firm-specific human capital, surprisingly little serious quantitative research exists that links firm-specific knowledge, employee governance mechanisms, and firm-level performance. In fact, there are few theoretical contributions that accomplish this. Work by Russ Coff as well as Gottschalg and Zollo come to mind (as well as this paper).
In “Firm-Specific Knowledge Resources and Competitive Advantage: The Roles of Economic- and Relationship-based Employee Governance Mechanisms,” in the December issue of the Strategic Management Journal (I received my copy October 28!), Heli Wang, Jinuy He, and former O&M guest blogger Joe Mahoney explore the economic- and relationship-based governance mechanisms that mitigate the latent underinvestment problem of employees making firm-specific human-capital investments. Overall, their results suggest that firms with more firm-specific knowledge resources are more likely to adopt those governance mechanisms that can reduce key employees’ concerns about potential hold-up.
The paper is very neat and clear, and my personal candidate for the best research paper in SMJ in 2009. Here is the abstract:
The resource-based view of the firm emphasizes the role of firm-specific resources, especially firm-specific knowledge resources, in helping a firm to achieve sustainable competitive advantage. However, the deployment of firm-specific knowledge often requires key employees to make specialized human capital investments that are not easily redeployable to other settings. Thus, in the absence of effective safeguards and trust building devices, employees with foresight may be reluctant to make such specialized investments. This study explores both economic- and relationship-based governance mechanisms that might mitigate this underinvestment problem. Effective use of these governance mechanisms enables a firm to obtain greater performance from its efforts to deploy firm-specific knowledge resources. Empirical results further support these key arguments.
Multitasking
| Peter Klein |
I was flipping channels last night and came across a Jimi Hendrix biopic. Lots of concert footage, with Hendrix doing his usual amazing Hendrix things — singing, crazy guitar riffs, playing with his teeth. Then I noticed something I hadn’t seen before: He’s doing all this while chewing gum. How can he sing without choking or spitting it out? How does he pluck guitar strings with his teeth and not leave a big wad on the pickups? Some people have trouble walking and chewing gum at the same time. How is he doing this?
Naturally, this got me thinking about multitask principal-agent problems. I liked one article that appeared in 2005 but didn’t generate much attention: Besanko, Regibeau, and Rockett’s “A Multi-Task Principal-Agent Approach to Organizational Form” (Journal of Industrial Economics, December 2005). Multitasking has often been applied performance evaluation, specifically the use of objective versus subjective performance measures. (If the agent is assigned multiple tasks, only some of which are measurable, than a quantitative evaluation scheme biases the agent’s effort toward more easily measurable tasks.) Besanko et al. apply this logic to divisionalization, examining the choice between product-line and functional organization:
This paper studies the choice of organizational forms in a multi-task principal-agent model. We compare a functional organization in which the firm is organized into functional departments such as marketing and R&D to a product-based organization in which the firm is organized into product lines. Managers’ compensation can be based on noisy measures of product-line profits. Measures of a functional area’s contribution to total profits are not available, however. This effect favors the product organization. However, if there are significant asymmetries between functional area contributions to organizational success and cross-product externalities within functions, organizing along functional lines may dominate the product organization. The functional organization can also dominate when a function is characterized by strong externalities while the other is not.
An obvious example: university faculty who are tasked with research, teaching, and service. Research is (in principle) easy to measure: publications, citation counts, grants, speaking invitations, etc. Teaching and service outputs are fuzzier. Even well-intentioned administrators tend to reward what they can count, which means refereed journal articles (and, in some fields, grant dollars) end up being the primary performance metric. Need I point out what this does to teaching?
The same issue is explored in Williamson (1975, pp. 155-75), where the ability to reward division managers based on standalone, divisional profit figures is cited as an advantage of the M-form structure.
Economic Methodology in Erkenntnis
| Nicolai Foss |
Economic methodology, or, meta-theoretical discussion of (and in) economics, has gone significantly beyond with theme that many practicing economists associate with the field, namely the realism-of-assumptions theme prompted by Friedman’s famous 1953 essay, “The Methodology of Positive Economics.” Of course that theme is by no means unimportant, and it has, of course, resurfaced under the impact of the financial crisis.
However, the main themes of the current economic methodology discussion have shifted from the role of assumptions to economic models in their entirety. Two main perspectives are sometimes distinguished, namely the “isolationists” who literally see economic models as simplified redescriptions of the mechanisms and causal factors of the real world, and the “fictionalists” who, as the name indicate, ascribe much less realism to models and think of them as purely mental laboratories that may still, however, allow for certain inferences to the real world.
The January 2009 issue of Erkenntnis: An International Journal of Analytical Philosophy is a special issue, edited by Till Grüne-Yanoff, dedicated to exploring these two positions, and entitled “Economic Models as Credible Worlds or as Isolating Tools?” Among the heavyweight contributors are Robert Sugden, Uskali Mäki, and Nancy Cartwright. I particularly liked Mäki’s argument that the two positions are in actually very close rather than opposed. Highly recommended for those who want to acquaint themselves with frontier issues in economic methodology.
How Machiavellian Are You?
| Peter Klein |
A test for university presidents, deans, department heads, center directors, etc. (via Anu).
(Yes, of course, there are management and leadership literatures on old Niccolò. Don’t act surprised!)
My Favorite New-Media Entrepreneur
| Peter Klein |
It’s Ben Huh, the brains behind FAIL Blog, Engrish Funny, and, of course, I Can Has Cheezburger. The best of the user-generated-content sites. Huh is profiled here in Fast Company. Interestingly, he’s a quant guy:
[W]e rely on the tools of the Internet — metrics and measurements and stuff like that — to help us decide what to post. We don’t have some guy somewhere deciding, “Oh, I think this it funny. I’m going to post it on the homepage.” That actually fails 50% of the time, because people are very bad at understanding what’s funny for other people. Everything we promote is there for a logical reason.
Internal Capital Market Activeness
| Lasse Lien |
In these Williamsonian times, here is a nice new working paper relevant to his internal capital market hypothesis. The paper measures, in various ways, how active a firm is in reallocating capital across its businesses. The paper finds that the more active a firm is, the lower the firm’s industry-adjusted profitability tends to be. This of course raises the question of whether active internal capital markets cause inferior performance, or whether inferior performance causes active internal capital markets. Using an impressive battery of robustness checks the authors conclude that internal capital markets are inefficient.
If the subject appeals to you, you have presumably already read this and this.
Sampling on the Dependent Variable: French Peasant Edition
| Peter Klein |
A useful example of the methodological flaw that plagues the “great companies” and “great leaders” literature in management, from Graham Robb’s excellent The Discovery of France (Norton, 2007):
[N]early every autobiographical account of ordinary life in eighteenth- and nineteenth-century France comes from the early chapters of memoirs written by exceptional men who rose through the ranks of the army or the Church, woo wrote their way to fame or who were plucked from obscurity by a patron, a lover or, eventually, an electorate. Few men and even fewer women had the means or the desire to write a book on “How I failed to overcome my humble origins.” Apart from the countless riches-to-riches tales written by aristocrats, almost all the lives that we know about follow the same untypical upward trend: the farmer’s son Restif de la Bretonne, the cutler’s son Diderot, the watchmaker’s son Rousseau, the Corsican cadet Napoleone Buonaparte.
These spectacular success are more typical of long-term trends than of individual lives. Categorical terms like “peasants,” “artisans,” and “the poor” reduce the majority of the population to smudges in a crowd scene that no degree of magnification could resolve into a group of faces. They suggest a large and luckless contingent that filled in the background of important events and participated in the nation’s historical development by suffering and engaging in a semblance of economic activity.
Likewise, business and entrepreneurial strategies can be understood by studying not only firms that tried them and succeeded, but also those that used the same strategies and failed. Reducing the majority of companies to smudges in an industry-wide or economy-wide crowd scene tells us little about what does and doesn’t work.
The Hodgson Petition
| Peter Klein |
Several friends and colleagues urged me to sign Geoff Hodgson’s petition on the financial crisis, but I declined. I agree with Krugman that economists have tended to mistake mathematical beauty for truth, but think this has little to do with the financial crisis. As discussed in previous posts, I view the financial crisis and recession as the (predicable!) result of government failure — massive credit expansion by the central bank, mortgage-lending rules and policies designed to inflate the housing market, a state-sponsored cartel of securities-rating agencies — not market failure resulting from unrealistic behavioral assumptions.
I respect many of the signatories to the petition, but statements like this (from Krugman), at the heart of the petition, are preposterous:
[Economists] turned a blind eye to the limitations of human rationality that often lead to bubbles and busts; to the problems of institutions that run amok; to the imperfections of markets — especially financial markets — that can cause the economy’s operating system to undergo sudden, unpredictable crashes; and to the dangers created when regulators don’t believe in regulation. . . . When it comes to the all-too-human problem of recessions and depressions, economists need to abandon the neat but wrong solution of assuming that everyone is rational and markets work perfectly.
“Regulators who don’t believe in regulation?” Paul, what color is the sky on your planet (1, 2, 3)? Notably absent from the petition’s list of villains is the Fed, Fannie and Freddie, the Treasury, or indeed anyone remotely connected with a government body.
Keep in mind it was Krugman himself who wrote in 2002: “To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that . . . Greenspan needs to create a housing bubble to replace the Nasdaq bubble.” St. Alan followed Krugman’s advice to the letter, and here we are today.
Making and Unmaking Economic Orders
| Dick Langlois |
The new issue of the online journal Capitalism and Society has a number of articles that should interest readers of this blog. Each is probably deserving of its own post. (Ah, but time prohibits.)
Jon Elster has a piece called “Excessive Ambitions” that criticizes not only mainstream rational-choice models (as we would expect from Elster) but also modeling in general. Roman Frydman and Michael Goldberg have a piece that applies something like Leijonhufvud’s “corridor” to risk regulation: when swings of asset values are small, government should stay out, since such swings are actually beneficial; but when asset prices get too far from “underlying values,” government regulation is called for.
My favorite paper is by Thorbjørn Knudsen and Richard Swedberg. Here’s the abstract:
This is a theoretical paper in which we attempt to present an economic and sociological theory of entrepreneurship. We start from Schumpeter’s idea in Theory of Economic Development that the economy can be conceptualized as a combination and innovations as new combinations. Schumpeter also spoke of resistance to entrepreneurship. By linking the ideas of combination and resistance, we are in a position to suggest a theory of capitalist entrepreneurship. An existing combination, we propose, can be understood as a social formation with its own cohesion and resistance — what may be called an economic order. Actors know how to act; and profit is low and even in these orders. Entrepreneurship, in contrast, breaks them up by creating new ways of doing things and, in doing so, produces entrepreneurial profit. This profit inspires imitators until a new order for how to do things has been established; and profit has become low and even once more. Entrepreneurship is defined as the act of creating a new combination that ends one economic order and clears the way for a new one. The implications of this approach for a number of topics related to entrepreneurship are also discussed.
This has some affinities to arguments I have made in the past. I am thanked in the acknowledgements, presumably for conversations that Richard and I had at a Schumpeter conference at Harvard last year; but I’m not cited. (Assume sad-faced emoticon here.)
I will talk about the fourth paper in the issue soon in a separate post.
Penrose (1959) Golden Anniversary
| Peter Klein |
This year marks the 50th anniversary of Edith Penrose’s Theory of the Growth of the Firm (1959), one of the most important and influential books on the firm and firm strategy. To celebrate, Yasemin Kor and Christos Pitelis organized a roundtable at last week’s SMS conference with remarks by Christos, Yasemin, Joe Mahoney, Margie Peteraf, and Maurizio Zollo. The participants have graciously allowed me to post their slides and materials (1, 2, 3, 4). Christos, Penrose’s friend and literary executor, has edited and introduced a new edition of the 1959 book, which you can purchase here. You can read his introduction here. Nice!
Penrose trivia: During the 1950s Murray Rothbard made his living by reviewing literature and grant proposals for the William Volker Fund. When going through Rothbard’s correspondence a few years ago I came across a proposal for a study on firm growth submitted jointly by Penrose and Fritz Machlup, her dissertation supervisor at Johns Hopkins. Apparently at one point, the book was going to be a joint project. (Rothbard thought the ideas in the proposal didn’t fit with Penrose’s earlier warnings about the use of biological analogies in economics. However, as Joe Mahoney has noted, there is no inconsistency between the 1952 article and the 1959 book; Penrose is careful in her work on growth not to treat growth tendencies in firms as automatic, but to model them based on the preferences, beliefs, and actions of the firm’s personnel. In other words, she accepts natural selection in this context but not random mutation.)
BTW, what other important works in our field appeared in 1959, to be celebrated this year? Coase’s article on the Federal Communications Commission is one. The 1970s may have been the golden decade but there were major contributions in the previous decades as well. What are your favorites? Whose anniversary should we be preparing to celebrate?
Other Brushes with Official Greatness
| Peter Klein |
In the spirit of Lasse’s post, here are stories about some of my other direct and indirect contacts with academic royalty, people whose achievements have nothing to do with anything I’ve ever said or done.
- As regular O&M readers know, there is a history of disagreement between Ronald Coase and Benjamin Klein over the GM-Fisher case, among other issues. A few years ago I spent some time with Coase during his visit to Missouri for the CORI Distinguished Lecture. He concluded one conversation by announcing, with evident satisfaction: “I see all Kleins are not alike.”
- One of the funniest, and most unusual, people I knew at Berkeley was Matthew Rabin, then a new assistant professor and now a chaired professor, John Bates Clark medalist, and probable future Nobel laureate in economics. He had a little construction-paper clock on his office wall with one hand tracking years until the tenure decision and another, going the opposite direction, counting publications. I was later his TA for the second PhD micro theory course. Sample test question: “I have the opportunity to lock you up. If I lock you up, you will scream for help with probability p, which gives me a benefit of minus 30. . . .” I laughed often.
- My Dad had this remarkable distinction: there were two future Nobel laureates in his high school class. (It was an unusual school.) Herbert Hauptman got the prize in chemistry and Julian Schwinger in physics. Ken Arrow went to the same school, which also produced six Pulitzer Prize winners. (more…)
Best Part About Winning a Nobel Prize at Berkeley
| Peter Klein |
I might not believe it if I hadn’t seen these parking spaces — in very choice locations — with my own eyes. (Thanks to Peter H. for the link.)
The spaces are marked with special signs that read: “Reserved For NL/Special Permit Required At All Times.” That “NL,” of course, stands for Nobel laureate.
Physics professor George Smoot, who won the Nobel Prize in 2006, said there’s a catch to the permit: It’s free, but it’s not automatically renewed each year. Some of Berkeley’s Nobel laureates have let their permits lapse.
“It’s a temporary permit,” Smoot explained. “You’ve got to renew it every year — like your Nobel laureate’s going to go away, or something! And so, twice now I’ve gotten tickets because I didn’t, you know, remember to renew it on time.”
But Williamson says a little paperwork will not discourage him from getting the permit.
“I think it ought to be automated, but apply if I must, apply I will,” he said.
Williamson’s “Economics of Institutions” Syllabus
| Peter Klein |
I was pretty clueless when I started graduate school. I had good undergraduate training in economics, and had the privilege of attending my first Austrian seminar, where I met Murray Rothbard, Hans Hoppe, Roger Garrison, and David Gordon, before beginning graduate work. But I really didn’t know exactly what I wanted to study. Like most economics PhD students, I wasn’t exactly turned on by the core theory and econometrics classes. Then I took Williamson’s course ECON 224, “Economics of Institutions,” and it was a revelation. The syllabus dazzled me, with readings from Coase, Simon, Hayek, North, Arrow, Chandler, Alchian, Demsetz, Ben Klein, and many other brilliant and thoughtful economists, along with sociologists, political scientists, historians, and others. I decided then that institutions and organizations would be my area, and I’ve never looked back.
Since Monday I’ve been digging through my files trying to find a copy of that syllabus. I found my folder for that course, containing notes, readings, and exams (no, you can’t see my test scores), but for some reason the syllabus has disappeared. I must have taken it out to study, perhaps when designing my own course in institutions and organizations, and it didn’t make its way back into the file. But I did find an older copy, the Fall 1988 edition. That was, I believe, Williamson’s first year at Berkeley, after arriving from Yale (where he didn’t teach PhD courses, his main appointment being in the law school). I took the course in 1989, but the syllabi are very similar. So here it is. Note the range of authors, journals, subject areas. Not at all like the typical economics PhD course!
Wodehouse
| Peter Klein |
We interrupt Williamson Week to remind you that today, 15 October, is the birthday of the great P. G. Wodehouse. If I were really clever I’d write something like “Principal-Agent Conflicts between Wooster and Jeeves” or “Lord Emsworth as Charismatic Leader,” but the best I can do is share some favorite Wodehouse quotes that might apply to writing, research, and university life:
“I pressed down the mental accelerator. The old lemon throbbed fiercely. I got an idea.”
“He had just about enough intelligence to open his mouth when he wanted to eat, but certainly no more.” [A university administrator? Journal reviewer?]
“I just sit at a typewriter and curse a bit.”
“I know I was writing stories when I was five. I don’t know what I did before that. Just loafed I suppose.”
Williamson and the Austrians
| Peter Klein |
My short piece on Williamsonian transaction cost economics and its relationship to the Austrian approach is up on Mises.org.
Williamson Miscellany, Continued
| Peter Klein |
5. Many useful summaries of Williamson’s (and Ostrom’s) contributions are appearing online, such as those by Ed Glaeser, David Henderson, John Nye, Jeff Ely, and Alex Tabarrok. I think the first few pages of my “make-or-buy” chapter in the NIE Handbook provide a decent overview too. I also have some slides on transaction cost economics (part 1, part 2) that may be helpful for those seeking more detail.
6. Joshua Gans credits me with anticipating the award, which is nice, but undeserved — it was just wishful thinking on my part!
7. Oliver’s son Dean reports that he’s having trouble getting through to his folks: “The house in Berkeley had become such a media circus with every media entity from UPI to Al Jazeera trying to get through that I’ve been holding off with some of my own phone calls.” More important, Dean says his dad
has had a good attitude about these things. For years Berkeley would ask him to sign off on candidate press releases. But this would just get him a little worked up, and he might have a hard time getting to sleep. Could they stop that, please? On top of that, he appreciates that life has been good. No complaints, no reason to get worked up. Better to be Zen about the whole thing.
8. Scott Masten tells me O&M made a list of 100 best professor blogs. Scott and I agree that Williamson would gladly trade the Nobel prize for this honor instead. (more…)
Hoisted from the Comments: Hoopes on Williamson
| Peter Klein |
Former guest blogger David Hoopes’s comment deserves its own post:
So, we’re leaving the serious discussion to our goody two-shoes organizations twin? Was Will Mitchell a Williamson student? No one has said anything about Teece. Teece’s early JEBO articles did a great job talking about economies of scope and transaction cost influences on strategy.
Unmentioned yet, there has been some contentious discussion about the implications of TC economics on strategy and organization. Many including Connor and Prahalad consider the implications of TC to lead to bad management and bad strategy. However, our very own Steve Postrel wrote a great paper, “Islands of Shared Knowledge” that (esp in an earlier version) does a great job of comparing and contrasting the RBV and TC as theories of the firm.
Harold Demsetz weighed in on this earlier in his, “Theory of the Firm Revisited” (which is one of my favorite all time papers). Harold argues that firms would exist without governance problems. Steve has tried to get Harold to see the light (i’m not sure i do) but to no avail.
Of course, CERTAIN org theorists, whose names i do not mention think that Williamson’s logic, as does all competition-based economic theory, leads to evil and terrible results: unethical business students who become tomorrow’s headlines.
I’m very happy to see Williamson win. His influence on strategy and organization is immense. And, at this point, I don’t see any theory of the competitive firm can reasonably leave him out. I will admit, in terms of competitive heterogeneity and competitive advantage I don’t think governance is anywhere near as important as productive capabilities. BUT, capabilities literature still has a lot of work to do to be specified as exactly as TCE.
David, more serious discussion is on the way. Unfortunately, we O&Mers have higher opportunity costs than the bloggers at our good-twin site, so we can’t get the posts up as quickly as they can. :-)
Williamson Miscellany
| Peter Klein |
1. I’ve been at the SMS conference, and traveling, and haven’t had a chance to read the vast blogospheric commentary on Williamson (and Ostrom). Those looking for an introduction to Williamson’s work will find good stuff in the forthcoming Elgar Companion to Transaction Cost Economics, including an introduction by Williamson himself, and chapters on core subjects by eminent Williamsoninans.
Briefly, my own (admittedly biased) take is that Williamson is second only to Coase as the key figure in modern organizational economics. Moreover, his work has revolutionized the way economists (and some antitrust lawyers) understand markets. The perfectly competitive general-equilibrium model, Williamson’s work shows, is unrealistic, irrelevant, and a distraction. The task of economists studying firms and markets is to understand the marvelous variety of organizational forms that emerge in competitive markets, virtually none resembling the “firm” of microeconomics textbooks (what Williamson calls the production-function picture of the firm). “Nonstandard” phenomena like vertical integration, vertical contractual restrictions, alliances and joint ventures, long-term supply or distribution agreements, and the like should be celebrated, not condemned. (Williamson is more circumspect, arguing that each form of organization should be evaluated on the merits, case by case — a refreshing contrast to the standard approach in antitrust law, which is to assume that every deviation from perfect competition is “anticompetitive.”)
2. The Nobel Committee’s scientific statement cites one of my papers. How cool is that? Coauthor Howard Shelanski tells me that law professors note on their CVs if one of their articles is cited in a Supreme Court decision. You can be sure I’ll find a way to list this on mine. (more…)
Wiliamson Linking with Guile
| Lasse Lien |
Now that Williamson got what he deserved, the race is on to associate oneself as closely as possible with the great man (Williamson linking with guile). Some try to link him to their research field, saying that he is really in sociology, strategy, organization theory, IO, or whatever is their own field. Some go for the personal link: “I know him like the inside of my pocket,” or “he is like a father/son to me.” My version will be the institutional link (which seems appropriate for Williamson). My own institution gave Williamson his first honorary doctorate, at the initiative of my own department. Apparently we recognized greatness quite early. Unfortunately this was back in 1986, well before my time.
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