Posts filed under ‘Theory of the Firm’
Organizational Structure and the Diversification Discount
| Peter Klein |
Do diversified conglomerates trade at a discount relative to more specialized firms? A huge literature in strategy and corporate finance emerged over the last couple of decades devoted to this question. Early studies claimed to find a substantial diversification discount, though more recent papers claim that the observed discount is due to measurement error, self-selection, and other characteristics, not a harmful effect of diversification per se. (For a good overview of this literature, now slightly dated, see this roundtable report edited by Belén Villalonga. Some of my own contributions are here and here.)
Seemingly lost in the search for a diversification discount, however, is a related question: What is being discounted? Potential benefits of diversification, according to the literature, include access to internal capital markets and more efficient redeployment of distressed assets; potential costs include inefficient rent-seeking, bargaining problems, and bureaucratic rigidity. But these benefits and costs have little to do with industry or geographic diversification per se — they apply to the management of any multi-unit organization, even if its activities do not span different industries or regions.
In a new paper, “Organizational Structure and the Diversification Discount: Evidence from Commercial Banking,” Marc Saidenberg and I try to distinguish the effects of diversification and organiztaional complexity by studying multi-unit firms within a single industry, commercial banking. (more…)
O&M at the AoM
| Peter Klein |
Ah, Los Angeles . . . land of “tattoos, breast implants, bleached hair, and vacuous egos,” as Nicolai recently wrote on Facebook. And then there are the people not in town for the Academy of Managment meeting!
As readers may know, the AoM is meeting this week in Anaheim. The O&M crowd is well represented, as usual. You can search the online program for your favorite person, subject, or interest area. Below are some of the sessions involving O&Mers, past and present: (more…)
Homogeneity and Cooperation
| Peter Klein |
Why are Scandinavians so cooperative? Nicolai and Lasse might suggest it’s their superior moral character. La Porta et al. (1997), Putnam et al. (1992), and others point to Protestantism: hierarchical religions like Catholicism and Islam, it is argued, tend to discourage trust and retard the development of social capital. The Protestants, who already have Max Weber in their corner, seem to be piling it on.
Not so fast, says Kevin O’Rourke in a recent paper, “Culture, Conflict, and Cooperation: Irish Dairying Before the Great War” (Economic Journal, October 2007). O’Rourke compares the Danish and Irish dairy industries before 1914 and argues that cultural and ethnic homogeneity, not religion, explains the success of Danish cooperatives. Unlike recent large-sample econometric work on trust, the paper uses deeper, more robust indicators of cooperation. Key findings:
At first sight, the contrast between Protestant Ulster and the Catholic South (as well as between Denmark and Ireland as a whole) seems a striking confirmation of the LLSV hypothesis that culture matters for the ability to cooperate, and that hierarchical religions such as Catholicism undermine both trust and cooperation. However, on closer examination it appears that politics, not culture, was responsible for the lower Irish propensity to cooperate. Suspicion between Catholics and Protestants, and tenants and landlords, spilled over into Nationalist suspicion of the cooperative movement and hindered its spread, despite the efforts of the [Irish Agricultural Organisation Society] to remain apolitical. To this extent, the results are more consistent with the stress on [ethnolinguistic fractionalisation] in Alesina and La Ferrara (2000) than with the cultural perspective of LLSV, Knack and Keefer (1997) and Zak and Knack (2001).
Denmark benefited from several relevant advantages that Ireland did not enjoy during this period. In particular, it was an extremely homogeneous country, ethnically, religiously and linguistically. There was no conflict over who should own the land, since land reform in Denmark had been underway since the late eighteenth century. . . . Nor was there any ethnic conflict, or disputes over where national boundaries should lie (all such controversies became redundant following the loss of Schleswig-Holstein in 1864). The results suggest that this homogeneity of Danish society is what explains the success of cooperation there.
Neuroeconomics and the Firm
| Peter Klein |
I’m not a big fan of neuroeconomics — Gul and Pesendorfer’s critique seems about right to me — but if you like that field you may be interested in this call for book chapters:
Neuroeconomics and the Firm
Editors:
Mellani Day
Angela Stanton
Isabell WelpeHow can we take advantage of neuroeconomics to inform organizations? Neuroscience can provide us with ways to understand causal relationships; it enables us to identify the biological drivers of beliefs, opportunity perception, opportunity analysis, risk-aversion or risk-seeking, motivation, incentives and reward mechanisms; in other words, we can map the pre-decisional dynamics of the human brain. Neuroeconomics has yielded important new insights and may provide powerful new ways of looking at the firm. (more…)
São Paulo Workshop on Institutions and Organizations
| Peter Klein |
See below for information on the Third Research Workshop on Institutions and Organizations, 13-14 October 2008 at Fundação Getúlio Vargas in Brazil. Session topics include “Organizations, law and corruption,” “Institutions and development,” “Institutions and environment,” “Psychological issues and organization strategies,” and “Industrial and competition policy.”
I participated in last year’s conference and enjoyed it tremendously. There is a growing network of Brazilian researchers working on various topics in the New Institutional Economics. It is a good group to be involved with. (more…)
NIE Guidebook
| Peter Klein |
The long-awaited New Institutional Economics: A Guidebook is due out this September from Cambridge University Press. Editors Eric Brousseau and Jean-Michel Glachant assembled an all-star team including Oliver Williamson, Paul Joskow, John Nye, Gary Libecap, Lee Alston, Pablo Spiller, Benito Arruñada, Stéphane Saussier, Jackson Nickerson, Brian Silverman, Joanne Oxley, Mike Sykuta, Mike Cook, and many others — even Foss and Klein. You can pre-order yours today — the hardback’s a whopping $140 but the paperback’s only $59.
Here’s the official CUP page and here’s an information page put together by Eric Brousseau. It should be a valuable reference for years to come.
Technology and Firm Size and Organization (Redux)
| Dick Langlois |
Peter blogged a while ago about an article by Giovanni Dosi, Alfonso Gambardella, Marco Grazzi, and Luigi Orsenigo in the bepress online journal Capitalism and Society. Both this article and the accompanying discussion by Bill Lazonick take aim at my 2003 article “The Vanishing Hand.” I have now crafted a response, which I propose to submit to the journal as a letter. But readers of O&M can read it right away here.
I should also mention that the same issue of Capitalism and Society has an interesting article on the family firm by Princeton historian Harold James, with a wonderful comment by Randall Morck. I met Morck this past November at a conference in Kyoto, and was extremely impressed.
Opportunities and Entrepreneurship Research: A Critique
| Peter Klein |
The notion of economic “opportunities,” and their discovery or creation, is one of the core concepts of contemporary entrepreneurship research. But the use of opportunities as the unit of analysis poses several problems. The opportunity-discovery or opportunity-recognition perspective tends to treat economic opportunities as objective phenomena, while, under Knightian uncertainty, profit opportunities are always subjective, existing only in the imagination of economic actors. In an alternative view that Nicolai and I have elaborated in several papers, entrepreneurship is best understood not as perception, but as action, the investment of resources under uncertainty in anticipation of uncertain rewards.
In a new paper, “Opportunity Discovery, Entrepreneurial Action, and Economic Organization,” I critique the opportunity-discovery perspective in more detail. In particular, I argue that the literature has misunderstood Israel Kirzner’s concept of “discovery,” the theoretical basis of much of the research on opportunity discovery. Kirzner’s explanandum is not entrepreneurship per se, but equilibration. He invokes the entrepreneur, and his “alertness” to exogenously determined profit opportunities, as a metaphor, to explain the tendency of markets to clear. It is not meant as a positive account of the entrepreneurial function, but rather an instrumental explanation of the market process. Hence a research program based on operationalizing “opportunities,” exploring thow they can be “discovered without search,” and so on, is unlikely to bear fruit.
The paper is forthcoming in the Strategic Entrepreneurship Journal. Comments welcome. Abstract below the fold. (more…)
Pirrong on Speculation
| Peter Klein |
Following up Dick’s post on speculation, Craig Pirrong had a nice piece in Friday’s WSJ providng more details on oil markets. Notes Craig:
The unprecedented run-up in oil prices is painful for consumers around the world. But the focus on speculation is misguided, and represents a convenient distraction from an understanding of the real, underlying causes of high oil prices — most notably continuing demand growth in the face of stagnant production, supply disruptions and the weakening dollar.
More restrictions and regulations of energy markets, in the vain belief that such actions will bring price relief, are counterproductive. They will make the energy markets less efficient, rather than more so.
The pointer is from Mike Giberson, who provides more information and links to Craig’s (brilliantly named) blog, Streetwise Professor. Craig testified Friday on oil-market speculation before the US House Agriculture Committee; you can read his remarks here. And for a classic paen to speculation more generally, see Victor Niederhoffer’s classic “The Speculator as Hero.”
Note to graduate students: If you haven’t read Craig’s classic papers on bulk shipping, introducing the concept of “temporal specificity,” your education is incomplete. Check ’em out:
Pirrong, Stephen C. 1992. “An Application of Core Theory to the Study of Ocean Shipping Markets.” Journal of Law and Economics 35: 89–131.
Pirrong, Stephen C. 1993. “Contracting Practices in Bulk Shipping Markets: A Transactions Cost Explanation.” Journal of Law and Economics 36: 937–76.
Technology and Firm Size and Organization
| Peter Klein |
As a New Economy skeptic (1, 2, 3, 4) I worry about sweeping claims that information technology has rendered obsolete the large, vertically integrated, publicly held corporation and its managerial hierarchy. Such claims suffer from two problems: First, they tend to be thinly documented — evidence on the economy-wide distribution of organizational forms is largely fragmentary and anecdotal. Second, they usually exaggerate what’s new about those changes that we can document. As I wrote in my review of Yochai Benkler’s The Wealth of Networks:
Benkler proposes social production as an alternative to the traditional organizational modes of “market” and “hierarchy,” to use Oliver Williamson’s terminology. Indeed, open-source production differs in important ways from spot-market interaction and production within the private firm. But here, as elsewhere, Benkler tends to overstate the novelty of social production. Firms, for example, have long employed internal markets, delegated decision rights throughout the organization, formed themselves into networks, clusters, and alliances, and otherwise taken advantage of openness and collaboration. There exists a variety of organizational forms that proliferate within the matrix of private property rights. Peer production is not new; the relevant question concerns the magnitude of the changes.
Here, the book suffers from a problem common to others in this genre. Benkler provides a wealth of anecdotes to illustrate the revolutionary nature of the new economy but little information on magnitudes. How new? How large? How much? Cooperative, social production itself is hardly novel, as any reader of “I, Pencil,” can attest. Before the web page, there was the pamphlet; before the Internet, the telegraph; before the Yahoo directory, the phone book; before the personal computer, electric service, the refrigerator, the washing machine, the telephone, and the VCR. In short, such breathlessly touted phenomena as network effects, the rapid diffusion of technological innovation, and highly valued intangible assets are not really really new. (Tom Standage’s history of the telegraph and its own revolutionary impact, The Victorian Internet [New York: Walker & Company, 1998], is well worth reading in this regard.)
A new paper by Giovanni Dosi, Alfonso Gambardella, Marco Grazzi, and Luigi Orsenigo, “Technological Revolutions and the Evolution of Industrial Structures: Assessing the Impact of New Technologies upon the Size and Boundaries of Firms,” looks at the empirical evidence more systematically and concludes that the effect of information technology on firm size and organization is real, but modest: (more…)
More on the Economic Organization of Law Firms
| Peter Klein |
As a follow up to these comments about the organizational structure of professional-services firms, law firms in particular, note Tom Ulen’s remarks on some recent trends, e.g., the growing importance of specialized, niche firms that provide specific services to corporate clients on a short-term basis.
The Ecconomics of Organizing Economists
| Peter Klein |
Most regulatory agencies are staffed by a mix of attorneys and economists. Members of these groups do not always play well together. How, then, should such an agency be organized — functionally, putting the economists in a single unit, reporting to a chief economist, or divisionally, spreading the economists throughout divisions organized by legal issue, industry sector, geographic region, etc. and having them report to an attorney in charge of each division? An interesting application of the U-form versus M-form problem posed by Chandler (1962).
An analysis of organizational structure at US and European competition agencies by Luke Froeb, Paul Pautler, and Lars-Hendrik Roller (via Dan Sokol) finds that
the main advantage of a functional organization is higher quality economic analysis while the disadvantage is that the analysis may not be focused on legal questions of concern, and is less easily communicated to the ultimate decision makers. Likewise, the advantages of a divisional organization are decentralized, and faster, decision making; however, the quality of the economic analysis is likely to be lower and can result in less information reaching the ultimate decision makers.
Froeb, Pautler, and Roller suggest that hybrid forms, such as (a) functional organizations with strong horizontal links between economists and attorneys or (b) divisional organizations with strong vertical links between economists and attorneys, and managers trained in both law and economics, are best.
My own experience at the CEA confirms the importance of both the vertical and horizontal links. We economists were organized into a focused unit for major projects like the Economic Report of the President but were also assigned to ad hoc, inter-Agency teams working on specific policy issues (I dealt with spectrum auctions, the pricing of air traffic control, and foreign ownership of domestic telecom assets, among other things). I was typically the lone economist (though hardly the nerdiest member) on each team.
The Puzzle of the Publicly Held Private-Equity Firm
| Peter Klein |
Like many observers, I was puzzled by last year’s IPO of the Blackstone Group, one of the nation’s largest private-equity firms. After all, the ability of PE firms to restructure and improve poorly performing companies owes a lot to their isolation from the day-to-day pressures of satisfying public investors. PE firms already face potential agency conflicts between their general partners and the managers of their portfolio companies, and between their general and limited partners; why add agency problems between the partners and public shareholders? Has the credit squeeze raised the cost of debt finance that much?
Today’s WSJ reports that KKR, which considered going public last year but pulled out, is again pondering an IPO:
The storied corporate-buyout firm has quietly and aggressively hired a battery of executives in recent months, creating an organization chart that looks remarkably similar to that of a public company. It has brought on a general counsel, a public-affairs chief, a chief compliance officer, a chief technology officer, a chief talent officer and a chief human-resources officer. . . .
[P]eople close to KKR acknowledge that it is still keen on becoming a public company and a raft of recent shifts, including the hiring spree, speak to a broader change at the firm and how it views its business.
Perhaps the publicly held PE firm is best described as a new hybrid form, an organization that combines the governance advantages of private equity with the lower capital costs of the publicly traded corporation. Or does it combine the worst features of both?
Vertical Is the New Horizontal
| Lasse Lien |
Unrelated horizontal diversification is widely seen as smoking-gun evidence of agency problems, and heavily sanctioned by capital markets, boards, media, etc. Consequently, we don’t see much blatant conglomeration anymore. But if you are a manger with a strong desire to build an empire, or more generally grow at “all costs,” what do you do?
My conjecture is that unjustified vertical integration is increasingly taking the place of unjustified horizontal diversification as an expression of such tendencies. Why? Simply because the penalties (i.e. the costs) of growing via the latter have increased, which presumably creates a tendency to substitute towards the former.
Admittedly, I don’t have much data to support this, but I do seem to recall that Fan & Lang (2000) found a strong positive link between verticality and the diversification discount. Less scientifically, I have tourist sampled the link between vertical integration and government ownership in my home country (Norway). There seems to be a strong positive correlation between public ownership and vertical integration, but no obvious correlation with horizontal diversification.
Notes from DRUID
| Dick Langlois |
I am in Copenhagen for the DRUID 25th Celebration Conference, which finished up yesterday. It’s called the 25th Celebration because it’s the 25th DRUID conference -– there have been generally two a year since the organization started in 1995. This conference represents a transition for DRUID, which has grown considerably over the years. One indication of transition is that the old scientific advisory board, of which I had been a member since 1996, has been dissolved and a new one reconstituted. The new board is made up of a number of smart and interesting people, but it tends more toward management and economic geography and away from the theory of the firm and industry as represented by the likes of Bo Carlson, Brian Loasby, and George Richardson (and me). It was perhaps fitting that Brian was asked to press the button that touched off the fireworks over the harbor after last night’s conference dinner.
Some highlights.
Steven Klepper presented the first keynote, a further development of his long-term research program on industry structure and the birth and death of firms. (I missed the very beginning of the talk because I was having breakfast with Nicolai; fortunately, the paper is available here.) What Klepper does is essentially top-flight quantitative economic history. In this paper he takes on the conventional wisdom (A) that Silicon Valley is unique because of the rate of spinoffs it engendered and (B) that universities are crucial to the spinoff process. It turns out that the early auto industry in Detroit and the early tire industry in Akron had almost identical spinoff patterns, both sans university. (In fact, there were more spinoffs than in Silicon Valley.) In Klepper’s account -– notably different from most accounts –- clusters arise when new profit opportunities get seized by defection of key personnel rather than through internal diversification. In all cases, the cluster tend to consist of successful spinoffs from already successful firms. Genuine new entrants and spinoffs from less-successful firms seldom prosper. Defections have to do in large part with the dysfunctionality of the parent company, involving a problem either with expectations (as when the soon-to-be defectors couldn’t convince management of the value of their ideas) or of incentives (read: inadequate stock options). There is an interesting connection here with the Penrose/Chandler theory of the growth of the firm. Penrose seems to assume, and Chandler more than assumes, that firms always build internal capabilities and then use their excess resources to diversify internally into profitable related areas. Klepper shows that those opportunities often result in the formation of new firms. (more…)
Ben Klein’s Contributions to Law and Economics
| Peter Klein |
Josh Wright has written a nice piece on Benjamin Klein for Josh’s forthcoming volume with Lloyd Cohen, Pioneers of Law and Economics. Klein’s 1978 paper with Armen Alchian and Robert Crawford and his 1981 paper with Keith Leffler are of course part of the organizational economics canon. His ongoing debate with Ronald Coase on the GM-Fisher Body case has helped clarify important issues on the role of asset specificity in vertical integration.
Trivia: Klein and Walter Block were college roommates at Columbia. Walter tells me they even went together to Ayn Rand’s apartment once during Walter’s Randian phase.
Reliving the 1980s
Peter Klein |
I recently watched the new Rambo film, an entertaining spectacle of blood and gore (for those who enjoy that sort of thing). The last few years have brought back several 1980s-era action heroes after long absences, not only Rambo but also Rocky Balboa, John McClane, the Terminator, and of course Indiana Jones.
We posted a while back on the golden decade of the 1970s, a fantastically productive period for research in organizational economics. How about bringing back the 1980s? Not the mullet, but the great works in organizational economics, strategy, entrepreneurship, and related subjects that appeared in that decade. Here are some of my favorites, listed chronologically. What are yours? (more…)
Middle Managers in the Theory of the Firm
| Peter Klein |
The current issue of Knowledge@Wharton features a piece on the challenges facing middle managers. The middle-management role is typically high in responsibility and low in authority — middle managers are accountable for the performance of their subordinates but selective intervention from above makes it difficult for them to commit to particular incentive schemes. Moreover:
[T]op reasons for dissatisfaction among middle managers include micromanagement by senior managers and lack of respect, says [author David] Sirota. “And sometimes the senior leader is just really ineffective; middle managers don’t want to be in a company that is run by that type of person.” . . .
Navigating the various relationships upward, downward and horizontally can be an emotional management challenge, adds Wharton management professor Sigal Barsade. “This is particularly noticeable with organizational change. If you are a middle manager, there may be a change that you didn’t have much to do with, but you need to translate it to your people and make them feel protected and valued. However, you are also someone being impacted by the change. Because you didn’t design the change, you might be left feeling like you don’t know what to do yourself, but you still need to comfort, protect and inspire your people.”
A more colorful description is provided by Chef Shuna Fish Lydon who blogs on all things culinary at eggbeater. Here she is on the role of the sous chef: (more…)
The Sphere of Economic Calculation
| Peter Klein |
Today’s Weekend Article from the Mises Institute is “The Sphere of Economic Calculation,” an excerpt from chapter 12 of Mises’s Human Action. (Check out the super-cool graphic!) The article expands on Mises’s pathbreaking 1920 paper on the need for prices in any system that aims at a rational allocation of resources.
Mises’s theory of factor pricing and its role in cost accounting — what he calls the problem of “economic calculation” — is near and dear to my heart, having written one of my first published articles on the subject. It’s also received a bit of attention here at O&M (1, 2, 3, 4, 5).
The Nature of the (Law) Firm
| Peter Klein |
Gordon Smith shared an interesting report on a recent Georgetown conference, “The Future of the Global Law Firm.” Apparently there is a healthy literature in legal scholarship examining the boundaries and internal organization of law firms. Writes Gordon:
The participants seem to have reached a few points of consensus. First, the legal profession has changed dramatically in the past two decades and it remains under significant stress, meaning that more change is on the way. Second, the rules that constrain change (e.g., prohibition of non-lawyer ownership, rules relating to conflicts, non-competition rules) should be changed sooner rather than later. Third, the traditional legal form (partnership) is largely irrelevant to the current practice of law, even if law firms want to create an organizational structure that encourages the collegiality of a traditional partnership. Fourth, the law firms that will succeed in the future are those that get the organizational structure right.
In a follow-up email, Gordon explains that the organizational features being challenged include the partnership model, the up-or-out “Cravath system,” and the outsourcing of routine services (e.g., electronic discovery) to places like India. Gordon recommends Laura Empson’s Managing the Modern Law Firm for an overview of the issues. I said I thought there was some work by economists and management scholars on the economic organization of the law firm (and professional services firms more generally), but couldn’t come up with much, aside from a series of interesting papers by Luis Garicano and Thomas Hubbard (here, here, and here). Any suggestions from our readers? Is the persistence of the partnership form, for example, mainly the result of arcane professional-ethics rules or is there an underlying efficiency rationale? If consulting firms can have IPOs, why not law firms?
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