Posts filed under ‘Theory of the Firm’
Langlois Paper on the Theory of the Firm and Austrian Economics
| Nicolai Foss |
Former O&M guest blogger Dick Langlois is IMHO one of the most original thinkers in the field of economic organization. He is also one of the best writers in management and in economics. So I try to keep track of his writings and usually succeed. However, this paper, “The Austrian Theory of the Firm: Retrospect and Prospect,” written for a conference at the George Mason Law School last May, had escaped my attention until today.
Dick develops a number of related arguments. One is that Hayek (of the 1945 essay, “The Use of Knowledge in Society”) developed richer insights in economic organization than Coase. Moreover, by pointing out the importance of dispersed knowledge, the coordination problem this raises, and the importance of “change” for “economic problems,” Hayek anticipated the capabilities theory of the firm. In a parallel argument, Dick links his own work on the capabilities theory of the firm to Austrian capital theory (see also here and here). He ends by speculating on the future of Austrian arguments in the theory of the firm, noting various manifestations, particularly in strategic management, of these arguments (he notes that “Some work in this literature is close in spirit to my own, in some cases extremely close (Jacobides and Winter 2005)” — one agrees). Definitely worth a read!
Hart on Transaction Costs
| Peter Klein |
In a new paper, “Reference Points and the Theory of the Firm,” Oliver Hart reflects on the progress economists have made on the theory of the firm since 1937. He argues that despite many advances, economists still have difficulty operationalizing Coase’s notion of transaction costs, or “haggling costs,” as Hart calls them. Why, he asks, can’t managers strike efficient bargains — call them Coasian bargains, ironically, after Coase 1960 — with managers of other firms?
The transaction cost literature . . . has implicitly assumed the existence of haggling (or rent-seeking) costs: it has not confronted the issue of how to model them. The more formal property rights approach has sided with Coase (1960), thereby avoiding haggling costs. In a typical model the parties bargain costlessly ex post, and the focus is on ex ante investment inefficiencies. I have argued elsewhere (Hart and Moore (2007)) that, while such an approach can yield useful insights about optimal asset ownership, it is unlikely to be helpful for studying the internal organization of large firms. Specifically, in a world of Coasian bargaining, it is hard to see why important aspects of organizational form such as authority, hierarchy, and delegation matter. Why wouldn’t the parties simply bargain about everything all the time, using monetary sidepayments?
The answer, Hart suggests, lies in the concept of “reference points,” discussed here (and later published here). Drawing on concepts from behavioral economics, Hart argues that parties enter transactions with some notion of fairness, and renege on commitments or shirk on performance to the extent that they feel aggrieved, or shortchanged relative to this reference point. (more…)
A Really Old Family Firm
| Peter Klein |
One advantage of the public corporation over the family-owned firm is longevity: few family firms last beyond two or three generations. Saturday’s WSJ profiled an interesting exception: Marchesi Antinori Srl, a wine business founded by Giovanni di Pietro Antinori in 1385 and run today by Piero Antinori, 26 generations later. Some of the Antinoris’ unusual business practices:
The Antinoris have flourished in part because of their willingness to flout conventional wisdom over how a family company should be run. Instead of creating clear lines that separate the family’s interests from the company’s, the Antinoris blur the two beyond recognition. The Marquis, his wife and their youngest daughter still live on the top two floors of the 15th-century Palazzo Antinori, a few steps from the Florence cathedral, where the family has resided for the past five centuries.
The business is still run on the palazzo’s bottom two floors, and the three daughters are top executives. . . .
Though the company has a six-person board of directors — including two non-family members — the Marquis says it only meets “for formalities.” The real board meeting, he says, “happens every Sunday, when we sit down to lunch.” That often takes place in one of the family’s nearby vineyards, either in the hills of Chianti, or along the Tuscan coast.
Instead of focusing on quarterly results, the Antinoris plan far into the future, laying the foundations for a company their grandchildren can run. They have been wary of following popular business trends. The family is suspicious of growing too much, which they say can compromise quality and run a company into debt.
One should be wary of drawing strong inferences from a sample of one. Of course, as Herbert Simon once noted, a sample of one is infinitely more informative than a sample of none.
Here is the Antinori wikipedia page. are some older posts on family firms.
Hubbard on Firm Boundaries
| Peter Klein |
Thomas Hubbard has a nice review article in the May 2008 issue of the Canadian Journal of Economics, “Empirical Research on Firms’ Boundaries.” (Thanks to Fabio Chaddad for the pointer.) It’s a well-worn subject but there is certainly room for new interpretations. And Hubbard himself has been an important contributor to this literature (e.g., here and here). Here’s the abstract:
La recherche empirique sur les déterminants des frontières de l’entreprise a fleuri au cours des derniers 25 ans. Cet article discute des progrès accomplis en mettant l’accent sur les avancées intellectuelles faites par les chercheurs dans la littérature spécialisée durant cette période. On souligne le rôle important des chercheurs empiriques dans l’opérationnalisation des concepts théoriques, et on explique comment les succès dans ce registre ont contribué à faire que ces concepts ont eu un impact sur les décisions de faire-ou-faire-faire dans la vie réelle. On discute aussi des déficiences de cette littérature — en particulier la pauvreté des travaux de recherche sur l’impact de la variation dans les frontières des entreprises sur les rendements économiques — et on suggère comment de telles déficiences pourraient être corrigées.
Ha ha, April Fool’s! OK, here it is in English: (more…)
Newspapers as Coasian Firms
| Peter Klein |
The hunter-gatherer model of journalism is no longer sufficient. Citizens can do their own hunting and gathering on the Internet. What they need is somebody to add value to that information by processing it — digesting it, organizing it, making it usable.
This is why we still need newspapers — or something like them. Ronald Coase, the British economist, once asked why we need business firms. Why can’t all their activities be coordinated by individuals contracting with one another instead of working in a bureaucratic, command-and-control environment? The answer, he said, is transaction costs. If a manager had to negotiate with a free-lancer for every task, the cost in time would be unbearably high.
Searching for information on the Internet involves something like transaction costs because we have so many varied sources to evaluate. We need somebody we trust to organize them for us. That can be the task of the new journalism.
That’s from the retirement speech of UNC journalism professor
The Make-or-Buy Decision: Corporate Lawyer Edition
| Peter Klein |
What are our Lawyers made of?
What are our Lawyers made of?
Of Causes and fees, demurrers and pleas,
Learned Brother and lots of pother,
Counsel and jury with very wise looks,
Flaw in the indictment and statue books,
Such are our Lawyers made of,
Such are our Lawyers made of.
That’s one answer. It ain’t sugar and spice and everything nice, that’s for sure. Whatever lawyers are made of, should firms make them in-house, or hire ones made by somebody else? Steven Schwarcz addresses this question in a new paper, “To Make or to Buy: In-House Lawyering and Value Creation” (Journal of Corporation Law, Winter 2008). Schwarcz notes that large firms have been shifting much of their transactional work from outside law firms to in-house lawyers. Analysis of survey data suggests that information costs and scale and scope economies are the most important drivers of this trend. Asset specificity seems to play a less important role, mainly because reputation effects are sufficient to mitigate opportunistic behavior by outside law firms. A very interesting paper on the make-or-buy decision.
Shared Governance: Benefits and Costs
| Peter Klein |
Back in grad school I was regularly hectored by a fellow student about joining the Association of Graduate Student Employees (AGSE), our local collective-bargaining association. Despite his attempt to stigmatize me as a free rider, I never joined. I didn’t think I agreed with the organizations goals, and I was sure I didn’t want to be associated with AGSE’s parent organization, the United Auto Workers (go figure). One year there was even a strike, which I found silly (I scabbed).
This semester I’m getting repeated invitations to join the American Association of University Professors (AAUP). Again, I hesitate. Of course, as an American university professor, I’m happy to see more power, prestige, and perquisites go to American university professors (OK, specifically, to me). But the AAUP has a strange agenda. Its mission includes not only protecting academic freedom and defending the role of the university in public life, but also preserving shared governance. Having spent many years in university settings, I’m convinced that shared governance is grossly inefficient, at least most of the time. There can be benefits, of course, to offset these costs, as is the case with worker-owned cooperatives and other non-standard forms of organization. But one searches the AAUP’s website in vain for any analysis or evidence on shared governance. What are the benefits and costs, relative to other feasible organizational forms? Why should professors defend this peculiar institution? (more…)
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.
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?
To 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?
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…)
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).
Economics and the Rule of Law
| Peter Klein |
This week’s Economist features a summary of recent economic controversies about the rule of law (thanks to Fabio Chaddad for the pointer). There is near-universal consensus among specialists in economic history and economic growth that the legal rules — and institutions more generally — “matter,” though the precise mechanisms are in dispute, and aspects of the institutional environment such as the quality of legal rules are difficult to measure consistently across societies and over time. We’ve touched on the closely related “legal origins” debate before. As with that controversy, the arguments in this one have become more subtle and complex in the last decade. As the Economist notes:
[A]s an economic concept the rule of law has had a turbulent history. It emerged almost abruptly during the 1990s from the dual collapses of Asian currencies and former Soviet economies. For a short time, it seemed to provide the answer to problems of development from Azerbaijan to Zimbabwe, until some well-directed criticism dimmed its star. Since then it has re-established itself as a central concept in understanding how countries grow rich — but not as the panacea it once looked like.
The Economist piece focuses on the distinction between “thick” and “thin” understandings of the rule of law. (more…)
Upcoming Events: A Busy June
| Peter Klein |
June is an exciting month for O&Mers looking for research conferences. First up is ACAC 2008, 12-14 June in Atlanta. ACAC, which has received high marks on this blog, is an annual workshop organized by Rich Makadok emphasizing the “big issues” in strategic management. Next is the DRUID 25th Anniversary Conference, 17-20 June in Copenhagen, with the theme of “Entrepreneurship and Innovation.” The distinguished participant list includes Rajshree Agarwal, Carliss Baldwin, Bo Carlsson, Kathy Eisenhardt, Maryann Feldman, Bronwyn Hall, Steve Klepper, Anita McGahan, Joanne Oxley, Olav Sorenson, Scott Stern, Sid Winter, and some Foss guy. Immediately afterward is ISNIE’s 12th annual meeting, 20-21 June, in Toronto. I am on the program committee, working with president-elect Scott Masten, and we got a bunch of great submissions this year. Barry Weingast and Robert Ellickson are keynoters. The preliminary program should be up on the ISNIE website soon.
Also, for graduate students in economics, history, philosophy, political science, business administration, and related disciplines there’s the Rothbard Graduate Seminar, 13-18 June in Auburn, Alabama. The RGS is an intensive workshop and research seminar on Austrian economics that uses Murray Rothbard’s Man, Economy, and State as its core text. I am one of the discussion leaders.
If I could teleport I’d attend all four!
Asset Specificity and International Trade
| Peter Klein |
The May 2007 issue of the Quarterly Journal of Economics featured a nice piece by Nathan Nunn, “Relationship-Specificity, Incomplete Contracts, and the Pattern of Trade.” The paper constructs an aggregate, country-level measure of asset specificity and relates it to characteristics of a country’s contract-law regime and its patterns of international trade. When asset specificity is high, firms tend to rely on contracts or vertical integration, rather than spot markets, so countries with good legal protection for contracts are more likely to specialize in the production of goods requiring specific investments.
Is a country’s ability to enforce contracts an important determinant of comparative advantage? To answer this question, I construct a variable that measures, for each good, the proportion of its intermediate inputs that require relationship-specific investments. Combining this measure with data on trade flows and judicial quality, I find that countries with good contract enforcement specialize in the production of goods for which relationship-specific investments are most important. According to my estimates contract enforcement explains more of the pattern of trade than physical capital and skilled labor combined.
One can quibble about the data and variables, such as the proxy for asset specificity (the absence of organized exchange or a publicly listed price for an input) and use of national input-output tables to construct measures of vertical integration, but overall this strikes me as an impressive piece of work, a clever combination of transaction cost economics and international trade theory. Check it out.
Steven Cheung Has a Blog
| Peter Klein |
Unfortunately it’s in Chinese. Perhaps one of our Chinese-speaking readers could summarize its contents?
Here is an English-language blog dedicated to Cheung’s ideas. Here is his wikipedia entry, which includes some information on the Late Unpleasantness. And of course the economic analysis of property rights, to which Cheung is a major contributor, is a popular topic on this blog.
New NSF Solicitation
| Steve Phelan |
This call might be of interest to organizational economists:
From Jack M at the NSF:
NSF issued a new solicitation on Virtual Organizations as Sociotechnical Systems yesterday. Proposals are due 2 June.
Further information and a link to the solicitation itself can be found at:
http://www.nsf.gov/funding/pgm_summ.jsp?pims_id=503256&org=NSF&sel_org=NSF&from=fundThis is a wonderful opportunity for US-based social scientists working on topics pertinent to virtual organizations, broadly construed. A synopsis and list of some potential topics is provided below. (more…)
Langlois Economics of Organization Course
| Peter Klein |
Don’t you wish you could sign up? Fortunately the reading list and slides are available to all. And check out this great homework assignment.
The Original Corporate Raider
| Peter Klein |
Did you catch Henry Manne’s tribute to Louis E. Wolfson, whom Manne calls “the original corporate raider,” in the 18 Jan WSJ?
[T]he obituaries dutifully acknowledged that he was a serious and valued benefactor of children’s health care, and that he devoted himself in later life to the cause of penal reform. . . . They missed the big story. Wolfson’s contribution to human welfare far exceeded the total value of all private philanthropy in history. He invented the modern hostile tender offer. This invention, which activated and energized the market for corporate control, was the primary cause of the revolutionary restructuring of American industry in the 1970s and ’80s, and the ensuing economic boom.
Before Wolfson’s innovation, executing a “hostile” (i.e., against the wishes of incumbent management) takeover required winning a long and potentially costly proxy contest. Now, potential bidders could appeal directly to shareholders, asking them to “tender” their shares at the offered price, bypassing the incumbent management team altogether. Naturally, this outraged the business establishment — the “powerful corporate elite of the 1960s,” as Manne calls them — and pressure mounted for legislation to restrict hostile takeover offers, leading to the 1968 Williams Act, designed to protect incumbent managers by giving them time to prepare counter-offers and otherwise restricting “raiders.” (more…)
Adoption and Diffusion of Organizational Innovation
| Peter Klein |
Most theories of organizational form are framed in comparative-static, equilibrium terms. What organizational forms — degree of vertical integration, use of incentive pay, assignment of decision rights, and the like — are “optimal” in given circumstances (transactional attributes, industry conditions, legal or political environments)? There are lots of theoretical and empirical studies on these questions. And yet, we know relatively little about how new organizational forms emerge and how existing organizations change. Is change explained best in a comparative-statics framework — some underlying condition changed, leading firms to jump from the previously optimal, equilibrium form to a new, equilibrium form? Or is some kind of experimental, evolutionary, or institutional model required?
A new paper by Lisa Lynch, “The Adoption and Diffusion of Organizational Innovation: Evidence for the U.S. Economy,” addresses these questions empirically:
Using a unique longitudinal representative survey of both manufacturing and non-manufacturing businesses in the United States during the 1990’s, I examine the incidence and intensity of organizational innovation and the factors associated with investments in organizational innovation. Past profits tend to be positively associated with organizational innovation. Employers with a more external focus and broader networks to learn about best practices (as proxied by exports, benchmarking, and being part of a multi-establishment firm) are more likely to invest in organizational innovation. Investments in human capital, information technology, R&D, and physical capital appear to be complementary with investments in organizational innovation. In addition, non-unionized manufacturing plants are more likely to have invested more broadly and intensely in organizational innovation.
See also this paper on the evolution of contractual practices in US agriculture.
Erin Anderson (1955-2007)
| Peter Klein |
Erin Anderson, John H. Loudon Chaired Professor of International Management at INSEAD and one of the pioneers of empirical research in transaction cost economics, died of an inoperable brain tumor this past November. Her papers “Integration of the Sales Force: An Empirical Examination” (Rand Journal of Economics, 1984, with David Schmittlein), “The Salesperson as Outside Agent or Employee: A Transaction Cost Analysis” (Marketing Science, 1985), and “The Multinational Corporation’s Degree of Control Over Foreign Subsidiaries: An Empirical Test of a Transaction Cost Explanation” (JLEO, 1988, with Hubert Gatignon) were extremely influential in the transaction-cost literature. They also showed, importantly, how TCE can be applied not only to backwards integration into component procurement, but also to forwards integration into marketing and distribution. She became one of the leading specialists in management and marketing on vertical integration and entry into foreign markets. Her chapter (with Gatignon) in the Handbook of New Institutional Economics, “Firms and the Creation of New Markets” (draft version here) provides an excellent overview of this work.
Erin was a warm, friendly, and helpful colleague and mentor as well as a fine scholar. Read the tributes at this INSEAD memorial page. I saw her last in April 2006 when she presented her paper “How Internal Transaction Costs Drive Compensation of Managers and Salespeople in Business-to-Business Field Sales” here at CORI. I never imagined it would be our last visit.
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