Posts filed under ‘Theory of the Firm’
Podcasts with the Big Boys
| Peter Klein |
O&M tells you all you need to know about mechanism design. For outside opinions, however, listen to these Bloomberg on the Economy podcasts with Paul Samuelson, Kenneth Arrow, Amartya Sen, and Thomas Schelling, commenting on the implications of mechanism design and game and information theory more generally. Supposedly they know something about this stuff.
More on the Noble Prize (or the Economics Prize in Memory of Nobel)
| David Hoopes |
Since the O&Mers have been so quiet about the N prize I guess I’ll ramble a bit. In a comment on one of Peter’s posts I mentioned Demsetz and Alchian. For some reason I had it in my head that A.A. had already won. That’s what I get for staying at UCLA for so long (Alchian had just quit teaching when I got there).
I don’t know why I thought Alchian had won it. “Production, Information costs and Economic Organization” (with Harold Demsetz), American Economic Review 62 (1972): 777-95 is a pretty amazing paper. And “Vertical Integration, Appropriable Rents, and the Competitive Contracting Process” (with Robert Crawford and Bejamin Klein), Journal of Law and Economics (1978) has been very influential. Though I think people think of Ben Klein for that paper. As noted above, Alchian is very well known for (and thought of because of ) “Uncertainty, Evolution and Economic Theory,” Journal of Political Economy 58 (1950): 211-21.
Having said all that, I think srp is correct in that Alchian’s best chance is going in with Nelson and Winter for evolutionary economics or Demsetz and Williamson or Oliver Hart for theory of the firm. It’s hard to imagine that evolutionary economics is that appreciated. I think Sid Winter is grossly underrated. His body of work in economics and strategy is pretty amazing.
As readers of my posts might guess, I am a pretty big fan of Demsetz. I don’t know that Harold is as productive or quantitative as most award givers might like. Stilger and Coase were pretty big fans. But, Hart and Williamson seem more likely award winners.
Over at orgtheory.net they’ve been discussing sociologists and management people who (in some alternate universe) might win. There are not too many Herb Simons out there.
Mechanism Design and the Theory of the Firm
| Peter Klein |
I’ve been asked a few times today what I think of the Nobel Prize to Hurwicz, Maskin, and Myerson for mechanism design. (And, more than once, “What the heck is mechanism design?”) Briefly, mechanism design is the study of rules or contracts (“mechanisms”) that give agents incentives to do what a designer wants — for instance, revealing private information. A simple example is the ticket-pricing rules used by airlines. To maximize revenue, airlines want to charge high prices to business travelers (with presumably inelastic demands) and lower prices to leisure travelers (with more elastic demands). But airlines don’t know which travelers are which type. They can’t can’t simply ask, upon booking, “Are you going on a business trip?” because people would lie. Instead, the airlines give lower-priced tickets to travelers who buy their tickets in advance, will take a non-refundable ticket, are willing to stay over a Saturday night, and so on, assuming that people willing to abide by those restrictions are probably leisure travelers. These rules constitute a mechanism that provides incentives for agents to reveal their types to the principal (or “proposer”).
The WSJ offers this roundup of economics commentary on the Prize. You can find plenty more using your search engine of choice. What does any of this have to do with organizational economics, the theory of the firm, institutions, entrepreneurship, and other topics enjoyed here at O&M? Here are some random thoughts (I hope Nicolai and Dave will chime in soon with their own reactions). (more…)
Why Are Markets So Scary? Some Things (Liberal) Academics Get Wrong
| David Hoopes |
Many people make incorrect assumptions about capitalism. Some would have us believe that capitalism is based on greed, selfishness, and promotes behavior that is completely self-centered. This is a common interpretation of Smith’s advice to allow people to make decisions based on self-interest. Examples are easy to find in the many organization theory-based papers complaining about economics and economists.
Two very good papers can aid in a deeper understanding of the invisible hand. First is James Q. Wilson’s “Adam Smith on Business Ethics.” A central point Wilson makes is that Adam Smith assumed people will behave with a moral sense. Wilson, “A moral man is one whose sense of duty is shaped by conscience; that is, by that impartial spectator within our breast who evaluates our own actions as others would evaluate it.” By suggesting people be allowed to make decisions based on their own self interest Smith was not advocating selfishness and greed. What then was he advocating?
This leads to the second paper, Harold Demstez’s “The Theory of the Firm Revisited.” In the third paragraph Demsetz notes that the debate between mercantilists and free traders was over the role of the government in the economic affairs of the state. “Is central economic planning necessary to avoid chaotic economic conditions?” The great achievement of the perfect competition model, what Demsetz argues should be called perfect decentralization, is its abstraction from centralized control of the economy.
Thus, the central element to capitalism is that decision making is pushed down as far as possible. (more…)
Hagel on Institutional Innovation
| Peter Klein |
Here is John Hagel with a nice post on institutional innovation. Product, process, and management innovation are important, he notes, but institutional innovation — that which “redefines roles and relationships across independent entities to accelerate and amplify learning and reduce risks” — is the key to long-term value creation. Hagel names diversity, relationships, modularity, federated decision-making, reputation mechanisms, feedback loops, and incentive structures as the design principles underlying institutional innovation.
Hagel is clearly right to emphasize institutional innovation as a key driver of long-term firm, industry, and overall economic performance. He names the creation of the joint-stock company as a primary example. We could perhaps add the M-form structure, the franchise arrangement, relational contracting, the loosely organized network, and the venture-funded startup to this list.
And yet, there is a lot we don’t know about institutional innovation. (more…)
Call for Papers: Entrepreneurship — Strategy and Structure
| Peter Klein |
The Journal of Economics and Management Strategy, founded and edited by Dan Spulber, seeks papers for a special issue on “Entrepreneurship: Strategy and Structure.” Thomas Hellmann and Scott Stern are editing the special issue.
While submissions from a wide range of perspectives and topics are welcome, we specifically invite theoretical and empirical papers on the following:
- The sources of value creation by entrepreneurial ventures
- Game-theoretic approaches to the organization of new firms, and the impact of entrepreneurs on market outcomes
- The determinants of entrepreneurial activity across industries and locations
- The determinants and consequences of the structure of entrepreneurial finance
- The impact of formal and informal networks (including strategic alliances) on the structure and conduct of entrepreneurial firms
- The impact of innovation policy, including intellectual property rights policy, the tax system, and the legal system, on the formation and strategic impact of new ventures
Here are the submission guidelines. Deadline is 15 November 2007.
Foss & Klein Chapter on “Organizational Governance”
| Nicolai Foss |
Peter and I often get requests that we blog something of a more introductory nature on organizational economics, the theory of the firm, etc. Until now, we haven’t really had the opportunity.
However, we just completed a draft of a chapter on “Organizational Governance” for the Handbook of Rational Choice Social Research, a major project initiated by sociology professors Rafael Wittek, Tom Snijders and Victor Nee for the Russell Sage Foundations (thus dispelling strange claims by Brayden and others that this is the anti-sociology blog). As the title suggests, the contributors, representing economics (/game theory), anthropology, and sociology are united by their commitment to the rational choice approach. The project involves such luminaries as Avner Greif, Jean Ensminger, Sigwart Lindenberg, and others. You can find the chapter under “Papers.” (more…)
What Are Hybrid Forms and How Can They Be Modeled?
| Nicolai Foss |
Many scholars have argued that hierarchies are increasingly infused by market mechanisms (e.g., here and here), and that elements of authority can increasingly be witnessed in market transactions. This has been referred to as the “swollen middle hypothesis.” A major step forward in the understanding of such hybrid governance is Williamson’s seminal 1991 paper in the ASQ, “Comparative Economic Organization: The Analysis of Discrete Structural Alternatives,” and Holmström and Milgrom’s equally important 1994 paper in the AER, “The Firm as an Incentive System.” (more…)
Me and Yu
| Peter Klein |
My review of Tony Yu’s Firms, Strategies, and Economic Change (Elgar, 2005) for the QJAE (volume 10, number 1, Spring 2007) is now online.
Blogfest at Sundance
| Peter Klein |
The BYU Conference on Comparative Organizations at Sundance begins today. Your humble correspondent is here, along with Teppo, Brayden, Fabio, and Omar of orgtheory.net, Gordon Smith of Conglomerate, and luminaries from throughout the world of organization studies. I haven’t yet seen Robert Redford (but if he shows up I’ll ask him to clarify his views on property rights).
This is an interdisciplinary conference, though the participants are primarily sociologists (with a few outsiders, like yours truly, thrown in for comic relief). The purpose is to develop better frameworks for making comparisons across organizational types. From the conference blurb: “[C]ontemporary organizational scholarship can not provide a coherent answer to questions regarding how one might translate corporate data on the predictors of employee motivation into a hospital or military setting, or to what extent conclusions regarding the relationship between financial performance and socially responsible business practices based on studies of small, young, private firms hold for large, old, public firms.”
I think there is actually a fair amount of empirical literature in organizational economics and strategy making these kinds of cross-sectional comparisons (public versus private firms, venture-backed versus non-venture-backed startups, M-form versus H-form conglomerates, etc.). The analysis is not particularly “deep,” however; it relies generally on reduced-form models with performance as the only dependent variable. I’m looking forward to learning about more nuanced approaches.
Knightian Uncertainty Workshop
| Peter Klein |
The authors of this blog find Knightian uncertainty a useful concept for understanding both entrepreneurship and the economic theory of the firm (e.g., here and here). So we were pleased to learn about a workshop on Knightian uncertainty organized earlier this month at Columbia University by and Daniel Beunza David Stark. Nassim Taleb was there, as were Douglass North, Anna Grandori, Bruce Kogut, Adam Branderburger, and others well known to readers of this blog. Buenza summarizes the discussion and offers some commentary at the Socializing Finance blog.
One problem with the treatment of Knightian uncertainty in the management literature (not necessarily in the presentations above) is that the concept itself is not always defined precisely and consistently. Terms like Knightian uncertainty, radical uncertainty, case probability, complexity, ambiguity, and plain old uncertainty are often used interchangeably. Sometimes what is meant is ignorance of the relevant probability distributions. Sometimes it is ignorance of one’s own ignorance. Sometimes it means simply the lack of common (Bayesian) priors. To move forward, more clarity is surely needed.
Corporate Venturing
| Peter Klein |
Here are presentation slides from a 2007 Academy of Management Professional Development Workshop (PDW) on corporate venturing. The presenters were Gary Dushnitsky, Thomas Keil, Riitta Katila, Suresh Kotha, Michael Lenox, Markku Maula, Corey Phelps, Shaker Zahra, and Rosemarie Ziedonis.
Don’t forget that slides from our PDW on Austrian economics are available as well.
New Survey Paper on Vertical Integration
| Peter Klein |
Francine Lafontaine and Margaret Slade’s superb review paper on vertical integration, “Vertical Integration and Firm Boundaries: The Evidence,” appears in the current issue of the Journal of Economic Literature. (Non-gated version here.) Unlike previous reviews focusing on particular theoretical frameworks (e.g., my NIE Handbook paper on the transaction-cost approach), Lafontaine and Slade consider a broad range of factors potentially affecting vertical integration such as risk, agent effort, firm size, monitoring costs, and repeated interaction as well as the usual transaction-cost variables (asset specificity and uncertainty). They also look closely, following Whinston (2003), at distinctions between the transaction-cost (Williamson) and property-rights (Grossman-Hart-Moore) approaches. Here’s the abstract:
Since Ronald H. Coase’s (1937) seminal paper, a rich set of theories has been developed that deal with firm boundaries in vertical or input–output structures. In the last twenty-five years, empirical evidence that can shed light on those theories also has been accumulating. We review the findings of empirical studies that have addressed two main interrelated questions: First, what types of transactions are best brought within the firm and, second, what are the consequences of vertical integration decisions for economic outcomes such as prices, quantities, investment, and profits. Throughout, we highlight areas of potential cross-fertilization and promising areas for future work.
Also recommended, from the same issue of the JEL, is Bentley MacLeod’s “Reputations, Relationships, and Contract Enforcement.”
Dissing the Corporation
| Peter Klein |
Several papers in economic history, law, and political economy argue that the corporate form owes its emergence and persistence not to superior performance, but to legal privilege. This two-part series by Piet-Hein van Eeghen in the Journal of Libertarian Studies (1, 2) makes such a case, as do many essays by regular O&M commentator Kevin Carson. I tend to be somewhat skeptical of this literature, finding it insufficiently comparative institutional and not always consistent with the historical record as I understand it.
A new paper by Naomi Lamoreaux, whose work I very much admire, may force me to rethink my views, however. In “Putting the Corporation in its Place” (NBER Working Paper No. 13109) Lamoreaux and her coauthors Timothy Guinnane, Ron Harris, and Jean-Laurent Rosenthal argue that entrepreneurs in common-law countries tended to choose the corporate form over the next-best alternative, the partnership, only because a still more desirable alternative, the private limited liability company, was not available. (more…)
Economic Darwinism During Recessions
| Peter Klein |
Some version of the survivor principle, or “economic Darwinism,” underlies much economics and strategy research. While the term “survivor principle” was coined by Stigler (1968), the idea is usually attributed to Alchian (1950) and Friedman (1953). Alchian argued that even though theories about rational decision makers making “optimal” choices are clearly unrealistic, the predictions of such theories need not be. The quest for profit, combined with competitive selection forces, ensures that the average firm will tend to behave like those described by theories of rational behavior (Alchian, 1950). Friedman (1953: 22), defending the profit-maximization hypothesis, puts it this way:
[U]nless the behavior of businessmen in some way or other approximated behavior consistent with the maximization of returns, it seems unlikely that they would remain in business for long. Let the apparent immediate determinant of business behavior be anything at all — habitual reaction, random choice, or whatnot. Whenever this determinant happens to lead to behavior consistent with rational and informed maximization of returns, the business will prosper and acquire resources with which to expand; whenever it does not, the business will tend to lose resources and can be kept in existence only by the addition of resources from outside. The process of “natural selection” thus helps to validate the [maximization] hypothesis or, rather, given natural selection, acceptance of the hypothesis can be based largely on the judgment that it summarizes appropriately the conditions for survival.
The problem with Friedman’s strong version of the survivor principle is that we know little about how such competitive selection processes actually work. (more…)
SDAE Sessions
| Peter Klein |
Sessions from the SDAE section of the upcoming Southern Economic Association annual meeting (New Orleans, 18-20 2007) that may interest our readers:
- Peter Lewin (University of Texas at Dallas) and Howard Baetjer Jr. (Towson University),“Can Ideas be Capital? Can Capital Be Anything Else?”
- Per-Olof Bjuggren and Johanna Palmberg (Jönköpings International Business School), “Swedish Listed Family Firms and Entrepreneurial Spirit”
- Joseph T. Salerno (Pace University), “The Entrepreneur: Real and Imagined” (more…)
Corporate Asset Purchases and Sales
| Peter Klein |
There’s a huge literature on mergers and sell-offs (see this excellent, if slightly dated, survey) but less work on the purchase and sale of corporate assets short of full acquisition or divestiture. Studying asset purchases and sales is a good way to learn about firms’ growth and retrenchment strategies because these transactions are not complicated by issues of corporate control.
Missaka Warusawitharana, a recent Wharton PhD now at the Federal Reserve Board, is doing interesting work in this area. In a forthcoming Journal of Finance paper he finds strong evidence that efficiency, not agency, considerations drive most asset purchases and sales. This contrasts with the M&A literature, in which the evidence on investment efficiency is mixed. A companion paper (with Sugata Ray) compares the sensitivity of acquisition returns to transaction value for both asset purchases and full acquisitions, finding evidence for value creation when corporate assets are purchased but not when an entire firm is acquired.
Investor Protection and Firm Governance: Substitutes or Complements?
| Peter Klein |
The new institutional economics often treats the institutional environment and institutional arrangements as substitutes. In countries with stable legal institutions, relatively efficient courts, and reasonable default rules for contract terms, for example, contracts tend to be less complete. If contracting parties can trust the courts to fill in the gaps, why bother to write out every contingency? Likewise, if a country has an efficient external capital market, firms can be small and specialized, relying on the capital markets to allocate resources among business units, but if the external capital market performs poorly, diversified business groups may arise to exploit their internal capital markets.
It is thus surprising to learn, from a new paper by Reena Aggarwal, Isil Erel, René Stulz, and Rohan Williamson, that firms tend to establish better mechanisms for corporate governance in countries that already have strong rules for investor protection. “[O]ur evidence suggests that firm-level governance attributes are complementary to rather than substitutes for country-level investor protection, so that better country-level investor protection makes it optimal for firms to invest more in internal governance.” The better the institutional environment, in this case, the more effort agents put into designing efficient institutional arrangements.
Clearly more work is needed to understand the interactions between “macro” and “micro” institutions. What are some other good papers in this area?
Outsourcing Bleg
| Peter Klein |
A friend asks for good examples of companies outsourcing core functions or selling core technology and brands. Suggestions?
Entrepreneurship, Arbitrage, and Capital
| Peter Klein |
Over the years I’m increasingly convinced that Israel Kirzner’s metaphor of entrepreneurship as costless discovery — a form of arbitrage, exploiting differences between actual prices and their Walrasian equilibrium values — is a misleading way to think about entrepreneurship. Emphasizing knowledge, the awareness of facts that other market participants do not possess, the metaphor leads our attention away from action, the employment of scarce means to achieve economic ends. I’ve argued in a series of papers (1, 2, 3) that opportunity exploitation, not opportunity discovery, drives the market process.
A key problem for the Kirznerian metaphor is that entrepreneurship does, in practice, involve capital investment, despite Kirzner’s insistence that “pure entrepreneurship” does not require ownership of resources. (As Joe Salerno reminds us, favorable reviews of Kirzner’s Competition and Entrepreneurship by Austrians Murray Rothbard, Henry Hazlitt, and Percy Greaves all pointed to the separation of entrepreneurship and property ownership as the lone weakness in Kirzner’s otherwise excellent exposition.) But what about financial-market arbitrage, an example often cited in the Kirznerian literature? Isn’t arbitrage an example of costless discovery of pure profit? Doesn’t the arbitrageur operate without capital? (more…)
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