Posts filed under ‘Theory of the Firm’
96K on the 96th: Happy Birthday, Ronald Coase
| Peter Klein |
Ronald Coase turns 96 today. In honor of his birthday, the Contracting and Organizations Research Institute (CORI), whose mission and programs grow out of Coase’s work, announces the addition of the 96,000th contract to its online, full-text searchable database of contracts. Writes Director Michael Sykuta:
December 29, 2006, marks the 96th birthday of Professor Ronald Coase, the Nobel Prize winning economist whose pathbreaking work on transaction costs and property rights continues to inspire CORI’s vision and programs. Professor Coase has been more than just a intellectual inspiration for CORI, having supported CORI’s early development with contributions of his time and resources and having served on the Academic Advisory Board.
December 29, 2006, also marks the day the CORI K-Base reached 96,000 contracts, an appropriate milestone on this important day in the history of economic thought and the history of CORI. And we’re not finished growing! In fact, we’re just getting started on a new phase of expansion to make the CORI K-Base an even more valuable resource to reduce the transaction costs of doing research on the economic system and of doing the business of contracting.
Largest Non-Public Companies
| Peter Klein |
Last week’s Financial Times offers a list of the largest companies you know little about. The Non-Public 150 includes the world’s largest state-owned enterprises, private equity companies, partnerships, mutuals, cooperatives, and other non-publicly traded entities. State-owned energy and utility companies (Aramco, Pemex, Petróleos de Venezuela, etc.) top the list but private firms such as Sparkassen-Finanzgruppe (banking), the Nippon Life Insurance Company, and buyout specialist Kohlberg Kravis Roberts Co. are up there as well. (Thanks to the PSD Blog for the pointer.)
Leaving aside the SOEs, why do these firms choose to avoid the public markets? Many people have the impression that only small, local firms are established as cooperatives or mutuals, but the FT 150 list includes some of the world’s largest financial institutions. Organizational scholars have paid relatively little attention to coops and mutuals (Henry Hansmann being the most obvious exception). Private equity has well-known advantages (nicely summarized in Michael Jensen’s “Eclipse of the Public Corporation”) but there is relatively little empirical work on the choice between private and public equity. More work on family firms is needed as well.
Here is the Times’s analysis (framed as a fresh look at Jensen’s “eclipse” hypothesis).
The Vertical Dis-Integration of Higher Education
| Peter Klein |
In 1975, 56.8 percent of the teaching faculty at US colleges and universities were tenured or on the tenure track, with 30.2 percent classified as part-time employees. By 2003, tenured and tenure-track faculty comprised only 35.1 percent of the teaching staff, with part-timers making up 46.3 of the total. These data are from the latest AAUP report on faculty employment, sounding an alarm over the rise of what it calls “contingent faculty.” (Thanks to Richard Vedder for the pointer.)
This trend may have important implications for academic freedom, faculty governance, political correctness, and the nature of higher education more generally. From an economic efficiency perspective, it looks like vertical dis-integration, a shift from long-term employment contracts to shorter-term, more flexible arrangements. If the higher-education sector is simply following the private sector’s lead, should we be surprised? And what factors would be driving the changes — a decrease in relationship-specific human capital, an increase in modular methods of production, changes in environmental uncertainty, etc.? (more…)
Make and Buy II
| Peter Klein |
We discussed earlier an emerging literature on dual sourcing or “make-and-buy” decisions. Why do firms simultaneously make a particular input and buy some quantity of this input on the open market? The CCSM featured another paper on this topic, Ranjay Gulati and Phanish Puranam’s “Complementarity and Constraints: Why Firms Both Make and Buy the Same Thing.” (Neither author could make it to Copenhagen, unfortunately, but Tobias Kretschmer gave a fine presentation on their behalf.) The paper presents a simple model in which firms choose plural sourcing because of external complementarities (to mitigate opportunistic behavior from an external supplier or to benchmark the supplier’s performance), capital constraints (that prevent the firm from internalizing all purchases of the input), exit costs (that prevent the firm from outsourcing as much as it would like), and other factors.
A general implication is that theories of optimal or first-best modes of organization may have limited explanatory power in a world of high transaction costs. Seemingly inefficient governance structures may be second-best solutions to capital constraints, regulatory barriers, bargaining problems, and other frictions. Understanding these constraints, and the processes of experimentation, learning, and adaptation that work around them, should be high on the organization theorist’s agenda.
Is Entrepreneurship a Factor of Production?
| Peter Klein |
When explaining the returns to factors of production economists often define wages as the payment to labor, interest as the payment to capital, rent as the payment to land, and profit as the payment to entrepreneurship. Treating entrepreneurship as a factor of production, earning a return we label profit, poses some challenging problems, however. Does entrepreneurship have a marginal revenue product, corresponding to a firm’s profit? Is there an upward-sloping supply curve for entrepreneurship (more of it is offered to the market when profits rise)? Are there diminishing returns to entrepreneurship?
The answer given by the classic contributors to the economic theory of entrepreneurship such as Cantillon, Say, Schumpeter, Knight, Mises, Kirzner, and others is clearly no. They treat entrepreneurship as ubiquitous, an attribute of the market mechanism that can never be absent. This came out in John Matthews’s paper, “Rents versus Profits: What Are the Appropriate Goals of Strategizing?”, presented Wednesday at the CCSM. (more…)
Interview with Oliver Williamson
| Peter Klein |
Here is Oliver Williamson, interviewed on video by Ken Train (requires RealPlayer).
Others in the series include Nobel Laureates George Akerlof and Dan McFadden as well as David Card, Hal Varian, and Janet Yellen. (Thanks to Michael Greinecker for the tip.)
Four Theories of the Firm
| Peter Klein |
This week in my PhD course, “Economics of Institutions and Organizations,” we discussed Bob Gibbons’s paper ”Four Formal(izable) Theories of the Firm” (JEBO, 2005; working-paper version here). Lest readers think I oppose formalization per se, let me take a moment to strongly recommend this paper, which provides an excellent summary and synthesis of several critical issues in the economic theory of the firm. (This review is also pretty good.) While the paper can be read profitably even without working through the mathematical models, Gibbons’s training in formal theory was obviously an asset in sorting out the similarities and differences among theories, harmonizing the diverse and sometimes-confusing terminology in this literature, and identifying the core assumptions of various approaches.
Gibbons distinguishes among four theories of the firm: rent seeking, property rights, incentive systems, and adaptation. Rent seeking is his label for TCE as expressed by Williamson and Klein, Crawford, and Alchian (1978). Students find the formulation of TCE in rent-seeking language, a la Tullock — “individually optimal (but socially destructive) haggling over appropriable quasi-rents” — useful and informative. Gibbons also provides an excellent discussion of the differences between TCE and the property-rights approach, showing that Grossman, Hart, and Moore’s model is not “a formalization of Williamson” (a distinction also emphasized by Williamson in his 2000 JEL piece and by Mike Whinston here and here). (more…)
John Chapman at AEI
| Peter Klein |
Kudos to my former PhD student John Chapman for landing a prestigious National Research Initiative Fellowship with the American Enterprise Institute. John is working on a book with Glenn Hubbard (official link; fun link) on the history and economic impact of the US private equity sector. For more information about the project contact John.
The Collected Works of Armen Alchian
| Nicolai Foss |
It has been said that “Armen Alchian’s output may be sparse and informal, but it has been among the most influential.” Still, his “virtuoso work on neoclassical price theory” has been sufficiently voluminous that his collected works run 1,620 pages!
The two volumes that contain all these pages were published in November by Liberty Fund at the ridiculously low price of $15 for the set. Over the years Liberty Fund has published an unbelievable amount of true classics in economics, law, history, philosophy and classical liberal scholarship in general at absolute bargain prices. (more…)
Economics of Multiple Voting Shares
| Peter Klein |
During the 1920s, the phenomenon of multiple voting shares expanded all over France and the world. This contributed significantly to the separation of ownership and control emphasized by Berle and Means (1932), and very much discussed by the foreign contemporaries. As is the case today, some argued that the reinforcement of the power of majority shareholders facilitated their firms’ development, while others emphasized the high agency costs that might result from managers’ and major shareholders’ absolute control. In this paper, we present detailed data on the development of multiple voting shares in France in the 1920s. We reword the arguments of the authors writing during the interwar period by using an interpretative framework of recent concepts in corporate finance and corporate governance. We test two alternative views from our data on the Stock Market performances: the “agency view,” in which the concentration of control did not affect the performances of firms issuing multiple voting shares, and the “timing view,” in which the issuing of these shares was favoured by the long bull market of the 1920s.
The paper is Muriel Petit-Konczyk, “Big Changes in Ownership Structures: Multiple Voting Shares in Interwar France,” Working Paper, ESA Lille2 University, 2006. Via EH.Net Abstracts.
ETP: Special Issue on Family Firms
| Peter Klein |
The latest issue of Entrepreneurship: Theory and Practice (30:6, November 2006) is a “Special Issue on the Theory of the Family Enterprise.” Plenty of fodder for the ongoing discussion of family firms. Here’s the table of contents: (more…)
Foss, Klein, Kor, and Mahoney on Entrepreneurship
| Nicolai Foss |
As readers of O&M will know, Peter and I are highly sympathetic to subjectivist economics, mainly Austrian economics, and both take an interest in entrepreneurship and the theory of the firm. Yasemin Kor is an expert on the RBV and top management, and former O&M guest blogger Joe Mahoney is, of course, an expert on the RBV and the theory of the firm. This makes, we think, for an excellent author team. Thus, we have collaborated in writing a paper, “Entrepreneurship, Subjectivism, and the Resource-based View: Towards a New Synthesis.” Here is the abstract:
This paper maintains that the consistent application of subjectivism helps to reconcile contemporary entrepreneurship theory with strategic management research in general, and the resource-based view in particular. The paper synthesizes theoretical insights from Austrian economics and Penrose’s (1959) resources approach, arguing that entrepreneurship is inherently subjective and firm specific. This new synthesis describes how entrepreneurship is manifested in teams, and is driven by both heterogeneity of managerial mental models and shared team experiences.
Enjoy!
Economics of Department Stores
| Peter Klein |
Speaking of diversification, decentralization, and the effective use of local knowledge, Lynne Kiesling offers some interesting commentary on the economics of department stores. Department stores have been doing well in the last few years. Notes Lynne:
A retail business model originating in the late 19th century, the department store for decades epitomized elegance, convenience, ubiquity of options. Then in the 1990s the department store fell on hard times as nimble, smaller retailers struck better production and/or procurement contracts, had more direct contact with the preferences of consumers, or were able to offer niche products to enable consumers to craft their own, individual, modern images. . . .
I am not convinced that the large department store that is managing many brands and a national image can be more nimble than a specialty store, and nimbleness is what a department store will require to become a successful complex adaptive system.
Again, we have a problem of selective intervention. Imagine a department store that operates like a shopping mall, providing space and transaction management for individual vendors, and centralizing particular functions (marketing, sales, customer support) only when doing so generates net gains. Amazon.com and Ebay have shown how such a model can work in virtual space. If equally decentralized, why can’t a department store be as good — as a complex adaptive system — as a set of specialty retailers?
An RBV Approach to Conglomerate Diversification
| Peter Klein |
The resource-based view of the firm has spawned a vast literature on corporate diversification. Inspired by Penrose (1959) and Rumelt (1974), this literature has emphasized the benefits of related diversification over expansion into industries that are not good fits for the firm’s current portfolio of resources. Unrelated or conglomerate diversification is typically viewed, within the RBV, as an anomaly, either a mistake (as in the conglomerate merger wave of the 1960s) or pure luck (those few conglomerates, such as GE, that are consistently high performers). Of course, relatedness is difficult to define and measure consistently, and the kinds of relatedness that presumably matter for firm performance are not captured well by conventional measures of inter-industry relatedness (see this paper for details). There is evidence that conglomerate diversification can add value by creating internal capital markets (see here and here), but this approach has little to do with resources and capabilities. (more…)
Another Cost of Selective Intervention: Convincing the Market
| Peter Klein |
Nicolai blogged recently on Williamson’s concept of the “impossibility of selective intervention.” Williamson asks why a large firm cannot do everything a collection of small firms can do and more. In princple, a set of projects could be combined into a single firm, with the firm’s management promising not to interfere with individual projects unless doing so would generate net gains. In this way, a firm could have responsibility an almost unlimited set of projects, each of which would be at least as profitable as it would be as a standalone entity. What, then, explains the limits to the firm?
Williamson’s answer has to do with the difficulties of making such a commitment credible. Project managers will not believe the firm’s promise not to interfere and will take value-reducing actions to protect their own returns and asset values. (Williamson identifies “asset malutilization” and “accounting contrivance” as specific problems; see Nicolai’s post for details.)
A story in today’s W$J on Blue Moon beer raises another issue. Even if central managers can convince division heads or project managers that they will not engage in opportunistic behavior, they may be unable to convince buyers, suppliers, or other market participants. Here’s an example: Blue Moon is a popular “craft,” or niche, beer that appeals to high-end, quality-conscious consumers. Such beers are typically produced locally, in small quantities, and marketed as “micro-brews.” The Journal piece explains how Blue Moon’s marketing department goes to great lengths to hide the fact that the beer is actually made by Molson Coors, North America’s third-largest brewer. A similar example is Chipotle, a restaurant chain popular with the young and trendy (and the not-so-young and even-less trendy — I love it!), which before going public was majority owned by McDonald’s. The fact that such niche products would be regarded, by their target demographic, as “tainted” were their parentage known, suggests that market participants do not believe that corporate parents can manage small subsidiaries without interference. The market, it seems, agrees with Williamson that selective intervention is a “myth.”
Can Prices Be Owned?
| Peter Klein |
Harold Mulherin, my former colleague Jeff Netter, and James Overdahl taught us that prices are property. That is, the information embodied in price quotations on financial markets does not pre-exist, but must be created by entrepreneurial activity, through the creation of organized financial exchanges. Financial exchanges are firms, and their assets are defined and governed by a complex set of contractual relations. (Like any firms, exchanges can expand, contract, reorganize, and try to acquire their rivals.)
But can an individual price — the number itself, not a trading institution — be owned? David Levine reports that a website posted some Best Buy Thanksgiving Day sale prices, and was subsequently served by Best Buy with a copyright infringement notice, demanding that the page be removed on the grounds that the prices were protected by the Digital Millenium Copyright Act (a truly odious piece of legislation).
More reason to be against intellectual property.
Are Profitable Firms Always Founded?
| Nicolai Foss |
No, says Matthias Kräkel. Here is the abstract of his recent neat paper, “On the ‘Adverse Selection’ of Organizations“:
According to New Institutional Economics, two or more individuals will found an organization, if it leads to a benefit compared to market allocation. A natural consequence will then be internal rent seeking. We discuss the interrelation between profits, rent seeking and the foundation of organizations. Typically, we expect that highly profitable firms are always founded but it is not clear whether the same is true for firms with less optimistic prospects. We will show that internal rent seeking may lead to a completely reversed result. The impact of internal rent seeking on overall investment and the implications of firm size and competition on the foundation of organizations are also addressed.
Admittedly, Kräkel’s stark result, that highly profitable firms may not be founded because of the prospect of heavy internal rent seeking, only holds for the situation where technology is exogeneosly given (he does relax this assumption and obtains other interesting results, however) and begs the question why exactly it is that rational cooperating individuals cannot constrain internal rent-seeking. However, there is a wider message in his paper, particularly for the resource-based approach in strategic management which — with the exception of the work of Russ Coff (see his 1999 Org Science paper and his 1997 AMR paper), Lippman and Rumelt (their 2003 SMJ paper on bargaining), and more recently Joe Mahoney (check Joe’s work on stakeholder theory) — has neglected internal bargaining processes in firms, including rent-seeking. Thus Kräkel’s work suggests that even if a projected venture controls resources that are strategic in the RBV sense, the venture may not materialize because of fear of rent-seeking in the second stage of the game (after the firm is actually founded).
Here’s To You, Mrs. Robinson
| Peter Klein |
I’m not a great fan of Joan Robinson but believe she has admirers among the O&M clientèle. So here’s a pointer to a new book on Robinson’s work and significance, Joan Robinson’s Economics: A Centennial Celebration (Cheltenham, UK: Edward Elgar, 2005). The volume, edited by Bill Gibson, stems from a 2003 conference on the centenary of Robinson’s birth. This passage from Michael Lawlor’s review in EH.Net may spark some interest:
One thing she particularly saw as useful in Marshall was his awareness of the difficulty of treating time by equilibrium constructs. Thus, rather than the highly artificial dynamic equilibria of modern theories of growth (of any stripe), she wanted dynamic economics to be “open” to uncertain expectations, technological change, habits, and the possible irreversibility that came with the “choice of technique.” In other words, she insisted that a theory of economic growth should be alive to the kinds of issues that, economic history teaches, have been real aspects of capitalist economies of the past. . . . She did not want to construct models that would reach the same “equilibrium” from radically different starting points, but ones that depended crucially on where a system began to determine part of where it ends up. In short, she wished for a dynamic economics in which a particular set of institutions and a particular history ought to be given its due as a factor that could influence the time path of an economy.
But as Donald Harris particularly emphasizes, this is no easy task. In fact one could say that her long struggle with a variety of complex approaches to such questions in the theory of economic growth (her most mature statements on this topic are to be found in Robinson, 1956 and 1962b) ended in her rejecting “equilibrium” altogether as a way to capture the manifold influences of “history” (Robinson, 1985).
New Evidence on Multinational Transfer Pricing
| Peter Klein |
The economic theory of the firm is ultimately about the differences between inter- and intra-firm transactions. How, for example, are employment contracts different from arms-length transactions with independent contractors? (Alchian and Demsetz, in the famous passage in their 1972 article about “firing the grocer,” say there is no difference; Coase and Simon argue otherwise.)
We know little about how intra-firm purchase and supply arrangements differ from those between firms. However, thanks to a new dataset, the Linked/Longitudinal Firm Trade Transaction Database (LFTTD) from the US Census and Customs Bureaus, we now know something about how such transactions are priced. A new paper by Andrew Bernard, Bradford Jensen, and Peter Schott, “Transfer Pricing by U.S.-Based Multinational Firms,” uses the LFTTD data to compare export prices for “related-party” and “arms-length” transactions among US multinationals. Bernard, Jensen, and Schott find that intra-firm transactions are priced significantly lower than sales of the same good to arms-length customers. (more…)
David Landes on Family Firms
| Peter Klein |
Economic historian David Landes’s new book, Dynasties: Fortunes and Misfortunes of the World’s Great Family Businesses, focuses on the family firm (discussed here, here, and here). As described by the New York Times, Landes wants to suggest that “the business-school mythos of the ‘professional manager’ has led to a persistent underestimation of the importance of family firms. Fully a third of Fortune 500 companies can properly be characterized as family businesses, and on average they outperform the ‘professionally managed’ firm by a surprisingly large margin.”
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