Posts filed under ‘Theory of the Firm’
Mises’s Bureaucracy
| David Gordon |
Mises’s Bureaucracy (1944) is seldom cited, at least by comparison with Human Action and Socialism; but it presents some of his key insights better than anywhere else. Mises contrasts profit-and-loss management with bureaucratic management.
A businessman can always tell how well a section of his enterprise is doing by looking at the profit-and-loss accounts. If a section shows a loss, this fact doesn’t by itself enable him to locate the problem; but at least he is aware that something needs to be done.
Government bureaucracies, by contrast, do not produce goods or services for profit. Lacking the tool of profit-and-loss accounts, they instead must operate according to fixed rules. The well-known failings of bureaucracies, according to Mises, do not primarily stem from deficiencies of character in the government personnel. Rather, resort to fixed rules makes bureaucracies much less flexible than profit-seeking businesses. (Mises’s views on bureaucracy were influenced by his friend Max Weber.)
Mises does not think that attempts to introduce business methods into government can succeed, and he deplores the bad effects of government regulations on private enterprise. These regulations interfere with profit-and-loss accounting.
Bureaucracy is available at the Mises Institute website.
Coase and the Myth of Fisher Body
| Peter Klein |
I vividly recall, at the inaugural meeting of the International Society for New Institutional Economics in 1997, a discussion about the best empirical strategy for that emerging discipline. Harold Demsetz stood up and said “Please, no more papers about Fisher Body and GM!” The Fisher-GM case had become the canonical example of holdup in transaction cost economics and was considered stale and even trite. Ronald Coase, who was at the podium, replied (I’m paraphrasing from memory) “Sorry, Harold, that is exactly the subject of my next paper!”
The GM-Fisher case was introduced into the transaction cost literature by Klein, Crawford, and Alchian in their 1978 paper “Vertical Integration, Appropriable Rents and the Competitive Contracting Process.” They cited the case as a classic example of vertical integration designed to mitigate holdup in the presence of asset specificity. As the story is told, Fisher refused to locate its plants near G.M. assembly plants and to change its production technology in the face of an unanticipated increase in the demand for car bodies. This led G.M. to terminate its existing ten-year supply contract with Fisher and to acquire full ownership of Fisher.
The basic facts of the account, and the interpretation of these facts, were challenged in five independently written papers, all appearing in 2000. Three of the papers, by Coase, Casadesus-Masanell and Spulber, and Freeland, are in the April 2000 Journal of Law and Economics. A fourth paper by Helper, MacDuffie, and Sabel appears in Industiral and Corporate Change and one by Miwa and Ramseyer is in the Michigan Law Review. These papers showed that nearly every detail of the canonical account is wrong. (more…)
“Coase and Simon Got It Right, Alchian and Demsetz Got It Wrong”
| Peter Klein |
A reader asks: “In a response to a prominent economist who asked ‘what have we learned about . . . organizations,’ you provided a list that began with ‘Organizations can have market-like features, but are inherently different from markets. I.e., authority is real — Coase and Simon got it right, Alchian and Demsetz got it wrong.’ What are the major papers that led to this conclusion?”
I have in mind the Alchian-Demsetz notion that the firm is a legal fiction, a convenient label for a nexus of contracts. (Recall the famous passage in their 1972 paper about “firing the grocer.”) Classic formulations of the opposite view — that the firm does, in fact, have some power of fiat — come from the two Olivers, Williamson and Hart. (more…)
The Treatment of Frequency in Transaction Cost Economics
| Peter Klein |
Every schoolboy knows that transactions are characterized by asset specificity, uncertainty, and frequency. (Every schoolboy schooled in transaction cost economics that is.) Yet, while asset specificity and uncertainty have been treated exhaustively in the literature, frequency has become the red-headed stepchild of the transaction cost triple.
As I read the TCE literature, frequency shows up in at least three distinct forms, not all of them compatible. (more…)
Industrial Entrepreneurship in Early Modern China
| Peter Klein |
Coase, Williamson, and others have long called for comparative institutional analysis across countries and across time. How do various institutional arrangements perform under alternative institutional environments? We are only beginning to understand this question. (Important contributors to the literature include Witold Henisz, Tarun Khanna, Masahiko Aoki, and various members of the Centre ATOM, among others.) Can changes in the institutional environment be regarded as exogenous “shift parameters,” as Williamson has articulated the problem, or is there a more subtle, complex co-evolution among institutions and organizational form?
These issues are raised in Madeleine Zelin’s The Merchants of Zigong: Industrial Entrepreneurship in Early Modern China (Columbia University Press, 2006), reviewed here by Carol Shiue for EH.Net. Zelin’s new book traces the history of the salt merchants of western Sichuan province, who created one of the first, vertically integrated industrial enterprises in modern China. Though not explicitly a comparative study, Zelin’s volume provides a useful companion to the landmark studies by Chandler and others of the history of modern enterprise in the West. As Shiue observes, “A recurrent theme of the book is that the business arrangements seen in the Chinese salt industry belie not only previous perceptions about the predatory influence of the ‘feudal’ state on entrepreneurial incentives in China, but also the purported uniqueness of Western business practice.”
See also Shiue’s earlier review of Zelin, Ocko, and Gardella, eds., Contract and Property in Early Modern China (Stanford University Press, 2004).
Measuring Organizational Form
| Peter Klein |
A reader, inspired by our discussion on organizational form, asks for references to empirical papers relating organizational form to performance. My suggestions:
1. The literature from the 1970s and 1980s on the “M-form hypothesis.” The classification scheme is described in Williamson and Bhargava, “Assessing and Classifying the Internal Control Apparatus of the Modern Corporation,” in Keith Cowling, ed., Market Structure and Corporate Behavior (London: Gray Mills, 1972). Empirical papers (you’ll have to Google them) include Armour and Teece (1978), Steer and Cable (1978), Teece (1981), Thompson (1981), Harris (1983), Cable and Dirrheimer (1983), Cable and Yasuki (1984), and Hill (1985). I’m currently working on a paper revisiting these data using some updated techniques.
2. The “diversification discount” literature in empirical corporate finance. This literature is about organizational form to the extent that organizational form is correlated with the number of industry segments, the distribution of activities across industries, or some measure of relatedness. (Among the many papers in this literature, the best known are Lang and Stulz, 1994; Berger and Ofek, 1995; Campa and Kedia, 2003, Chevalier, 2004). A few papers try to infer organizational form from past activities, such as prior acquisitions (Hubbard and Palia, 1999; Klein, 2001).
3. More direct measures include segment or subsidiary counts within a single industry (Klein and Saidenberg, 2005, Sanzhar, 2006), the ratio of administrative staff to total employees (Zhang, 2005), the number of positions reporting directly to the CEO (Rajan and Wulf, 2003), and the average number of management levels between the CEO and division managers (Rajan and Wulf, 2003).
This will all be discussed in more detail in the magnum opus.
The Corporation versus Tom Cruise
| Peter Klein |
Hollywood studios are standing up to eccentric, pampered stars like Tom Cruise and Lindsay Lohan. At last, says Professor Bainbridge, corporate studios are acting like corporations. “Once again, the public corporation and its norm of shareholder wealth maximization prove to be a force for good.” (Prof. B. is not a fan of stakeholder theory, if you didn’t know.)
On the other hand, if the dependent variable is individual film revenues, rather than film studio market value, the presence (and presumably behavior) of particular stars seems to have little impact on performance. So says Art DeVany (via Marginal Revolution).
What Do We Really Know About Organizations?
| Peter Klein |
Recently a prominent economist, having discovered O&M for the first time, emailed me: “So what have we learned about how organizations really, really work in the past decade?”
I was in an airport when I received the query, and didn’t have time to prepare a thoughtful, well-crafted response. Rather than ignore the question, however, I replied with a few off-the-cuff remarks. After reading my remarks, I’d like readers to respond with their own brief thoughts. I.e., if you had to answer this question, quickly, in 250 words or less, what would you have said?
Here’s what I wrote (with a few small touch-ups): (more…)
Take That, Berle and Means
| Peter Klein |
When the Board and senior management of media company VNU agreed to a buyout by a private-equity group headed by Kohlberg Kravis Roberts, shareholders did something usual: they rebelled.
The rebels — including some of the world’s largest mutual funds — proposed their own business plan and new executives, and tried to force the chairman to quit. “We took the initiative to defend long-term shareholders’ interests,” says the group’s leader, Eric Knight, head of New York-based Knight Vinke Asset Management.
After a months-long battle, shareholders eventually won a modest increase of nearly $250 million from the private-equity firms — or 2.5% more than the original deal. But that improvement was less significant than the fact that shareholders had rebelled, proposing a do-it-yourself restructuring plan that competed with a big private-equity offer accepted by management and the board.
So reports the W$J in its last Friday’s issue. The story is pitched as indicating a more-general backlash against LBOs. Warren Buffett is quoted as warning his shareholders against “deal flippers.” However, there is plenty of evidence that LBOs, on average, generate long-term gains, not only for shareholders but also for the economy as a whole. (Look for a major contribution to this literature from my PhD student John Chapman.) And isn’t it ironic to find stockholders taking an active stand against private-equity investors, given Michael Jensen’s warning of the “Eclipse of the Public Corporation”? Maybe the public corporation has life in it still.
A Muddle on Vertical Integration
| Peter Klein |
Slate’s Daniel Gross offers a hopeless muddle on vertical integration in his latest Moneybox column. Citing several examples of forwards integration mentioned in a recent WSJ article, Gross proclaims “the return of one of the great industrial developments of the late 19th century: vertical integration.” But the reasoning is a mess.
First, there’s no systematic evidence that vertical integration ever went away. We have plenty of anecdotal information about outsourcing, increased use of networks and alliances, “refocusing,” and the like, but little systematic evidence for a comprehensive, economy-wide trend toward vertical dis-integration. (more…)
Firms, Strategies, and Economic Change
| Peter Klein |
My review of Tony Yu’s Firms, Strategies, and Economic Change: Explorations in Austrian Economics (Edward Elgar, 2005), written for the Quarterly Journal of Austrian Economics, is available for preview here.
All Firms Are Not Alike
| Peter Klein |
This may come as a shock to regulators, but all firms are not alike. No one-size-fits-all regulatory policy can possibly be effective. Yet, SOX and similar governance codes impose a host of blanket requirements (audit committees, majority of outside directors, etc.) on all companies, large and small, focused and diversified, profitable and unprofitable, and so on. Economically literate regulators must be schooled in industrial-organization models in which the “representative firm” is identical to every other firm.
This new paper by LSE economists Sridhar Arcot and Valentina Giulia Bruno examines heterogeneity among governance choices at UK companies and finds that the best-governed firms are not always those that conform to the “best practices” imposed by regulators.
A [governance] measure which accounts for different choices by companies of corporate governance is significantly associated with performance as against measures based on a tick-box approach, which are not. We find that companies departing from best practice for valid reasons perform exceptionally well and out-perform the fully compliant ones. In contrast, mere compliance with the provisions of the Code does not necessarily result in better performance.
(Via Professor Bainbridge)
Update: Dale Oesterle argues that uniform listing requirements for IPOs are depressing the US IPO market, suggesting that small firms should be allowed to make their IPOS over the Internet, as is allowed in the UK.
Architecture
| Richard Langlois |
I too am at the Academy of Management meeting in Atlanta. And I have already run into Peter and Nicolai more than once.
It occurred to me that I ought to write about whatever important new idea I’ve picked up here. I now think that I see such an idea, and it would come under the heading of architecture. (more…)
Thoughts on Stakeholder Theory
| Peter Klein |
Yesterday I attended the Academy of Management session “Stakeholders: The Keys to Effective Strategy and Performance Measurement.” Panelists included Joe Mahoney, Russ Coff, Christos Pitelis, Tom Donaldson, Amy Hillman, Sybille Sachs, and Kathryn Pavolovich. I’m pretty much an unreconstructed Friedmanite on this issue so I went to raise my consciousness.
What I learned was interesting, but I still have several questions about stakeholder theory, at least in its normative version. (more…)
Technological Development and the Boundaries of the Firm
| Nicolai Foss |
Increasingly, my favorite journal is Management Science (along with Organization Science). It seems to me to feature more research that is truly at the frontier than, say, Strategic Management Journal and the Academy of Management Journal, and one will certainly not encounter the silly pomo exercises that too often feature in the pages of the Academy of Management Review.
Of course, a journal is made great by the great articles that are published in it. Case in point: Jeffrey T Macher’s “Technological Development and the Boundaries of the Firm: A Knowledge-based Examination in Semiconductor Manufacturing” in the June issue. (more…)
An Agency-Theoretic Analysis of the State
| Peter Klein |
Tim Swanson recommends this series by Michael Rozeff, “The State as an Organization” (part 1, part 2, part 3). Rozeff is a Rochester-trained financial economist (currently Louis M. Jacobs Chair of Financial Planning and Control at the University at Buffalo) and not surprisingly, his analysis is an agency-theoretic one. The main point is that the mechanisms that mitigate agency problems in firms — competition in the product market, the market for corporate control, discipline from suppliers of capital, the market for managers, etc. — are largely absent in governments. Writes Rozeff:
States are organizations whose composition, aims and methods depend on the institutions the society uses to control agency costs. The classical liberal vision was of a contractual state cleverly arranged so as to keep agency costs low. The ideal contractual state is an organization that, like a corporation, is owned by its principals, who are the citizens. Commissioned by them, the state’s aims are to dispense law and justice which includes protecting the resources or property of its owners. . . .
With weaker controls over agency costs, we observe instead varieties of the predatory state. Here the state moves toward becoming an autonomous organization, more like a company owned and operated by one person or a small group of persons but without outside stockholders. Its residual claimants are its members. They are the owners. Citizens do not own the predatory state. They are the prey.
Assets versus Activities
| Richard Langlois |
At the risk of injecting some substance into my posts, let me raise an issue in the economics of organization that I have been thinking about recently.
There has been much discussion in the literature about the differences between the transaction-cost and capabilities views of organization, something that Nicolai and I, among many others, have written about. But another division might be between asset theories and activity theories. Asset theories are of course the province of the mainstream economics of organization. In this literature, one typically defines vertical integration as joint ownership of productive assets, and integration typically arises because of hazards from cooperating without joint ownership. Activity theories come from the literatures on product design and modularity. Here the issue is how tasks (or activities) ought to be designed given the structure of the production process. In this literature, the logic of integrality versus modularity provides clues to which activities out to be “outsourced.” Perhaps the best example of this kind of thinking is by Baldwin and Clark. I have also tried to think about the issues in a paper that will be coming out in Organization Studies. In many ways, this approach harkens back to Adam Smith. (more…)
Capitalism, Socialism, and the Cote d’Azur
| Richard Langlois |
Thanks to Nicolai and Peter for inviting me to join in on the fun.
I trust that Nicolai and family are enjoying their vacation in Antibes, soaking up the sun and t
he local communist ideology. As it happens, I was in that part of the world about a month ago. On a free day while exploring Nice, I headed up to Nice Castle in search of some medieval ambience. Instead I found the annual local fete of the French Communist Party. The experience was surreal in that the event reminded me of nothing so much as the small-town agricultural fairs here in New England. The main difference seemed to be that the booths offering grilled sausages were staffed not by the Columbia Lions Club but by the Pablo Picasso Cell. (I must admit, however, that, even though the towns near me have names like Hebron and Lebanon, none of them would have had a pro-Palestinian anti-Israeli booth.) Adding to the surreal experience, the sound system kept pumping out Steely Dan’s “Cousin Dupree” over and over, apparently as a way of checking the settings.
I was in Nice — actually Sophia Antipolis, which is closer to Antibes — for the biennial meeting of the International Joseph A. Schumpeter Society. This was a rather more capitalistic experience, at least from my point of view. For one thing, the conference dinner, which featured the award of the Schumpeter Prize, took place at a former Rothschild Villa overlooking the sea. As a certain modicum of self promotion is apparently de rigeur in blogs, I suppose I should admit that one of the winners of the Schumpeter Prize was, well, me. The manuscript in question, called The Dynamics of Industrial Capitalism: Schumpeter, Chandler, and the New Economy, started out as the Graz Schumpeter Lectures in 2004. (In this respect I followed in the footsteps of Brian Loasby, whose 1996 Graz Lectures won the 2000 Schumpeter Prize.) The book (which Routledge is to publish) mixes intellectual history and economic history, tracing the (remarkably similar) Weberian accounts of Schumpeter and Chandler, who see the large managerial corporation as the apotheosis of “rational” economic organization, and confronting those accounts with the rather contrary evidence of the last quarter century — what I call the Vanishing Hand thesis. At least until I sign the rights over to Routledge, the manuscript is available here.
More substance next time.
Emergence of the East India Company
| Peter Klein |
An example of spontaneous order in the emergence of the large firm: Emily Erikson and Peter Bearman’s “Routes into Networks: The Structure of English Trade in the East Indies, 1601-1833,” forthcoming in the American Journal of Sociology. Working paper here. Abstract:
Drawing on a remarkable data set compiled from ships’ logs, journals, factory correspondence, ledgers, and reports that provide unusually precise information on each of the 4,572 voyages taken by English traders of the East India Company (hereafter EIC), the authors describe the EIC trade network over time, from 1601 to 1833. From structural images of voyages organized by shipping seasons, they map the (over time and space) emergence of dense, fully integrated, global trade networks: of globalization before globalization. The paper shows that the integration of the world trade system under the aegis of the EIC was the unintended by-product of systematic individual malfeasance (private trading) on the part of ship captains seeking profit from internal Eastern trade.
The paper even gets a plug from Scientific American:
The researchers . . . describe how many rogue captains ignored orders to trade in established markets and then return directly to England, choosing instead to explore new locations and trade between local Asian ports for their own personal profit. Although they were breaking the law by appropriating supplies and ship crews for this private trading, in doing so they ultimately benefited the East India Company by building a larger market and gaining a unique knowledge of local market fluctuations.
Via Craig Newmark. Related: my earlier post on market-based management.
Syllabus Bleg
| Peter Klein |
As part of a curriculum review project I’m collecting syllabi for first- or second-year PhD courses in strategy, organization theory, and the economics of organizations. If you have a syllabus you’re willing to share, please send it to me at pklein@missouri.edu. I will discuss broad themes and patterns with my colleagues but will keep details confidential. Thanks!
Organizations and Markets 
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