Posts filed under ‘Theory of the Firm’
Organizing Entrepreneurial Judgment: Kindle Edition Now Available
| Peter Klein |
Here’s the link — and the price is right, just $16.50!
According to the latest sales figures, we’re up to #1,070,026 on Amazon. So close to the top spot! Incidentally, my sole-authored Capitalist and the Entrepreneur is just behind at #1,210,245, suggesting that the market places only a small value on the marginal Foss contribution. That’s the correct inference, right?
More Coase
| Peter Klein |
Russ Roberts interviews Coase on EconTalk. Familiar stuff, but it’s great to hear Coase talk about it at age 101. Some highlights:
Roberts: “[I]t’s hard to measure transactions costs; it’s hard to quantify the theory. Is that correct or is it irrelevant.” Coase: “It’s very relevant. But the state of economics is such that people don’t try to measure these things, to study them, and so people can engage in discussions and explanations without any real knowledge of what happens in the real world.”
Roberts: “What was your reaction to [game theory] and its influence on the study of the firm?” Coase: “I think the influence was wholly bad, because people developed high theoretical approaches instead of approaches based on what actually happens.”
Roberts: “[D]id you have contact with Keynes and Hayek, two great economists of that era in England?” Coase: “Yes. I was very friendly with Hayek. I liked him, and he liked me. But we didn’t have great contact. He tended to deal with these big questions, and I’m always interested in how the actual system operates. Therefore, in much smaller matters than Hayek.” Roberts: “And how about Keynes? Did you know Keynes?” Coase: “I can tell you– I was helping when Britain was trying to get a loan from the United States immediately after the war, and I was talking to one of Keynes’s assistants. And Keynes came in the room and walked over to us and the man I was talking to us said, ‘This is Coase, who is helping us with the statistics. I don’t think you know him.’ And Keynes said, ‘No, I don’t.’ And walked off. And that’s my life with Keynes. “
Vertical (Dis)integration and Technological Change
| Dick Langlois |
One of my longest-running interests has been the relationship between economic change, including technological change, and the boundaries of the firm. In broad strokes, my story is this: when markets are thin and market-supporting institutions weak, technological change, especially systemic change, leads to increased vertical integration, since in such an environment centralized ownership and control may reduce “dynamic” transaction costs; but when markets are thick and market-supporting institutions well developed, technological change leads to vertical disintegration, since in that environment the benefits of specialization and the division of labor outweigh the (now relatively smaller) transaction costs of contracting. This latter scenario is what I called the Vanishing Hand. I recently ran across a new working paper by Ann Bartel, Saul Lach, and Nachum Sicherman, called “Technological Change and the Make-or-Buy Decision,” that supports the Vanishing Hand idea empirically. Here is the abstract.
A central decision faced by firms is whether to make intermediate components internally or to buy them from specialized producers. We argue that firms producing products for which rapid technological change is characteristic will benefit from outsourcing to avoid the risk of not recouping their sunk cost investments when new production technologies appear. This risk is exacerbated when firms produce for low volume internal use, and is mitigated for those firms which sell to larger markets. Hence, products characterized by higher rates of technological change will be more likely to be produced by mass specialized firms to which other firms outsource production. Using a 1990-2002 panel dataset on Spanish firms and an exogenous proxy for technological change, we provide causal evidence that technological change increases the likelihood of outsourcing.
The Spanish dataset is based on questionnaires about outsourcing activities in various mechanical industries. The exogenous proxy is number of patents granted in the U. S. in each industry. So, basically, Spanish firms in industries in which there are a lot of American patents tend to outsource more ceteris paribus than Spanish firms in industries with fewer American patents. Although I always like empirical evidence that supports my own arguments, I also like to play the devil’s advocate. The incomplete-contracts literature (which for me is Coase and Knight as much as Hart and Moore) reminds us that it is harder to write contracts when knowledge is tacit and inchoate. Could it thus be that number of patents is a proxy for the importance of explicit versus tacit knowledge in the industry, and it is the prevalence of the explicit, rather than technological change per se, that makes contracting less costly? My money is still on the Vanishing Hand story.
Why Do Firms Differ?
| Peter Klein |
This year marks the thirtieth anniversary of two major contributions to strategy and organization, Nelson and Winter’s Evolutionary Theory of Economic Change and Lippman and Rumelt’s “Uncertain Imitability: An Analysis of Interfirm Differences in Efficiency under Competition.” Both tried to explain inter-firm performance differences without reference to market power or random shocks. Interestingly, as Ruff Coff points out, both were aimed at economists, but had little impact there, instead becoming foundational contributions to the emerging strategy field. Here’s a concise summary of Lippman and Rumelt from Peter Zemsky:
Lippman and Rumelt (1982), in the first formal theoretical paper inspired by the distinctive concerns of the strategy literature, demonstrate how superior performance can arise without assumptions of imperfect competition and market power, which are the defining features of the IO approach. In their model there are a large number of potential entrants that can pay a fixed cost to enter an industry. The key assumption is that there is imperfect imitability so that each entrant’s cost function is determined by an independent draw from a known distribution. In equilibrium, firms with bad draws exit and the remaining firms on average must have abnormal returns even when in the case where the firms are all small and have no market power. Ex ante however expected profits from entry are zero. The paper remains an outstanding example of high quality theorizing in strategy. Barney (1986) in his paper on strategic factor markets applies the same reasoning in his verbal argument that from an economics perspective superior performance must be the result of luck.
L&$ also explain the background and context of their article in a new video.
Kirzner’s theory of entrepreneurship is another example of a contribution intended to change the conversation in economics — by shifting attention from equilibrium states to adjustment processes — that seems to have little impact upon its intended audience, while becoming hugely influential in a different field (entrepreneurship).
A Curious Case of Vertical Integration
| Peter Klein |
The WSJ reports that Delta Airlines wants to acquire a Pennsylvania oil refinery. The reporters, quoting the ubiquitous “people familiar with the situation,” says that Delta “could save between $20 and $25 a barrel on some of its jet-fuel costs by acquiring the refinery, a big advantage as industry costs now approach $140 a barrel, up 11% so far this year.” But how? No particular economies of integration are mentioned in the article (apparently the WSJ doesn’t consider this an important point). Jet fuel is a standardized commodity, so asset specificity isn’t an issue. Organizational capabilities don’t seem to be relevant. Market power? Price discrimination? I don’t see it. In short, I can’t imagine where these cost savings would come from. Any ideas?
CFP: Bricolage in Art and Entrepreneurship
| Peter Klein |
Bricolage — doing the best you can with the materials on hand, rather than choosing and end and getting the resources you need — is an important concept in the contemporary entrepreneurship literature. Garud and Karnøe’s influential 2003 paper on the Danish wind power industry helped bring bricolage into the mainstream, and it has important parallels with effectuation and other approaches to entrepreneurship that emphasize experimentation and incremental learning.
The University of Missouri’s Department of Romance Languages and Literatures is hosting an interdisciplinary conference, 12-13 November 2012, on bricolage in art and entrepreneurship, focusing on the work of Ediciones Vigía, a unique artists’ collective that produces limited edition handmade books by Cuban and international authors and musicians. Participants will come not only from the humanities, education, and journalism, but also economics, management, and entrepreneurship. Among the featured speakers are Ivo Zander, who recently co-edited a book on Art Entrepeneurship, and Sharon Alvarez.
O&M readers interested in the relationship between business and the arts, the parallels between artistic creativity and entrepreneurial creativity, the economic organization of artist networks, and related issues should check it out. The full call for papers, along with related information, is below the fold.
Capabilities and Organizational Economics Once More
| Nicolai Foss |
As readers of this blog will know, the dialogue between the firm capabilities literature and organizational economics has a long history in management research and economics. Co-blogger Dick Langlois has been an important contributor in this space. The forty years long discussion (dating it from George B. Richardson’s 1972 hint that his newly coined notion of capability is complementary to Coasian transaction cost analysis) has proceeded through several stages. Thus, the initial wave of capabilities theory (i.e., beginning to mid-1990s) was strongly critical of organizational economic. This gave way to a recognition that perhaps the two perspectives were complementary in a more additive manner. Thus, whereas capabilities theory provided insight in which assets firms need to access to compete successfully, organizational economics provide insight into how such access is contractually organized. However, increasingly work has stressed deeper relations of complementarity: Capabilities mechanisms are intertwined with the explanatory mechanisms identified by organizational economists.
In a paper, “The Organizational Economics of Organizational Capability and Heterogeneity: A Research Agenda,” that is forthcoming as the Introduction to a special issue of Organization Science on the the relation between capabilities and organizational economics ideas, Nick Argyres, Teppo Felin, Todd Zenger and I argue, however, that the discussion has been lopsided—hardly qualifying as a real debate—and that a reorientation is necessary.Specifically, the terms of the discussion have largely been defined by capabilities theorists. Part of the explanation for this dominance is that capability theorists have had a rhetorical advantage, because everyone seems to have accepted that organizational economics has very little to say about organizational heterogeneity. We argue that this rests on a misreading of organizational economics: while it is true that organizational economics was not (directly) designed to address and explain organizational heterogeneity, this does not imply that the theory is and must remain silent about such heterogeneity. In fact, we discuss a number of ways in which organizational economics is quite centrally focused on explaining organizational heterogeneity. Specifically, we argue that organizational economics provides guidance around how organizational design and boundaries facilitate the formation of knowledge, insight, and learning that are central to the heterogeneity of firms. We also demonstrate how efficient governance can itself be a source of competitive heterogeneity. We thus call on organizational economists to actively and vigorously enter the discussion, turning something closer to a monologue into real dialogue. (more…)
First Copies of the New Book
| Peter Klein |
Nicolai was in town yesterday to deliver the 2012 Sherlock Hibbs Distinguished Lecture in Economics and Business, and he gave a terrific talk about “open entrepreneurship,” the application of concepts and principles from the open innovation literature to the discovery, evaluation, and exploitation of entrepreneurial opportunities. Upon returning to my office after the lecture, I found a surprise waiting for me: the first hardcopies of our new book, Organizing Entrepreneurial Judgment: A New Approach to the Firm (Cambridge University Press, 2012). As both authors happened to be together, we preserved the moment for posterity.
You can order today on Amazon’s UK site (or pre-order on the US site, which shows a publication date of 30 April). You can order directly from Cambridge (UK or US).
A brief description and some endorsements are below the fold.
NB: Tomorrow Nicolai is giving the Hayek Lecture at the Austrian Scholars Conference, which you can watch live online.
Update: O&M readers can order directly from Cambridge and receive a 20% discount! Use this link.
Zenger, Felin, and Bigelow on “Theories of the Firm-Market Boundary”
| Peter Klein |
Here’s a nice review and synthesis of “Theories of the Firm-Market Boundary” by Todd Zenger, Teppo Felin, and Lyda Bigelow, just out in the Academy of Management Annals.
A central role of the entrepreneur-manager is assembling a strategic bundle of complementary assets and activities, either existing or foreseen, which when combined create value for the firm. This process of creating value, however, requires managers to assess which activities should be handled by the market and which should be handled within hierarchy. Indeed, for more than 40 years, economists, sociologists and organizational scholars have extensively examined the theory of the firm’s central question: what determines the boundaries of the firm? Many alternative theories have emerged and are frequently positioned as competing explanations, often with no shortage of critique for one another. In this paper, we review these theories and suggest that the core theories that have emerged to explain the boundary of the firm commonly address distinctly different directional forces on the firm boundary — forces that are tightly interrelated. We specifically address these divergent, directional forces — as they relate to organizational boundaries — by focusing on four central questions. First, what are the virtues of markets in organizing assets and activities? Second, what factors drive markets to fail? Third, what are the virtues of integration in organizing assets and activities? Fourth, what factors drive organizations to fail? We argue that a complete theory of the firm must address these four questions and we review the relevant literature regarding each of these questions and discuss extant debates and the associated implications for future research.
Lots of good stuff here, especially in integrating economic and sociological perspectives on boundary (I guess all that time Teppo spends over there has influenced his thinking).
Foss at Missouri
| Peter Klein |
O&M co-founder Nicolai Foss will give the 2012 Sherlock Hibbs Distinguished Lecture in Business and Economics Tuesday, 6 March 2012, 10:00-11:30am, in 205 Cornell Hall on the University of Missouri campus. The title is “Open Entrepreneurship: The Role of External Knowledge Sources for the Entrepreneurial Value Chain.” The lecture is sponsored by the Hibbs Professors of the University of Missouri’s Trulaske College of Business and the University of Missouri’s McQuinn Center for Entrepreneurial Leadership (which I direct).
The full announcement (with Nicolai’s impressive bio) is below the fold. The lecture is free and open to the public, so all are welcome! (more…)
CFP: “Effects of Alternative Investments on Entrepreneurship, Innovation, and Growth”
| Peter Klein |
Along with Don Siegel, Nick Wilson, and Mike Wright, I am guest editing a special issue of Managerial and Decision Economics on the “Effects of Alternative Investments on Entrepreneurship, Innovation, and Growth.” Proposals are due 15 June 2011. A special issue conference for developing the papers is planned for 29 October 2011 at the SUNY Global Center in Manhattan. The conference is jointly sponsored by the SUNY-Albany School of Business, the Centre for Private Equity Research at Imperial College Business School, and the McQuinn Center for Entrepreneurial Leadership. Further details and submission guidelines are below the fold. (more…)
Virtual Ownership and Managerial Distance
| Dick Langlois |
If you’re in New York on February 6, you might want to go hear the always-interesting Henry Hansmann talk about work he is doing with Nicolai’s CBS colleague Steen Thomsen. The talk is at 4:20 in Room 701 Jerome Greene Hall at Columbia. This is part of the Columbia Law and Economics Workshop. (I’m on their mailing list but seldom have the time to make the trip.) Here’s the abstract:
Industrial foundations are nonprofit holding companies that own business firms. These entities are common in Northern Europe, and many successful international companies are owned in thus fashion. Because of their strong economic performance and unusual combination of nonprofit and for-profit entities, they present interesting challenges to theories of the firm. In this paper, we present the first study of the manner in which the foundations govern the companies that they own. We work with a rich data set comprising 121 foundation-owned Danish companies over the period 2003-2008.
We focus in particular on a composite structural factor that we term “managerial distance.” We interpret this as a measure of the clarity and objectivity with which a foundation-owned company’s top managers are induced to focus on the company’s profitability. More particularly, managerial distance seems best interpreted as a factor, or aggregate of component factors, that put the foundation board in the position of “virtual owners,” in the sense that the information and decisions facing the managers are framed for them in roughly the way they would be framed for profit-seeking outside owners of the company. Our empirical analysis shows a positive, significant, and robust association between managerial distance and company economic performance. The findings appear to illuminate not just foundation governance, but corporate governance and fiduciary behavior more generally.
Birger Wernerfelt to Become Honorary Doctor at CBS
| Nicolai Foss |
Over the last few years, CBS has bestowed honorary doctoral degrees on the likes of Jay Barney, Oliver Williamson, Oliver Hart, Michael Brennan, and other luminaries in strategy, the theory of the firm, and finance (in addition to a number of reps of pomo in management research that are of small interest to O&M readers). At a ceremony on 19 April a CBS honorary doctorate will be bestowed upon Birger Wernerfelt.
Wernerfelt is the JC Penney Professor of Management of the MIT Sloan School of Management. A Danish citizen, Wernerfelt holds degrees from the University of Copenhagen and Harvard. Wernerfelt’s best known work is no doubt “A Resource-based View of the Firm.” With more than 12,000 cites (google scholar) this paper is also one of the most cited social science research articles ever, and, of course, one of the founding papers of strategy’s (still) dominant view, the resource-based approach. The paper develops a conception of firms as bundles of heterogeneous and partly firm-specific resources, and links this conception to sustainable performance differences between firms as well as to growth strategies through resource-based diversification. These ideas opened up several paths of research in strategic management in the following decades, including Wernerfelt’s own influential empirical work (with Cynthia Montgomery) on diversification and its link to performance (e.g., here).
More recently, Wernerfelt has been working on other truly fundamental aspects of the theory of the firm, namely the reason why firms exist and what explains their boundaries and internal organization. Thus, in a series of papers, Wernerfelt has developed an argument that the employment relationship exists because it allows the parties to the contract to exploit economies of scale in bargaining costs (e.g., here) — a stream that may be seen as much more true to the original message in Coase’s (1937) “The Nature of the Firm” than the asset-specificity branch of the theory of the firm. Wernerfelt has extended the argument to the understanding of asset ownership, communication within and between firms, and the strength of incentives in firms versus markets. In addition to these contributions to strategic management and the theory of the firm, Wernerfelt has contributed to the economics of search and numerous important contribution to marketing theory.
Finance and the Nature of the Firm
| Peter Klein |
Raghu Rajan’s AFA presidential address is now online as an NBER working paper:
The nature of the firm and its financing are closely interlinked. To produce significant net present value, an entrepreneur has to transform her enterprise into one that is differentiated from the ordinary. To achieve the control that will allow her to execute this strategy, she needs to have substantial ownership, and thus financing. But it is hard to raise finance against differentiated assets. So an entrepreneur has to commit to undertake a second transformation, standardization, that will make the human capital in the firm, including her own, replaceable, so that outside financiers obtain rights over going-concern surplus. I argue that the availability of a vibrant stock market helps the entrepreneur commit to these two transformations in a way that a debt market would not. This helps explain why the nature of firms and the extent of innovation differ so much in different financing environments.
Conference on the Law & Economics of Organization: New Challenges and Directions
| Peter Klein |
Via Scott Masten, an important call for papers:
The Walter A. Haas School of Business at the University of California, with support from the Alfred P. Sloan Foundation, is issuing a call for original research papers to be presented at the Conference on the Law & Economics of Organization: New Challenges and Directions. The conference will be held at the Haas School of Business in Berkeley, CA, on Friday, Nov. 30, and Saturday, Dec. 1, 2012. The purpose of the conference is to take stock of recent advances in the analysis of economic organization and institutions inspired by the work of 2009 Nobel Laureate Oliver Williamson and to examine its implications for contemporary problems of organization and regulation. Empirical research and research informed by detailed industry and institutional knowledge is especially welcome. Conference papers will be published in a special issue of the Journal of Law, Economics, & Organization. Submissions are due March 31, 2012. See the Call for Papers for details.
Kaplan on Private Equity
| Peter Klein |
Mitt Romney’s time as head of Bain Capital has put private equity in the public spotlight. Jonathan Macey gave a vigorous defense of PE in Friday’s WSJ. I am certainly a fan, though of course PE as a governance mechanism has benefits and costs, like all organizational structures. For a great overview of the industry and its role in job creation and economic growth, listen to last Thursday’s Diane Rehm show, where Steve Kaplan gave a terrific presentation emphasizing the data and challenging popular myths about takeovers and layoffs.
The Economic Organization of Disaster Relief
| Peter Klein |
J. Vernon Henderson and Yong Suk Lee have released a fascinating study of the make-or-buy decision in the provision of disaster relief. “We distinguish four organizational structures by implementation method. . . . (1) donor-implementers who are NGO donors who do their own implementation in villages, (2) international implementers who represent different donors who choose not to do their own implementation, (3) domestic implementers hired by donors which have chosen neither to do their own implementation nor to hire an international implementer, and (4) a country level governmental organization . . . used primarily by domestic and foreign governments.” Henderson and Lee find that donor-implementers offer the highest-quality aid, and the government agency the lowest, with the contract implementers in-between. The framework is agency theory, not transaction cost economics, but there may be a role for asset specificity as well, particularly in cases where a longer-term commitment is required. In any case, this is an interesting and important application of organizational economics to an unconventional setting.
A Turkey of a Thanksgiving Post
| Peter Klein |
Many US bloggers try to post something clever on Thanksgiving about religious freedom, agricultural productivity, colonialism, property rights, immigration, etc. We’ve done it ourselves. But this year I thought I’d share something different: nerdy academic stuff about — what else? — the economic organization of the turkey industry. Tomislav Vukina’s 2001 paper on vertical integration in poultry is instructive. For example:
The pattern of vertical integration is less uniform in the turkey industry than in the broiler industry. A turkey company is less likely to own its own hatchery but is more likely to have company owned production farms (Martin et al. 1993). There is also more variation among production contracts in terms of division of risks and profits from growing turkeys than in the broiler industry. The processing plant is the center for control of placement.
A processor may contract directly with farmers or contract with a feed supplier who in turn contracts with farmers. In the turkey industry, there are still some independent producers with formal marketing contracts with processors. Such marketing contracts do not always provide any price or margin guarantees to producers. (more…)
A Formal Model of Experimentation in Firms
| Peter Klein |
Following Knight, Mises, and Lachmann, we have often characterized entrepreneurship on this blog (and the McQuinn blog, which should be on your reading list) as experimentation with combinations of heterogeneous capital resources. Experimentation itself is relatively understudied in the entrepreneurship and strategy literature — we have general theories about the nature and effects of experimentation, indirect empirical evidence on competition as experimentation (e.g., my relatedness stuff with Lasse), case-study evidence about experimentation and innovation within firms, but don’t fully understand the exact mechanisms.
Here’s a new paper that will not be to everyone’s taste, but tries to get at these issues in a formal model of interaction between experimenting firms:
The Role of Information in Competitive Experimentation
Ufuk Akcigit, Qingmin Liu
NBER Working Paper No. 17602, November 2011Technological progress is typically a result of trial-and-error research by competing firms. While some research paths lead to the innovation sought, others result in dead ends. Because firms benefit from their competitors working in the wrong direction, they do not reveal their dead-end findings. Time and resources are wasted on projects that other firms have already found to be dead ends. Consequently, technological progress is slowed down, and the society benefits from innovations with delay, if ever. To study this prevalent problem, we build a tractable two-arm bandit model with two competing firms. The risky arm could potentially lead to a dead end and the safe arm introduces further competition to make firms keep their dead-end findings private. We characterize the equilibrium in this decentralized environment and show that the equilibrium necessarily entails significant efficiency losses due to wasteful dead-end replication and a flight to safety — an early abandonment of the risky project. Finally, we design a dynamic mechanism where firms are incentivized to disclose their actions and share their private information in a timely manner. This mechanism restores efficiency and suggests a direction for welfare improvement.
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