ECONOMICS
Org economics began with Coase’s (37) challenge of economic assumptions of perfect markets.
Coase asked why are there firms if markets are efficient and if firms could be more efficient how is the market not one huge firm?
The common assumptions of org economics are profit maximization, bounded or perfect rationality and that competition is the major driving force. There are two major paradigms
of organizational economics.
Governance models focus on the exchange dynamics of actors and consist of transaction cost economics (Will 75), agency theory (Jens & Meck 76) and property rights (Hart 89).
Competency models focus on internal factor of differentiation such as the resource based view (Penrose 59), dynamic capabilities (Teece 84) and industrial organization (Porter
79).
Behavioral theory of the firm is an info processing perspective (C&M 63) that uses cognitive constructs at the org level such as goals, expectations and choices constructed by
processes where individual cognitions are in relationship.
The Carnegie School led by M,S&G (58) introduced bounded rationality to explain limited info processing abilities that lead to quasi-resolutions of contradicting goals made
compatible by local rationality, satisficing, and sequential attention to goals.
Rules, programs, schedules departmentalization, hierarchy, delegation and micro-coordination are coordination mechanisms organizations use to increase info processing.
Organizations group tasks to minimize coordination, or transaction, costs and focus on efficiency.
Transaction cost analysis is an open rational system model studying orgs at the ecological level whether to make or buy a material or product.
In transaction cost economics there are two main governance structure, the market and the organization.
Transactions, the unit of analysis, are exchanges negotiated by contracts where parties are assumed to operate in self-interest.
Transaction cost economics has two key behavioral assumptions 1. Bounded rationality prevents the ability to see all possible consequences of the contract and 2. Opportunism
prevents the possibility of relying on promises.
However those two factors alone are not enough to prevent proper contracting if the market operates with perfect information and competition. Williamson formalized three
conditions that prevent reliance on contracts: 1. Uncertainty regarding unfolding events pertaining to the contract, 2. Asset specifity where the investment required for a contract is
tied to it and 3. Frequency of the transactions is expected with regularity.
Market failures framework explains Williamson (85) fundamental transformation that predicts situations where bringing exchanges into the firm is better than leaving them in the
marketplace.
In situations where exchangers have good opportunities to cheat and there are few exchangers to choose from it is better to bring the exchange inside the organization.
Freeland’s (00) seminal example is of GM and Fischer Body who made a big investment to supply GM.
Fisher Body made the investment and GM’s difficult in replicating the investment rapidly and cheaply elsewhere led GM to acquire Fischer Body. Organizations supplant long-
term open contracts among exchange partners, replaced by employment contracts where people sell the promise to obey command (Commons 24).
A criticism of transaction cost is that it only explains static arbitrage, not the dynamic emergence of a firm and has no predictive power regarding the performance difference
between firms.
There are claims it overestimates the power of hierarchical controls and incentive systems and underestimates the extent economic behavior is embedded in a web of social
relations (Milgrom Roberts 88; Uzzi 97).
Opportunism has been critiqued as an unnecessary assumption and questioned whether an independent cause or a consequence of context (Conner Prahalad 96; Ghoshal Moran
96).
Agency theory focuses on conflicts of interest intrinsic to corporate governance typically between principal and agent (Barney Hesterley, 96).
Positive agency theory is a theory of firm ownership capital structure that examines the power and politics of corporate control, assuming the rationality of actors and constraints of
real governance situations (Jen & Meck, 76, Eisenhardt 89).
Property rights include ownership and control not just the principal-agent problem (Alchian Demsetz 72, Hart 89).
Agency theory claims firms do not have unity of action and that political arenas generate asymmetric info because principals and agents are boundedly rational, self-interested,
opportunistic and risk averse (Allison 71).
Economist identified three sources of principal-agent problems as moral hazard, adverse selection and asymmetric information (Akerlof 70; Spence 73; Arrow 85).
The delegation of decision making authority is problematic because interests diverge and the principal is unable to monitor the agent without cost.
The theory explores the issues of controlling and monitoring for the alignment of interests (Dalton et al, 03).
However, agents develop power bases and owners become dependent on expertise.
Labor wields power through union activity, strikes and slowdowns.
Individuals interfacing with suppliers and regulatory agencies also gain power.
Hickson et al (71) made three propositions about power based on Emerson’s (62) definition: 1. If you can cope with uncertainty, 2. Have low substitutability and 3. Have high
centrality, through pervasiveness (degree) and immediacy (affect) then the greater the power.
Criticisms of governance models is the asocialized view of the actor as self-interested, atomistic, market oriented and uninfluenced by social relations. There is an unrealistic view
of motivation as primarily financial gain, however behavioral research shows individuals are also motivated by things such as status and community (Hirsh et al, 90).
Guarding against opportunistic behavior can stifle initiative, creativity, entrepreneurship and innovation within firms (Davis et al, 97).
Critiques led to a more socialized version of agency theory on whether incentives have more symbolic than economic value, whether demographic similarities is a true determinant
of incentives, and whether increased board control is balanced by the social influence of management (Westphal Zajac 94,98,02).
Resource based view is a competence based model that asks why firms are different and answers because firms own specific rents.
Penrose (59) first had the idea of resources shaping firm behavior and org growth over time.
RBV assumes markets host imperfections and was developed in response to structure-conduct-performance and firm performance in industrial economics (Bain 50; Porter 80;
Barney 86).
RBV focuses on the continuing search for rent and ways that unique resources can be deployed in changing circumstance (Rumelt 74).
RBV argues that attributes of the firm that are hard to copy drive performance and competitive advantage (Rumelt 84,87).
Resources of interest are valuable, rare, inimitable and non-tradable (VRIN) (Barney 91).
There is a strong epistemological criticism that RBV is tautology (Priem Butler 01; Williamson 99).
The existence of resources is based on differential performance which is then used to predict …performance.
The view does not address when a resource is crucial if everything has a unique resource and more resources are always better than less.
Finally, the theory ignores the environment which weakens any predictions on developing resources that may become obsolescent with environmental variation.
Dynamic capability research explores how firms build and sustain competitive advantage in dynamic markets.
Dynamic capabilities derive from managerial processes and competence only generates rents if based on routines difficult to imitate and heterogeneity is an outcome of
Schumpterian competition (creative destruction) (Teece Pisano 97).
Dynamic capability has a strong affinity with learning perspectives, sustained competitive advantages depend on effective manipulation of knowledge sources.
Eisenhardt & Martin (00) explained dynamic capabilities by its contrast to RBV:
RBV assets purchasable, DC assets deploy and recombine RBV inimitable resource, DC inimitable processes
RBV rents assets, DC rents transformation RBV specific assets, DC specific skills, acq, learning
RBV assets valuable, DC assets inimitable RBV vs. SCP, DC vs. TCE
RBV no isolation of rents, DC isolation of rents