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									What is Organizational
    Economics?

   (and Should Any
  Sociologists Care?)

        B. Gibbons
     September 2, 2004
     Bob Learns Something About
     Organizations (and Sociology)

July, 1991
    —   Move next to Victor
    —   Institutions Conference
    —   PhD course w/ John Freeman
    —   BEDR
    —   David Strang‘s PhD course
    —   ―Snow‖ Conference
    —   Ed Lawler‘s PhD course
    —   Steve Barley‘s ―ASQ Forum‖
    —   MDRPOI (!)

June, 1997
Organizational Economics?

   Industrial
Organization                   Labor




          Theory of   Internal
           the Firm   Organization




  Law and                     Corporate
  Economics                   Finance
    Governance Economics?


Constitutional                  New Institutional
Economics                      Economic History
(eg, Buchanan)                        (e.g., North)




           Organizational Economics
                 (e.g., Williamson)
    Within Economics, OE is …

• An emerging field?
   — What does this mean?
   — How does this happen?

• Part of an emerging approach?
   — Choice vs governance
   — Price vs. contract


• A playground for under-employed theorists?
    What is Economic
Sociology and Should Any
    Economists Care?



        B. Gibbons
        JEP, 2005
            OE and Organizational Studies?
                              Economic
                 Industrial
              Organization                   Labor




Positive                Theory of   Internal                Social
Political                the Firm   Organization
                                                        Psychology
Theory



                Law and                     Corporate
                Economics                   Finance

                              Sociology
           H. Zuckerman ‗04
Your comments ―address the general issue of the
diffusion of concepts, findings, methods, and
orientations across disciplinary boundaries …‖
Bob ―would have especially liked the idea that all the
traffic wasn‘t moving from economics to sociology.
He would also have noted that the ideas you cite were
developed decades ago, and that the convergence of
modern organizational economics and ‗post-
Weberian‘ organizational sociology happened
inadvertently.‖
  Outside Economics, OE is …
• Economists‘ contribution to OS?
    — Gains from interaction?
    — How to facilitate?

• Case study in sociology of science?
    — Development of OE within Econ?
    — Interaction between disciplines?


• Narrow-minded imperialism (again)?
      Possible Outline

I.   Our Organizational Economy

II. Internal Organization
III. Theories of the Firm
IV. Managing Governance

V. Groping Towards A Field
VI. Should Any Sociologists Care?
I. Our Organizational Economy

―Sociologists have long argued that we live in
an organizational society: ‗all important social
processes either have their origin in formal
organizations or are strongly mediated by
them‘ (Perrow, 1986).‖       Gibbons-Waldman 99



~ 1 of ~ 37 chapters
               Simon ‗91

Suppose that ―a mythical visitor from Mars …
approaches the Earth from space, equipped
with a telescope that reveals social
structures…
―Our visitor … might be surprised to hear the
structure called a market economy. ‗Wouldn‘t
‗organizational economy‘ be the more
appropriate term?‘ it might ask.‖ (1991: 27-28)
 Foundational Questions for
 Organizational Economics

What is an organization?
What do organizations do?
Does it matter (that some activities are
      ―governed‖ instead of ―priced‖)?
      What is an organization?
―Organizations are a means of achieving the
benefits of collective action in situations
where the price system fails.‖ (Arrow, 1974: 33)
      -- firms          -- governments
      -- schools        -- political parties
      -- churches       -- social movements

      -- markets!
   What do organizations do?
―All of them … share the common
characteristics of the need for collective action
and the allocation of resources through
nonmarket methods.‖ (Arrow, 1974: 26)
     -- allocate capital
     -- employ people
     -- interact with other organizations
     -- govern / manage (vs. price)
            Does it matter?

• Resource allocation within firm vs.
  between?
• Employment in large firms vs. spot market?
• Interactions between organizations
  governed / managed vs. priced?
• Mullainathan-Scharfstein AER 01
     – ―Do Firm Boundaries Matter?‖

• Bidwell 04
     – ―What Do Firms Do Differently?‖

• Zuckerman 04
     – ―Do Firms and Markets Look Different?‖
    II. Internal Organization
•   200 years:      firm = black box
        K, L              F(K, L)
                  Firm



•   Recently:       looking inside
    –   Microfoundations:      F(K, L)
    –   Omitted variable(s):   F(K, L, M)
                       Early Work

•       Weberian bureaucracy                                    (1924)
    —     ―precision, speed, expert control, continuity, discretion, and
          optimal returns on input‖

•       Post-Weberian Orgz‘l Sociology                          (1950s)
    —     ―rules are often violated, decisions are often unimplemented, …
          and evaluation and inspection systems are subverted‖

•       Team Theory                         (Marschak & Radner, 1972)
    —     rules for investigating, communicating, and deciding
    —     Weber meets statistical decision theory
             Recent Convergence

•       Org. econ. models  post-Weberian spirit
    —     Inefficient, informal, and institutionalized organizational
          behaviors (vs. team theory)


•       ―Game Theory and Garbage Cans‖
    —     Get what you pay for
    —     Lobbying and politics
    —     Culture and relationships
    —     Herd behavior and group think


•       Behavioral Theory of the Firm (CM 63)
  Inevitability of Convergence?

• Coase (1937)
  – If markets were perfect, why would we need firms?

• Heckman (1976)
  – If two actors make different choices, they may be
    solving different problems

• ―Taking Coase Seriously‖
  – Markets may look more effective, but firms may be
    handling tougher problems
                            Firms are not immune to forces
                          that wreck markets. Organizations
Effect- 100%                 are a mess, but not a mystery.
iveness
               observed
                markets
                           observed firms


                                                Firm

                                                Market
                                       Transaction
                                       Difficulty
       Coase (1937) Meets Heckman (1976)
•       Some progress: explaining the mean
    –    Microfoundations:                  F(K, L)

•       New avenue:       noticing the variance
    –    Leibenstein      case studies, paired comparisons
    –    Griliches etc    enterprise productivity panel data
    –    Rumelt etc       enterprise profitability panel data



•       Next agenda:      explaining the variance
    –    Omitted variable(s):               F(K, L, M)
Summary of Internal Organization

1. ―Behavioral Theory of the Firm‖
  –   Orgzns. are a mess, but not a mystery
  –   Recent models have post-Weberian spirit.

2. Microfoundations vs. omitted
   variables
  –   Explaining the mean would be nice, but the
      variance may be as / more important.
  –   What do managers do?
        III. Theories of the Firm

•       Rent-seeking
    –   Klein-Crawford-Alchian 78, Williamson 71/79
    –   Monteverde-Teece 82, Masten 84, Joskow 85, …

•       Property rights
    –   Grossman-Hart 86, Hart-Moore 90, Hart 95

•       Incentive systems
    –   Holmstrom-Milgrom 91/94, Holmstrom-Tirole 91, Holmstrom 99

•       Adaptation
    –   Simon 51, Williamson 75, Klein 96, Klein-Murphy 97
          Birds Eye‘s Frozen Peas


   farm   freeze      store    distrib.      retail



Farmer             Birds Eye

                         Farmer           Birds Eye
                         Other rights     Seeds, planting,
                                          fertilizer,
                         Profits          harvesting

Control (via Contract or Ownership)
A Vertical Transaction

            Ownership of asset conveys
  U         ownership of good
            U owns asset (non- ):
               U = indep. contractor
  A         D owns asset ( ):
               U = employee


  D         D
Relational Contracts Within Firms

•Firms are riddled with relational contracts:
 Barnard 38, Simon 47, Selznick 49, Gouldner 54, Blau 55

•Applications:
 Lawler 71, Eccles 85, Dalton 59, Bower 70
Relational Contracts Between Firms

   • So are business dealings:
    Macaulay 63, Macneil 78, Dore 83

   • Applications:
    Powell 90, Podolny-Page 98, Gerlach 91, Gulati-
    Singh 98, Kogut 89, Dyer 96
                  C + (1/r)C > D + (1/r)P ?




Basic repeated-game model of “trust”
 Theories of Relational Contracts
• Theory, I: relational incentive contracts
   – Klein-Leffler ‗81, Telser ‗81, Bull ‗87
   – MacLeod-Malcomson ‗89, Levin ‗03

• Theory, II: formal and informal co-exist and
  interact
   – BGM ‗94, ‗99, ‗01, ‗02, ‗04a, ‗04b
   – Garvey ‗95, Halonen ‗02, Bragelien ‗03, Rayo ‗03
                    Cg + (1/r)Cg > Dg + (1/r)Pg ?


              Dg




                                               Cg

                                                Pg




Relational Contract in Gov. Structure g
    (Partial!) Summary of Theories
               of the Firm
•       Formal and informal co-exist & interact, …
    –     ―Sociological babes in the woods …‖
    –     ―The formally instituted and the informal emerging
          patterns are inextricably intertwined‖

•       … and so require joint optimization
    –     Take the total derivative: optimize bricks, taking
          account of ivy
    –     Choose governance structure to facilitate relationship
    –     ―What the Folk Theorem Didn‘t Tell You‖
   IV. Managing Governance
• Pick a decent governance structure
   – Contracts
   – Control rights
   – Formal structures and processes

• Improve it through relationships / informal
  structure / culture
   –   Clarity
   –   Credibility
   –   Anticipate extremes
   –   Anticipate change
    What the FT Hasn‘t Told Us
1. ―Management‖ in typical FT setting:
       a) Shared history, stationary environment
       b) Example: bonus B in Bull 87
       c) Tasks: conceive, communicate, implement eqbm.
2. ―Leadership‖ in real settings:
       a) Ambiguous histories, unforeseen events
       b) Example: layoffs at HP (& ―genesis amnesia‖)
       c) Tasks: create, maintain, change eqbm.
3. Tough tasks (for managers & theorists):
       a) Building credibility / creating equilibrium
       b) Managing relationships / preserving equilibrium
       c) Credible change / switching equilibria
V. Groping Towards a Field

 • Proxies for a field?
 • Pitfalls in field development?
 • Case study: economic geography
        Proxies for a Field?
• Research:
    – Articles, conferences, journal, handbook

• Education:
    – Routine course, text, general exam

• Job Market:
    – Rookies, slots, groups
    Pitfalls in Field Development

― … a mass of descriptive material waiting for
a theory, or a fire‖ (Coase 1984: 230)

― … the way in which reasonably clever
businessmen and lawyers cope with problems
scholars might consider intractable.‖ (Goldberg
and Erickson, 1987: 369)
          Economic Geography
             (Krugman, 1995)

―The reason that economic geography failed
to ‗make it‘ into mainstream economics was
the inability of [its] creators to express their
ideas in a way suitable for the modeling
techniques available at the time.‖ (p. 6)

―Like it or not, the influence of ideas that have
not been embalmed in models soon decays.‖
(p. 27)
Von Thünen‘s model ―… was the one piece of
a heterodox framework that could easily be
handled with orthodox methods, and so it
attracted research effort out of all proportion
to its considerable merits.‖ (p. 54)

These are ―… tales of frustration: sensible
ideas that could not be effectively formalized,
[and] formalizable ideas that seem to have
missed the point.‖ (p. 59)
VI. Should Sociologists Care?
  • Substantive overlaps
       – power & politics
       – complex organizations
       – markets & institutions

  • Case study
       – OE within Econ
       – Across disciplines
            Complex Organizations
•       Corporate Strategy
    –     BMGI, Beatrice            (homogeneous , conglomerate)
    –     Jacobs Suchard, J&J       (decentralization  ?)
    –     Disney, ABB               (synergy group, matrix)

•       Extended Enterprises
    –     Chrysler‘s suppliers      (hand-in-glove)
    –     Fuji-Xerox, Honda-Rover   (JV, alliance)
    –     XTV, Birds Eye            (spin-offs, industry dynamics)
                  non-       
incentives,
  initiative                      ―multi-domestic‖ =
                                    loose federation



                          ―transnational‖
                             = networked




                           ―global‖ = scale thru
                                standardization
                                                       coordination,
                                                       control


          Structures for Corporate Strategy
                              non-
incentives,
  initiative   spot                    
               market




                            command
                                firm
                                           coordination,
                                           control


     Relational Contracts in Extended Enterprises
                                   Figure 6
Ne tworks in Re combinant Capital Database of Pharmaceutical-Biote ch Alliance s
                                                      Table 1
             Operational Objectives and Governance Structures for Pharmaceutical-Biotech
                                     Strategic Alliances, 1973-2001

                                                     Governance Structure for Alliance

Operational Objective                                  Merger or        Joint        Structure
                             License     Investment                                                        Total
of Alliance:                                           Acquisition     Venture      not Specifed

Development                   16.2%         4.6%          0.1%           0.7%           7.7%               29.4%
Research                      13.3%         3.5%          0.1%           0.4%           7.3%               24.6%
Manufacturing
or Marketing                  4.7%          1.8%          0.4%           0.3%           10.6%              17.9%
Collaboration                 7.3%          2.2%          0.0%           0.2%           6.9%               16.7%
Supply                        4.3%          1.3%          0.3%           0.1%           3.1%               9.2%
Objective not
specified                     20.6%         4.9%          12.8%          2.1%                              40.3%

Total                         66.5%         18.4%         13.8%          3.8%           35.7%
Note: Data ext racted from R ecombinant Capital database of alliances in the pharma -biotech industry, based on
      approximately 12,500 publicly disclosed contracts and arrangements from 1973-2001. Totals sum to more than
      100% because contracts frequently mention multiple objectives (e.g., research and developme nt) and often note
      multiple governance structures (e.g., investment and license agreeme nt).

								
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