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Organization Studies Chapter 1.3

Organization Studies Chapter 1.3. Organizational Economics. What Distinguishes OE from Other Research Streams in Org Studies?. Focuses on economic reasons for the existence of firms Some parts of OE focus on equilibrium-based models of economics (not all).

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Organization Studies Chapter 1.3

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  1. Organization StudiesChapter 1.3 Organizational Economics

  2. What Distinguishes OE from Other Research Streams in Org Studies? • Focuses on economic reasons for the existence of firms • Some parts of OE focus on equilibrium-based models of economics (not all)

  3. What Distinguishes OE from Other Streams in Economics Research? • Most economists focus on markets, OE focuses on firms • Organizational economists tend to focus on the relationship between competition and firms

  4. Four Main Areas in OE • Transaction Cost Economics (Williamson 1975) • Agency Theory (Jensen & Meckling 1976) • Strategic Management Theory • Co-Operative Organizational Economics

  5. Why Do Organizations Exist? • Coase (1937) questioned the lack of treatment in economics to the theory of the firm. • Firms exist because some exchanges are better managed (cost less) inside organizations as opposed to across markets • Coase placed transaction costs at the center of analysis of firms – which led to TCE

  6. Teamwork – Alchian & Demsetz • Teams outproduce individuals • Individuals on teams have incentives to shirk • Teams will assign a monitor who gathers the profits from teamwork and pays members accordingly • The “monitor” is the shareholder, which suggests why firms form

  7. Transaction Cost Economics • Williamson 1975 • Conditions of Uncertainty around Specificity • Bounded rationality • Opportunism

  8. Applications of TCE • Vertical Integration: Make or Buy • Multidivisional form • Ouchi’s (1979) Markets, Bureaucracies, and Clans • Multinational Enterprise • Hybrids

  9. Criticisms of TCE • Focuses on cost minimization • Understates the cost of organizing • Neglects the role of social relationships in economic transactions • Emphasis on opportunism can be harmful

  10. Agency Theory • Do those associated with the firm agree about how it should be managed? • Major themes (Eisenhardt 1989): • Goal misalignment • Information asymmetry • Differences in risk tolerance

  11. Responses to the Agency Problem • Monitoring • Bonding & Incentives

  12. Criticisms of Agency Theory • Treats people as primarily financially motivated • Ignores other behavioral sciences • Lack of realism in approach to governance • Not necessarily generalizable • Some scholars argue it is self fulfilling

  13. Strategic Management Theory • Why do some organizations outperform others? • Structure-Conduct-Performance (SCP) • Resource Based View (RBV)

  14. Structure – Conduct – Performance • Originated as a search for industries that lacked competition • Overly profitable industries failed to maximize social welfare • Innovation was stifled • Once identified, regulation was used to “remedy” the problem and increase competition

  15. SCP – Industry Structure • Performance-enhancing industry attributes: • Industry concentration • Level of product differentiation • Barriers to entry

  16. Product Differentiation • Termed “monopolistic competition” by Chamberlain (1933) • Differentiating products allows firms to charge abnormal profits above the cost

  17. Industry Concentration • Fewer firms in an industry can lead to collusive strategies • Large economies of scale required to achieve certain profits can lead to performance differences

  18. Barriers to Entry • Economies of scale • Product differentiation • Cost advantages independent of scale • Contrived deterrance • Government imposed restrictions

  19. Strategic Management & SCP • Strategy research now uses SCP concepts to suggest ways firms can reduce competition • Porter’s Five Forces • Model of generic industry structure and environmental opportunities • Strategic groups

  20. Porter’s Five Forces • Level of threat • in an industry Threat of rivalry Threat of substitutes Threat of new entry Threat of suppliers Threat of buyers

  21. Industry Structure and Opportunities

  22. Criticisms of SCP • Firm performance being determined by industry fails to explain heterogeneity within industries • By focusing on “attractive” industries, opportunities in other industries are overlooked • The inversion of the research stream has, in all likelihood, counteracted its original intent of improving social welfare

  23. Resource Based View • Built on the work of: • Penrose (1959) • Schumpeter (1934) • Michael Ricardo • First introduced by: • Rumelt (1984) • Wernerfelt (1984) • Barney (1986) • Teece (1982) • Prahalad and Bettis (1986)

  24. Resource Base View • Unit of analysis: resources and capabilities of firms • Financials resources • Physical resources • Human resources • Organizational resources • Two assumptions • Resources and capabilities can vary significantly across firms • Resources can be immobile (differences may be stable)

  25. Sustainable Competitive Advantage • The be sources of superior performance resources must be: • Valuable • Rare among current or potential competitors • Costly to imitate • Without close strategic substitutes • Types of imitation • Role of history • Role of causal ambiguity • Role of socially complex resources and capabilities

  26. Implications of RBV • Various studies suggest that firm resources may explain more about its performance than the industry within which it operates • Firms may consider “unattractive” industries ideal for their blend of resources • Instead of reducing social welfare by infringing on competition, RBV focuses on firms doing the best at something

  27. Cooperative Organizational Economics • Tacit Collusion • Strategic Alliances

  28. Collusion • Collusion is said to occur when the output of an industry is less than it would be in a competitive environment • Reduced production leads to increased prices, which then lead to improved performance • The collusion can also invite cheating on the agreement by one or more parties • Game theory suggests that incentives to cheat generally outweigh benefits of collusion

  29. Tacit Collusion • Because explicit collusion is often illegal, tacit collusion is more often engaged in by firms • Tacit collusion requires managers to interpret signals by competitors because no negotiating takes place

  30. Industry Conditions for Collusion • Tacit collusion is easier when there are • Few firms in an industry • Similar cost structures & product offerings • High barriers to entry • Monitoring competitor behaviors is uncomplicated

  31. Strategic Alliances • Contractual alliance • Joint venture

  32. Incentives to Form an Alliance • Exploit economies of scale • Low-cost entry into new markets • Low-cost entry into new industry segments and new industries • Learning from competition • Managing strategic uncertainty • Managing costs and sharing risks • Facilitate tacit collusion

  33. Incentives to Cheat in Alliances • Adverse selection • Moral hazard • Hold up

  34. Methods to Reduce Cheating • Governance • Trust

  35. Big Questions in OE • Why do organizations exist? • Why do some organizations survive and others don’t? • How and why do organizations differ? • How and why do organizations change? • What are the emerging issues?

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