Class 4

1. Class 4

2. Class Outline • Historical development of the neoclassical theory • Criticisms • Separation of ownership from control • Managerial and behavioral theories of the firm • Coasian view • Team based • Transaction Cost theory; Property rights theory • Resource based and knowledge based theory

3. The Neoclassical Theory • Wealth of Nations Adam Smith (1776) • Pin factory on production costs • Value is related to production cost • Augustic Cournot was one of the first economist to attept a formal mathmematical analysis of the behavior of the monopolists and duopolists. Value depends ultimately on demand • Utility concapt by Stanley and Jevons (1871) • Alfred Marshall (1890, 1892) was the one who drew the link between costs of production and market demand • John Bates Clark The Theory of Perfect Competitin (1899) • Frank Knight (1921) lists a number of conditions required for a market to conform to the model of PC • Joan Robinson and Edwin Chamberlein (1930)

4. Critique of the NC Model • Insufficiently realistic • Based on oudated view of competition • Organizational goals • Max. of profits or ??? 2. Rationality ?? 3. Perfect information ?? 4. Decision making ??

5. The emphasis of the neoclassical theories is that they miss dynamics • The entrepreneur is the personification of the firm, plays an unimportant rolein the long run. • Price competition is the only form of rivalry • Schumpeter (1942) and the Austrian school give the enterpreneur a central role within a more dynamic model of competition

6. Separaton of Ownership from Control • Two implications: • Increasing organizational compleqity meant that it was impossible for the large firms to be managed solely by the owner • Teams of managers • Functional divisions • Impractical for the enterpreneur to finance solely by personal resources • Presence of capital markets

7. Baumol’s Theory of Sales Revenue Maximization • Maximize sales revenue subject to minimum profit constraint • Why sales revenue and not profits?? • Sales are good general indicatof of organizational performance • Executive power, influence, status tend to be linked to the sales performance • Lenders tend to rely on sales data

8. Figure 3.1Baumol’s sales revenue maximization model

9. Multiperiod version: Sales revenue depends on current sales revenue, annual rate of growth on sales revenue and ciscount rate. • Figure 3.1 shows that short run profit maximization implies that sales revenue is lower than it could be • By increasing output beyond its short run profiy max. Level, the firm achieves an increase in current sales revenue at the expense of reduction in g

10. Marris’s Theory of Growth Maximization • Baumol (1962); Marris (1964) and Williamson (1963) suggest that managers may pursue a strategy of maximum growth of the firm • Strategy of max. Growth of firm :Max. Growth at the expense of firms’ future profit streams. • Managers strive for growth rather than profit max. • Growth of demand => advertising expenditures; further price reductions; extensive advertisements • May be harmful due to: • Managerial constraint on growth • Financial constraint on growth

11. Figure 3.2Marris’s growth maximization model

12. As the rate of growth of demand is increased, profitability is increased as well until a certain point. Then managerial constraints on growth tend to take place. • The maximum growth of capital function shows the relationship between the firm’s rate of profit and the maximum ate at which the firm is able to increase its capital • This model suggests several testable hypothesis one of which is: “owner controlled firms achieve lower growth and higher profits”.

13. Williamson’s Theory of Managerial Utility Maximization • Baumol’s model view that managers’ interests are tied to a single variable: sales revenue. • Williamson (1963) argue that several variables should be in the manager’s utility functrion • U=U(S,M,ProfitD) • U= Utility function S= Expenditure on staff (which leads to a higher prestige on behalf of the manager) M= Expenditure on managerial banefits (company car, fringe benefits, ..) ProfitD= Net profit (after tax and expenditure over and above the minimum level of profit required

14. Figure 3.3Williamson’s managerial utility maximization model

15. The Behavioral Theory of the Frm • Cyert and March (1964) • Defines the firm in terms of its organizational structure and decision making processes • Boundaries of the firm are loosely defined • Bounded rationality (Simon (1959)) • Satisficing behavior • Due to observance of actual behavior within organizations

16. Coasian Firm • Newer theory on why firms exist • Feature that are common to all firms: • Specialization and exchange • Coordination and cooperation • Efficiency in production • Why markets and why firms? • Coordination creates a saving in TC • TC economics • Search on the most effective organization structure

17. Figure 3.4Unitary or U-form organizational structure

18. Figure 3.5Multidivisional or M-form organizational structure

19. Figure 3.6The science of choice and the science of contract Source: Adapted from Williamson (2002), p. 181.

20. Figure 3.7Modes of governance and the degree of asset specificity Source: Adapted from Williamson (2002), p. 173.

21. You will be responsible for writing a research paper on an industry of your choice. This research paper will most likely be between 15 - 25 pages, although it will not be graded on length. Conditions to be met include,   but are not limited to, established major industries with available firm-level performance and industry-wide data. It must also be an industry that has an interesting   regulatory and/or antitrust history.   The paper must have a bibliography. For example, you may choose to have the following headings for the paper: History of the industry Market Structure Conduct (Pricing Policies/Foreign Markets/Other Behavior/Antitrust issues) Performance Conclusion: If appropriate, your conclusion could include some policy suggestions or implications for this industry. Any graphs or tables may be included in the body of the paper or in the appendix, whatever you prefer. NOTE FOR THE TERM PAPER

22. Suggested List of possible industries to study: (This list is not exhaustive. There are many other possibilities.) • Agriculture, Airlines, Aluminum, Automobiles, Beer, Casino Gaming, Cement, Cereals (ready to eat breakfast cereals), Chemicals, Cigarettes and/or Tobacco, College Sports, Crude Oil, Electric equipment/products, Grain Farming, Health Care, Motion Picture Entertainment, Petroleum Refining and Marketing, Pharmaceuticals, Rayon and Other synthetic fibers, Semiconductors, Soft drinks, Steel, Telecommunications • Grading Criteria for Paper: • 10 points: Grammar/Spelling10 points: Presentation/Use of tables and figures 10 points: Innovativeness/Uniqueness/Imagination/Inclusion of some interesting policy issues15 points: Organization/Logical Flow/Introduction and Conclusion15 points: Bibliography/ Use of Outside Sources and Timeliness of Data40 points: Content/Completeness (Do you include the relevant topics of: History, Market Structure, Conduct (Pricing Policies/Foreign Markets/Other Behavior/Antitrust issues), Performance, and Conclusion. Are there any apparent "holes" in the content or arguments of the paper? http://cc.ysu.edu/~rlruffer/Economics%205801/Syllabus5801.html