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The problem of Economic Organization
Aim:
Introduce the notion of an efficient organization, i.e. an organization
that produces efficient outcomes.
Efficient outcome: the total value of the organisation is maximised
C G Life-cycle (Clark, T (2007)
Partnership:
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The general partners both own and exercise management
The partners cannot sell or otherwise transfer their
ownership claims without permission of the other partners
There are no markets for corporate control connected to
the partnership form
When borrowing money each partner is individually
responsible for the entire liabilities and the liability is
unlimited
Economic organizations
Entities within and through which people interact to reach
individual and collective goals
Boundaries of the organization?
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which ‘stakeholders’ should be included in the organization
Size of the organisation?
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the CEO has to define the optimal span of control better
Contractual view:
An organisation (firm):
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a nexus of contracts
a legal fiction that enters into bilateral contracts
between itself and its suppliers, workers, investors managers
and customers.
Efficient performance
Efficient choice (outcome of economic processes)
There is no available alternative that is universally
preferred in terms of the goals and preferences of the
people involved
Efficiency of organizations
Properties of organizations such as the bargaining
procedures people use to seek out ‘efficient choices’ and to
implement and enforce their choices
Transaction Cost Approach to analysing
efficiency of organizations
Transaction is the basic unit of analysis: the transfers of
goods and services from one individual to another
Two principal categories of transaction costs
1. Coordination costs: costs of determining prices and other
details associated with a transaction
2. Motivation costs: a)Information incompleteness and
asymmetries, b) Imperfect commitment
Design of an efficient organization
Choose an organizational form that - as far as possible minimize transaction costs and produces efficient
outcomes
The efficiency principle
If people are able to bargain together effectively and can
effectively implement and enforce their decisions, then the
outcomes of economic activity will tend to be efficient.
Alternative “theories of the firm”: Becerra, M (2009), Theory of
the Firm for Strategic Management, Cambridge, ch. 1-3
Basic Shareholder Value model:
I : Set up cost of the project
A: “Initial equity” (contribution by the entrepreneur to cover
part of investment costs)
R: Profit at the end of the project (R>0 a success; R=0 a
failure)
pH: Probability of success if the entrepreneur “behaves”
pL: Probability of success if the entrepreneur “misbehaves”
B: Private benefit if the entrepreneur “misbehaves”
w: Compensation the entrepreneur receive in case of success
(w=0 in case of failure)
The Coase theorem
Is it possible to define an efficient bargaining organization, where
the division of income from ownership has no influence on the
outcome.
The utility function must have certain properties
Are they realistic?
ui: The utility of two contractual parties i=1,2
y: Total input provided by the two parties
γi: Costs for individual i
x: Total income in cash generated by the investment
P: The value creating process in the firm
No Wealth Effect
1. Individual parties evaluate the benefits they receive and
costs and risks they bear as being equivalent to some cash
transfer
2. These evaluations do not depend on the amount of wealth
they hold
3. People are able to make payments in whatever amounts
required to divide the benefits of the transaction without
affecting the costs or feasibility of any other aspect of the
transaction.
Example:
Two actions:
1) organize all activities in one large firm
2) decentralize the activities to a large number of small oneperson firms.