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:

• 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?

• which ‘stakeholders’ should be included in the organization

Size of the organisation?• the CEO has to define the optimal span of control better

Contractual view:

An organisation (firm):

• 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 costs1. 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 projectA: “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 one-

person firms.