Research coordination on industrial organisation Professor Patrick Legros tells us about the OIO project. By bringing together insights from the industrial organization and organization economics literature, the new approach shows how the market performance and firms organizational choices are co-determined The behaviour of
firms in the commercial marketplace has a direct impact on our everyday lives, as strategic decisions affect the price and availability of goods. Research into industrial organisation has historically focused on the consequences of major companies exerting market power. But situations that are harmful to consumers seem directly linked to dysfunctions in the organization and governance of companies, e.g., the Enron bankruptcy or the financial crisis. Research in organizational economics has paid attention to incentive problems, conflicts of interest in firms and on how the allocation of decision rights among stakeholders affects a firm’s performance. Researchers in the OIO project aim to bring these two elements together. “The goal of this project is to integrate the two, and to show that when it is difficult to solve conflicts of interests, the market conditions affect and are affected by - the way firms form (their ownership boundaries, their scale and scope of products), the way they are organized, and their performance,” says Professor Patrick Legros, the project’s Principal Investigator.
Industrial organisation and Decision Rights People in positions of authority within a firm will have a major influence on its performance, whether or not they are the owners. “Shareholders may want to maximise profits, while managers may want to manage their own career. That creates tensions and conflicts of interest in the firm, and also affects the investment, pricing and quantity decisions made in the enterprise,” Professor Legros explains. The way in which these conflicts are resolved affects how firms behave on the market, and in turn the returns that different stakeholders can get on the market affects the decisions made within enterprises. “Once you realise that you have these different stakeholders, the firm doesn’t really have one objective (like profit maximization). What you will observe in terms of how enterprises are organized and perform is something that cannot be understood in isolation to the market conditions,” continues Professor Legros. The external market conditions indeed
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How the division of revenue (R) affects the willingness of A;B to merge.
favour integration (hence merger activity), low prices tend to favour non-integration (or divestitures if the firms are already integrated). Sometimes this dependence of organizational choices on prices leads to ‘reorganizational dampening’ of technological innovation, which results in little or no gain in industrial productivity. “So, what happens outside the firm will matter for how it is organised, and how a firm is organised will affect what happens in the market. This is why combining the two approaches is important,” says Professor Legros. So far the theory is independent of any single sector, but it will be applied in
What happens outside the firm will matter for how it is organised, and how a firm is organised will affect what happens in the market. Firms and market performances are intertwined and should be studied in conjunction. determine the means by which conflicts of interest can be resolved. A good example is that of coordinating decisions made by different suppliers who have different cultures on how to produce their goods. Generally, such differences lead to coordination failures (too little output is produced or the quality of the output is below standard), unless suppliers can be incentivized. One possibility is to offer suppliers monetary stakes in the output; but this may be difficult because individual contributions to output are difficult to identify, and this is also costly for the owners. An alternative could be a merger, such as a transfer of authority on decisions to headquarters, who can impose coordination; but the loss of control of the suppliers may lead to large ‘private’ costs for suppliers, making them reluctant to abandon their decision rights. A merger, and coordination, will happen only if the benefits of cooperation, in particular the monetary revenue from production is sufficiently large to compensate for the (unobserved) costs of losing control: this is a simple illustration where a market variable like the price of or the demand for - the output affects the way enterprises are organized and perform. In such an environment, high prices tend to
a more detailed, industry-specific way in future. “We will adapt the general theory to particular industries like the health sector,” continues Professor Legros.
OIO Organizational Industrial Organization Funded by the European Research Council under the European Union’s Seventh Framework Programme (FP7-IDEAS-ERC) / ERC Grant Agreement n. [339950]. Part of this research is done in collaboration with Professor Andrew Newman from Boston University. Patrick Legros, Professor of Economics Université libre de Bruxelles (ECARES) and Northeastern University T: +32 2650 4219 E: plegros@ulb.ac.be W: http://www.plegros.net
Patrick Legros is a Professor of Economics at Université libre de Bruxelles in Belgium and Distinguished Professor of Economics at Northeastern University in Boston. His main research interests are in theory of contracts, microeconomics, industrial organization, competition policy and regulation. He is currently the Managing Editor of the Journal of Industrial Economics.
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