Theoretical underpinnings

Theoretical underpinnings • • • •

From last session: Theory sucks??

Empisicism vs pure theoretical reasoning Positive vs. normative theories Fields related to strategy – Industrial sociology • Reward systems • Social rewards among workers • Relationship between formal and informal organisations

– Labour history – The theory of the firm • Transaction costs • Principal-agent

Transaction cost theory • • • •

Emerged from the legal side (Williamsson) Focus on governance of contractual relations Main assumption: Opportunism is a problem Three critical dimensions for characterising transactions: – Uncertainty – Frequency with which transactions occur – Degree to which durable transaction-specific investments are incurred

• Idiosyncratic transactions are those with a high level of transactionspecific expenses (both in phsical and human capital) – Purchase of specialised components – Location of specialised plants – Personal knowledge, craftmansship

Commercial transactions • Investment characteristics – Nonspecific – Mixed – Idiosyncratic

• Frequency – Occational – Recurrent

Governance structures • 3 types of governance mechanisms – Non-transaction specific – Semi-specific – Highly specific

• Market governance - Classical contracting – When transactions are non-specific

• Trilateral governance - Neoclassical contracting – For occational idiosyncratic transactions

• Transaction-specific governance - Relational contracting – For recurrent idiosyncratic transactions • Bilateral • Unified

The critics of transaction cost • The essence of transaction cost theory is to argue for governance mechanisms trying to curb negative effects of opportunism • Governance mechnisms will be some form of control: Fiat, monitoring, surveillance, control systems • Opportunism - attitude or behaviour?

• What if opportunism is a variable?

• A cycle of self-fulfilling prophecy

Logic • The market logic: Autonomous adaption • The organisations logic: Purposive adaption • Essence of organisations – Not overcoming opportuism by control and hierarchy, but: – Leveraging human ability to take initiative, to cooperate and to learn

Principal-agent theory • A principal contracts with an agent to perform som specific tasks – The agent chooses an action – The action has consequences for the welfare of both parties

• Examples – – – –

Worker - employer Doctor - patient Lawyer - client Owner - manager

• The agent has skills or productivity advantages over the principal • Principals main problems: – Choose the right agent – Choose the right procedures of reward

Principal-agent theory cont.

• Why is principal-agent relationships important?

– Uncertainty related to the way the agent’s actions get transformed into outcomes – Assymetrical information about both action and outcome

• Interesting problems on various levels – Selection or hiring of employees – How to motivate employees – Motivation in group work

The five central elements • Agents differ in types – – – –

Careful vs careless Industrious vvs lazy Reliable vs unreliable Trustworthy vs untrustworthy etc

• Agents actions - the care vs the cost • Influence of random factors • The outcome – Obersvability – Quality vs. quantity

• Assymetrical information

Adverse selection • Choosing the right type • Tyep is normally not observable • Screening procedures – – – – –

Letters of recommendations Job interviews Probationary periods Hiring extrnal evaluators Using reward systems that have appeal to certain types

Contingent rewards and moral hazard • Make the agent perform • Reward systems based on outcome or action?

– Obervability of outcomes and actions – How actions impact the outcome – Number of facets involved • Private secretary vs. meat packer

• Reward systems give different incentives – Agent paying the principal a fixed fee • Strong incentives, no risk-sharing

– Principal paying the agent a fixed fee • No incentives

Moral hazard • Agents performing actions out of self-interest more than what the principle would have wanted the agent to do • Shirking problems – Supervision vs target rate schemes