Class 4Class 4

Class OutlineClass Outline

Historical development of the neoclassical Historical development of the neoclassical theorytheoryCriticismsCriticismsSeparation of ownership from controlSeparation of ownership from controlManagerial and behavioral theories of the firmManagerial and behavioral theories of the firmCoasian viewCoasian viewTeam basedTeam basedTransaction Cost theory; Property rights theoryTransaction Cost theory; Property rights theoryResource based and knowledge based theoryResource based and knowledge based theory

The Neoclassical TheoryThe Neoclassical Theory

Wealth of Nations Adam Smith (1776)Wealth of Nations Adam Smith (1776)– Pin factory on production costsPin factory on production costs– Value is related to production costValue is related to production cost

Augustic Cournot was one of the first economist to attept a formal Augustic Cournot was one of the first economist to attept a formal mathmematical analysis of the behavior of the monopolists and mathmematical analysis of the behavior of the monopolists and duopolists. Value depends ultimately on demandduopolists. Value depends ultimately on demandUtility concapt by Stanley and Jevons (1871)Utility concapt by Stanley and Jevons (1871)Alfred Marshall (1890, 1892) was the one who drew the link Alfred Marshall (1890, 1892) was the one who drew the link between costs of production and market demandbetween costs of production and market demandJohn Bates Clark The Theory of Perfect Competitin (1899)John Bates Clark The Theory of Perfect Competitin (1899)Frank Knight (1921) lists a number of conditions required for a Frank Knight (1921) lists a number of conditions required for a market to conform to the model of PCmarket to conform to the model of PCJoan Robinson and Edwin Chamberlein (1930)Joan Robinson and Edwin Chamberlein (1930)

Critique of the NC ModelCritique of the NC Model

Insufficiently realisticInsufficiently realistic

Based on oudated view of competitionBased on oudated view of competition

1.1. Organizational goals Organizational goals

Max. of profits or ???Max. of profits or ???

2. Rationality ??2. Rationality ??

3. Perfect information ??3. Perfect information ??

4. Decision making ??4. Decision making ??

The emphasis of the neoclassical theories is that The emphasis of the neoclassical theories is that they miss dynamicsthey miss dynamics

The entrepreneur is the personification of the The entrepreneur is the personification of the firm, plays an unimportant rolein the long run.firm, plays an unimportant rolein the long run.

Price competition is the only form of rivalryPrice competition is the only form of rivalry

Schumpeter (1942) and the Austrian school give Schumpeter (1942) and the Austrian school give the enterpreneur a central role within a more the enterpreneur a central role within a more dynamic model of competitiondynamic model of competition

Separaton of Ownership from Separaton of Ownership from ControlControl

Two implications:Two implications:– Increasing organizational compleqity meant Increasing organizational compleqity meant

that it was impossible for the large firms to be that it was impossible for the large firms to be managed solely by the ownermanaged solely by the owner

Teams of managersTeams of managers

Functional divisionsFunctional divisions

– Impractical for the enterpreneur to finance Impractical for the enterpreneur to finance solely by personal resourcessolely by personal resources

Presence of capital marketsPresence of capital markets

Baumol’s Theory of Sales Revenue Baumol’s Theory of Sales Revenue MaximizationMaximization

Maximize sales revenue subject to Maximize sales revenue subject to minimum profit constraintminimum profit constraint

Why sales revenue and not profits??Why sales revenue and not profits??– Sales are good general indicatof of Sales are good general indicatof of

organizational performanceorganizational performance– Executive power, influence, status tend to be Executive power, influence, status tend to be

linked to the sales performancelinked to the sales performance– Lenders tend to rely on sales dataLenders tend to rely on sales data

Figure 3.1  Baumol’s sales revenue maximization model

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

Marris’s Theory of Growth Marris’s Theory of Growth MaximizationMaximization

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

Figure 3.2  Marris’s growth maximization model

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

Williamson’s Theory of Managerial Williamson’s Theory of Managerial Utility MaximizationUtility Maximization

Baumol’s model view that managers’ interests are tied to Baumol’s model view that managers’ interests are tied to a single variable: sales revenue.a single variable: sales revenue.Williamson (1963) argue that several variables should be Williamson (1963) argue that several variables should be in the manager’s utility functrionin the manager’s utility functrion

U=U(S,M,ProfitU=U(S,M,ProfitDD))

U= Utility functionU= Utility functionS= Expenditure on staff (which leads to a higher prestige S= Expenditure on staff (which leads to a higher prestige

on behalf of the manager)on behalf of the manager)M= Expenditure on managerial banefits (company car, M= Expenditure on managerial banefits (company car,

fringe benefits, ..)fringe benefits, ..)

ProfitProfitDD= Net profit (after tax and expenditure over and = Net profit (after tax and expenditure over and above the minimum level of profit requiredabove the minimum level of profit required

Figure 3.3  Williamson’s managerial utility maximization model

The Behavioral Theory of the FrmThe Behavioral Theory of the Frm

Cyert and March (1964)Cyert and March (1964)Defines the firm in terms of its Defines the firm in terms of its organizational structure and decision organizational structure and decision making processesmaking processesBoundaries of the firm are loosely definedBoundaries of the firm are loosely definedBounded rationality (Simon (1959))Bounded rationality (Simon (1959))Satisficing behaviorSatisficing behaviorDue to observance of actual behavior Due to observance of actual behavior within organizationswithin organizations

Coasian FirmCoasian Firm

Newer theory on why firms existNewer theory on why firms existFeature that are common to all firms:Feature that are common to all firms:– Specialization and exchangeSpecialization and exchange– Coordination and cooperationCoordination and cooperation– Efficiency in productionEfficiency in production

Why markets and why firms?Why markets and why firms?Coordination creates a saving in TCCoordination creates a saving in TCTC economicsTC economicsSearch on the most effective organization Search on the most effective organization structurestructure

Figure 3.4  Unitary or U-form organizational structure

Figure 3.5  Multidivisional or M-form organizational structure

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

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

NOTE FOR THE TERM PAPERNOTE FOR THE TERM PAPERYou will be responsible for writing a research paper on an industry of your You will be responsible for writing a research paper on an industry of your choice. choice. This research paper will most likely be between 15 - 25 pages, although it This research paper will most likely be between 15 - 25 pages, although it will not be graded on length. will not be graded on length. Conditions to be met include,   but are not limited to, established major Conditions to be met include,   but are not limited to, established major industries with available firm-level performance and industry-wide data. industries with available firm-level performance and industry-wide data. It must also be an industry that has an interesting   regulatory and/or It must also be an industry that has an interesting   regulatory and/or antitrust history.   antitrust history.   The paper must have a bibliography. The paper must have a bibliography. For example, you may choose to have the following For example, you may choose to have the following headings for the paper:headings for the paper: – HistoryHistory of the industry of the industry– Market StructureMarket Structure– Conduct (Pricing Policies/Foreign Markets/Other Behavior/Antitrust issues)Conduct (Pricing Policies/Foreign Markets/Other Behavior/Antitrust issues)– PerformancePerformance– ConclusionConclusion: : If appropriate, your conclusion could include some policy If appropriate, your conclusion could include some policy

suggestions or implications for this industry. Any graphs or tables may be 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. included in the body of the paper or in the appendix, whatever you prefer.

Suggested List of possible industries to study: (This list is not exhaustive. Suggested List of possible industries to study: (This list is not exhaustive. There are many other possibilities.) There are many other possibilities.) Agriculture, Airlines, Aluminum, Automobiles, Beer, Casino Gaming, Cement, Agriculture, Airlines, Aluminum, Automobiles, Beer, Casino Gaming, Cement, Cereals (ready to eat breakfast cereals), Chemicals, Cigarettes and/or Tobacco, Cereals (ready to eat breakfast cereals), Chemicals, Cigarettes and/or Tobacco, College Sports, Crude Oil, Electric equipment/products, Grain Farming, Health College Sports, Crude Oil, Electric equipment/products, Grain Farming, Health Care, Motion Picture Entertainment, Petroleum Refining and Marketing, Care, Motion Picture Entertainment, Petroleum Refining and Marketing, Pharmaceuticals, Rayon and Other synthetic fibers, Semiconductors, Soft Pharmaceuticals, Rayon and Other synthetic fibers, Semiconductors, Soft drinks, Steel, Telecommunicationsdrinks, Steel, Telecommunications

  Grading Criteria for Paper:Grading Criteria for Paper:10 points: Grammar/Spelling10 points: Grammar/Spelling10 points: Presentation/Use of tables and figures 10 points: Presentation/Use of tables and figures 10 points: Innovativeness/Uniqueness/Imagination/Inclusion of some 10 points: Innovativeness/Uniqueness/Imagination/Inclusion of some interesting policy issuesinteresting policy issues15 points: Organization/Logical Flow/Introduction and Conclusion15 points: Organization/Logical Flow/Introduction and Conclusion15 points: Bibliography/ Use of Outside Sources and Timeliness of Data15 points: Bibliography/ Use of Outside Sources and Timeliness of Data40 points: Content/Completeness (Do you include the 40 points: Content/Completeness (Do you include the relevantrelevant topics of: topics of: History, Market Structure, Conduct (Pricing Policies/Foreign Markets/Other History, Market Structure, Conduct (Pricing Policies/Foreign Markets/Other Behavior/Antitrust issues), Performance, and Conclusion. Are there any Behavior/Antitrust issues), Performance, and Conclusion. Are there any apparent "holes" in the content or arguments of the paper?apparent "holes" in the content or arguments of the paper?

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