economic organisation and the knowledge economy
TRANSCRIPT
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Int. J. oftheEconomics ofBusiness, Vol. 9, No. 1, 2002, pp. 935
`Coase vs Hayek: Economic Organization and the
Knowledge Economy
NICOLAIJ.FOSS
ABSTRACT
Many writers argue that economic organization is undergoing majotransformation in the emerging knowledge economy; authority relations are withering; lega
and ownership-based definitions of the boundaries of firms are becoming irrelevant an
there are increasingly few constraints on the set of feasible combinations of coordinatio
mechanisms. The present paper critically deals with these claims, beginning from the bas
idea that they may be analysed as turning on the implications for the Coasian firm of th
Hayekian notion that the distributed knowledge is a strong constraint on the use of planne
coordination. It argues that there are efficiency reasons for the existence of authority unde
Hayekian distributed knowledge; that the increasing importance of knowledge i
production does not render legal and ownership-based notions of the boundaries of the firm
irrelevant; and that coordination mechanisms will also cluster in certain, predictabl
combinations in the emerging knowledge economy. Thus, Coasian firm organization
consistent with Hayekian knowledge conditions.
Key words: The knowledge economy; Authority; Firms boundaries; Interna
organization.
JEL classification:D23,L14,L22,D80.
1. Introduction
Duringthelastdecade,managementacademicshavestronglystressedtheroleo
organizational factors in the process of building knowledge-based strategies tha
will bring sustained competitive advantage.1 Thus, it is typically argued tha
adopting`neworganizational forms(Daft and Lewin,1993) that is, newway
ofstructuringinternalorganizationandtheboundariesoffirms isnecessaryfo
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10 N. J. Foss
becoming the `information ageorganizations(MendelssonandPillai,1999) tha
can build the `dynamic capabilities required for competing in the emergin
`knowledge economy. Radical changes in the organization of economic activitie
arearguedtotakeplaceintandemwith,andperhapspromptedby,changesinth
composition of inputs toward knowledge inputs, an increase of the `knowledge
content of outputs, the declining importance of physical capital in productioand the parallel and increasing importance of human capital, a stepping up o
innovative activity, and increasingly inexpensive networked computing that is
those changes that are increasingly taken to indicate the emergence of th
knowledge economy (Halal and Taylor, 1998; Prusac, 1998; Tapscott, 1999
Munro, 2000).
There is growing, although still somewhat sparse, evidence that firms are, i
fact, increasinglyexperimentingwithnewwaysofstructuring theirgovernanceo
transactions, and that these changeshave implications forprofitability(MendelssonandPillai,1999),productivity(Ichniowskiet al.,1996;CappelliandNeumark
2001), and innovationperformance(Laursen 2002; Laursenand Foss, 2002). I
seemsthatsomeofthesechangesarerelatedtochangesintheformofcompetitiv
activities, infirms inputrequirements,andtheiruseof informationtechnologie
(Rajan and Zingales, 1998).The still rather open questions are how, and how
much, economic organization will be affected. Much more empirical work
neededtoassess thevalidity of thesometimes rather far-reaching claims that ar
put forward by advocates of the radical decentralization of firms, empowermen
schemes,andthelike.However,itiscertainlypossibletoengageindialogueon
purelytheoreticallevelwiththosewhoarguethateconomicorganizationis inth
processofaradicaltransformationasaresultoftheemergenceoftheknowledg
economy.Todo so is the purpose of thepresentpaper.Thus,Ishalldiscuss th
implications for the organization of economic activities of industries becomin
increasingly `knowledge-intensive,2 an increasing share of the workforce bein
constituted by `knowledge workers, commercially useful knowledge becomin
increasingly distributed, etc., accepting, for the sake of argument, these allege
tendenciesasfacts.Ingenerictheoreticalterms,IdiscusstheimplicationsforthCoasianfirmoftheHayekiannotionthatthedistributedandsubjectivecharacte
ofeconomicallyrelevantknowledgeisastronglybindingconstraintontheuseo
plannedcoordination.Hence,thetitleofthepaper.
Understandingeconomicorganizationinthecontextoftheemergingknowledg
economyisanimportantchallengeforanumberofreasons.Strongclaimsarebein
madeonthesubject,particularlybymanagementscholarsandsociologists,and
isimportanttoexaminethevalidityandreachofthoseclaims.Sofar,organizationa
economistshaveonlygivensporadicattentiontotheseissues(e.g.,HolmstromanRoberts,1998;MendelssonandPillai,1999),althoughtheygorighttothehearto
h i l d i l i i h h f i i i Th i
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Economic Organization and the Knowledge Economy 1
Thefollowingargumentsandpositionsaredevelopedinthepaper.Although
is a justified complaint that organizational economics so far has not serious
addressed economic organization in the context of the knowledge economy
organizational economics insights are extremely useful for framing the issue
Moreover,theyhelptotemperbymakingclearthelimitsofmoreextremeclaim
about organization in the knowledge economy. Among such claims are thaauthority relations will strongly diminish in importance (Zucker, 1991); tha
ownership-based and legal definitions of the boundaries of firms will becom
increasingly irrelevant for understanding the organization of economic activitie
(Helperet al.,2000);andthatconstraintsonthespaceoffeasiblecombinationso
coordination mechanisms will be very significantly relaxed (Miles, et al. 1991
Tapscott,1999).
Thispapershowsthatevenintheknowledgeeconomy,authorityrelationswi
continuetoexistasefficientcoordinationmechanisms,definingtheboundariesofirms in terms of asset ownership is entirely meaningful, and relations o
complementarity between coordination mechanisms will obtain, so that transac
tionswilltendtocluster indiscretestructuralforms(i.e.,governancestructures)
However,thisdoesnotmeanthatorganizationaleconomicscansurviveconfronta
tion with the knowledge economy in a completely unchanged form. On th
contrary, work needs to be done to better understand the impact of knowledg
assets (cf. also Holmstrom and Roberts, 1998), distributed knowledge (Foss
1999), and environmental complexity on organizational design.4 In particular
organizational economists need to develop a more refined and realistic unde
standing of authority than the existing crude view which has been essentiall
unchangedsinceCoase(1937)andSimon(1951).
The design of the paper is as follows. I begin byclarifying the subject unde
discussion,isolatingtwoassumptionsontheroleofknowledgeinproductionan
fourpropositionsthatconcernhowchangesinauthorityrelations,theboundarieso
the firm and internal organization are driven by changes in the way in whic
knowledgeentersintoproductiveactivities.Takentogether,theseassumptionsan
propositions are intended to capture the main thrust of recent claims aboueconomicorganizationintheknowledgeeconomy(section 2).Thestrategy inth
remainingpartsofthepaperthenistoexaminewhetherthestatedassumptionso
the role of knowledge in production imply the propositions as these pertain t
authority (sections 3 and, 4), the boundaries of the firm (section 5), and th
combinabilityofcoordinationmechanisms(section6).
2. Economic Organization in the Knowledge Economy: An Interpretationof Recent Debate
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12 N. J. Foss
Thus, a typical line of argument begins from noting that because of th
increasing importance in knowledge-intensive industries of combining divers
knowledge inputs, sourcing knowledge for this purpose, and keeping sourcin
optionsopen,networksbetweenagentscontrollingcriticalknowledgeincreasingl
become the relevant dimension for understanding the organization of econom
activities(Powell,1990; Zucker, 1991;Harryson,2000).Suchnetworks typicallcutacrosstheboundariesofthefirm,atleasttotheextentthatthesearedefinedi
termsofownership.5The legalboundariesofthefirmwillonlycoincidewithth
boundaries of knowledge-based networks if considerations of appropriability
imposing a need for protecting knowledge, dominate considerations of sourcin
knowledgefromnetworks.More likely,however,theboundariesbetweenmarket
andfirms,asdefinedinlegaland/orownershipterms,willfadeintoinsignificanc
asgeneralizedreciprocalknowledgeexchangeincommunitiesofpracticeandothe
networkforms,aswellashyper-competitiveconditions,makeknowledgeprotectioissueslessrelevant.
Thus, according to this argument the (presumed) fact that knowledge
becomingmoredispersed,andincreasinglymustbesourcedoutsideofthefirma
traditionallydefined,hasprofoundimplicationsforourunderstandingofthelocio
economicactivitiesandtheboundariesbetweenthese.Anaccompanyingargumen
asserts thatas knowledgebecomes increasinglydispersed, authority also tendst
shifttoexpertindividualswhocontrolimportantknowledgeresources.Thishastw
effects. First, to the extent that the agents controlling these resources are no
employees orotherwise agentsofthefirm, this contributes to theblurringof th
boundariesofthefirm.6Second,totheextentthatimportantknowledgeassetsar
increasinglycontrolled byemployees(`knowledgeworkers)themselves,authorit
relations are fading into insignificance.This is partly a result of the increase
bargaining power on the partof knowledge workers(stemming from the contro
overcriticalknowledgeassets)(Coff,1999),andpartlyaresultoftheincreasingl
specialist nature of knowledge work (Hodgson, 1998a).The specialist nature o
knowledge work implies that principals/employers become increasingly ignoran
aboutthemembersofthesetofactionsthatareopentospecialistagents/employeethusmakingtheexerciseofauthoritythroughdirectionincreasinglyinefficient.Th
combinedeffectofthesetendenciesistowrecktheeconomiststraditionalauthorit
and/or ownership-based criteria of what distinguishes market transactions from
hierarchical transactions (Zingales, 2000).Thus, whether direction by means o
ordergiving(Coase,1937;Simon,1951;Williamson,1985;Demsetz,1988)an
backedupbytheownershipofalienableassets(HartandMoore,1990)obtainso
not is increasingly irrelevant for understanding the organization of econom
activitiesinaknowledgeeconomy(Grandori,2002).Theemergingknowledgeeconomyalsoinfluencesthedesignoffirmsinterna
i i h i h i i l ll i f d i i i h d h i i
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Economic Organization and the Knowledge Economy 1
In the future, cellular organizations will be used in situations requiring
continuouslearningandinnovation.
Bysuggestingthatradicalinternalhybrids,`builtontheprinciplesofentrepreneur
ship, self-organization, and member ownership, are emerging asstable organiza
tionalmodes,suchquotationssuggestthatmechanismsforcoordinatingeconomactivities are more combinable, and that the set of stable discrete governanc
structuresislarger,thanisconventionallyassumedinmuchoforganizationtheor
andintheeconomicsoforganization(e.g.,Coase,1937;Williamson,1996).7Thes
newgovernancestructuresareincreasinglyreferredtoas neworganizationalform
(Daft and Lewin, 1993; Zenger and Hesterly, 1997). To the extent that new
organizational forms represent new ways of combining mechanisms that hav
traditionally been seen as characteristic of governance structures that are pola
opposites, they also exemplify the fading boundaries between markets and firm(Helperet al.,2000).
What Is Going On Here? Some Interpretive Assumptions and Propositions
Itisfirstnecessarytodefinethoseaspectsoftheknowledgeeconomythataremos
obviously relevant for an understanding of economic organization. Existin
treatmentsemphasizephenomena,suchasincreasedknowledgecontentofoutput
and the composition of inputs, hyper-competition and therefore the paramoun
importance of learning, decreasing average corporate size, the importance of IT
innovations,increasingdifferentiationofdemand,increasedgeneralenvironmenta
complexity, increasing importanceofnetworksforthetransfer andproductiono
knowledge, etc.(e.g.,DAveni, 1994; Nonaka andTakeuchi,1995;Grant,1996
Mileset al., 1997;Boisot, 1998; MatusikandHill, 1998;Coombs andMetcalfe
2000;Zingales,2000).
Dealingwithalloftheseastheyimpactoneconomicorganization isatasko
forbiddingcomplexity.Forthe purposes of understanding economic organization,recenclaimsabouttheimpactoftheknowledgeeconomyoneconomicorganizationma
be usefully narrowed down to two basic assumptions about knowledge i
production and four basic propositions about economic organization.8 Th
assumptionsare:
d Assumption 1: Knowledge that is sourced for productivepurposes is becomin
increasinglydistributed(e.g.,CoombsandMetcalfe,2000).9
d Assumption 2: Knowledge assets controlled by individual agents (`knowledgworkers) are becoming increasingly important in production in terms o
ib i l dd d ( B i 1998)
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14 N. J. Foss
d Proposition 2:Theboundariesoffirmsblurbecauseoftheincreasingimportanc
ofknowledgenetworksthattranscendthoseboundaries.Thus,whileformallega
andownership-baseddefinitionsoftheboundariesofthefirmmaybemade,the
will be increasingly irrelevant from an economic perspective (e.g., Badaracco
1991;Zucker,1991;Helperet al.,2000).
d Proposition 3: Coordinationmechanisms arecombined in new, innovativeway(i.e., neworganizationalforms).10Thissuggeststhatefficiencydoesnotrequir
suchmechanismstobecombinedindiscretegovernancestructures.Coordina
tion mechanisms combine over a continuum, not in discrete chunks (e.g
Grandori,1997,2002).
Although these propositions are rather open-ended, they are open to theoretica
treatment(andinprincipletoempiricaltestaswell).Soisthefinalproposition:
d Proposition 4:The effects described in Propositions 1, 2 and 3 are driven b
changes in the way in which knowledgeenters into the productive process, a
describedinAssumptions1and2.
Proposition4iscriticallydiscussedinthefollowingsectionsbyexaminingwhethe
theeffectsdescribedinPropositions1,2and3necessarilyfollowfromAssumption
1and2.Idiscusstherole(ifany)ofauthority inHayekiansettings,examineth
connections between authority and ownership, and finally discuss how authorit
and ownership constrain the malleability and combinability of coordinatio
mechanisms.
3. The Knowledge Economy as a Challenge to Authority Relations
The Standard Economics View of Authority: Coase and Simon
ItisconventionaltodatethebirthoforganizationaleconomicstoRonaldCoase
1937paper,`TheNatureoftheFirm.ThisisjustifiedbyCoasesstressonmarkefailurecausedbytransactioncostsasthestartingpointforanyexplanationoffirm
andbyhiscontractualapproach,comparativeinstitutionalism,andclearidentifica
tionofthemainexplanatoryrequirementsofatheoryofthefirm(i.e.,explainin
the existence, boundaries, and internal organization of firms).11 Of particula
interest here, Coase also founded the widespreadpracticeof identifying the firm
with theemployment contract; indeed, he putsmuch emphasis on the flexibilit
afforded by incomplete employment contracts and the authority relation as th
ultimate reason for the existence of firms.12
Thus, as Langlois and Foss (1999argue, Coases explanation for the emergence of the firm is ultimately
di i Th fi i i i i h l h f li i
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Economic Organization and the Knowledge Economy 1
`worker to select actions, A0cA, where A is the set of the workers possibl
behaviours. More or less authority is then simply defined as making the set A
largerorsmaller.Themodel isbasicallyamulti-stagesgame inthecontextofa
incomplete contract with ex post governance: In the first period, the prospectiv
worker decides whether to accept employment or not.Then nature intervenes
uncertainty is resolved, and the costs and benefits associated with the varioupossible tasks are revealed. Finally, the boss directs the worker to a task.To th
extent that the boss cares about his reputation, he will not direct the worker t
undertake tasks that lie outside the latters `zone of acceptance, and there ma
thus bean equilibrium in the three-stages game.15
To sum up, in the Coase-Simon view of authority, the action space is wel
defined and known both to the boss and the worker; the boss observes thos
statesofnaturetowhich itisnecessarytoreact(e.g.,arealizationofdemando
the firms productmarkets); he possesses theright to direct the worker, and thworker obeys the boss instructions`within limits.
The Sources of Authority
TheCoase-Simonviewofauthorityraisesanumberofproblems.Oneofthese
well-establishedin the literature, and concerns the problemof what isultimatel
thesourceoftheemployersauthoritygiventhathumanassetsare inalienable,s
thatslaveryisusuallynotaviablearrangement.Aswillbediscussedsubsequently
there are other problems that only become apparent in what was earlier calle
`Hayekiansettings,andwhichrelatetothecritiqueputforwardbyproponentso
the knowledge economy of authority relations. However, since addressing thes
latter problems is made easier by an understanding of the more conventiona
problem concerning the sources of the employers authority, we briefly conside
thisproblem first.
Theproblemofthesourcesofemployersauthoritywasfamously initiatedb
AlchianandDemsetzs(1972)argumentthatitisnotmeaningfultoassumethata
employercanforceanemployeetodowhattheemployerwantsintheabsenceocoercion.Animplicationofthisviewisthatthedistinctionbetweentheauthority
basedandtheprice-basedmodesofallocationemphasizedbyCoaseandSimon
superficial.Onemayperhapstalkaboutanexusofcontractsbecomingmore`firm
like, as continuity of association among input owners increases and/or residua
claimancybecomesmoreconcentrated,butitisnotingeneralusefultotalkabou
`firmsasdistinctiveentities.Inreality,theyargue,thereisnoeconomicdifferenc
between`firingonesgrocerandfiringonessecretary.16
Oneresponseto thisview istheWilliamsonian one(Williamson,1985,1996thatthereareinfactfundamentaleconomicdifferencesbetweenfirmsandmarket
b h l k li i di i i b k i
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16 N. J. Foss
indirectly acquired through authority (ownership)over alienable assets.Since us
willbemadeofthiskindofreasoninglater,itisworthbrieflyexaminingit.
Contributorstotheincompletecontractliteraturedistinguishtwobasictypeso
decisionrights(`property rights), namelyspecific rights and residual rights.Th
latteraregenericrightstomakedecisionsincircumstancesnotspelledoutinth
contract,andimplytheabilitytoexcludeotheragentsfromdecidingontheuseocertain assets. Residual control rights are conferred by legal ownership.17 I
contrast, specific rights are allocated through contract terms. If contracts wer
complete,allrightswouldbespecific,andtherewouldbenoresidualrights.Tw
kinds of assets are distinguished, namely alienable (i.e., non-human) and non
alienable(i.e.,human)assets.Giventhis,thedistinctionbetweenanindependen
contractor and an employee (i.e., between an inter-firm and an intra-firm
transaction)nowturnsonwhoownsthenon-alienableassetsthatanagent(whethe
independentoremployee)utilizesinhiswork.Anindependentcontractorownshtoolsetc.,whileanemployeedoesnot.Theimportanceofassetownershipderive
from the fact that the willingness of an agent to undertake a non-contractib
investment(say,exertionofeffortorinvestmentinhumancapital),whichisspecifi
totheasset,dependsonwhoownstheasset.
As inAlchianandDemsetz,the partiestoarelation whether customeran
grocer,oremployerandemployeeareseenasbeinginabargainingsituation,eac
having an outside option. Although the parties are assumed to always reach a
efficientagreement,thedivisionofthesurplusfromtherelationwillnevertheles
depend on who owns the alienable assets in the relation, since the pattern o
ownership will influence the parties outside options. In this scheme `. . . a
employers authority is represented notbytheability to force an employee tod
whats/hewants,butratherbytheabilitytoobtainasubstantialshareoftheex po
surplusfromtherelationshipthroughthecontrolofnon-humanassets(Hart1996
379).Efficiencyconsiderationsthensuggestthatauthority(i.e.,ownershiptoth
alienableassets) should beallocatedto theagentwhomakes the most importan
(non-contractible) relation-specific investment.Thus, in an elegant manner Har
(andhiscolleagues)linktogethertheissuesoftheboundariesofthefirm(whichardefinedintermsofownershipofalienableassets)andauthority.18Usewilllaterb
madeofthisargument.However,theproblemofthesourcesofauthorityisnotth
onlychallengetothenotionofauthority.
Knowledge-based Challenges to Authority
Sofar,thedebateonauthorityinorganizationaleconomicshasalmostexclusivel
centred on providing responses to the Alchian and Demsetz (1972) challengeHowever,theseresponsesdonotmeet(atleastdirectly)theargumentsofthosewh
l i h h i l i ill i h i h i k l d (i
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Economic Organization and the Knowledge Economy 1
possibilityisexplicitlyexcludedintheCoase-Simon viewofauthority(Simon
1951).
(2) If the employee is better informed than the employer with respect to how
certain tasksshould(optimally) becarried out? In the Coase-Simon view o
authority there is an implicit assumptionthattheemployer isatleastas we
informed, and presumably better, about the efficiency implications of alternativeactions.19
Onereasonwhysolittleattentionhasbeendevotedtotheseproblemsarguably
that they are not necessarily problems of `asymmetric information as this
understoodininformationeconomics(sothatstandardmodelingtoolsarenoteas
to apply). In a typical asymmetric information problem, an uninformed agen
knowswhatheisuninformedabout(e.g.,theprecisequalityofacar).However,thi
excludes ignorance (Kirzner, 1997; Foss, 1999).A possible interpretation of thclaimthatauthorityrelationswillbetransformed,andlikelywither,intheemergin
knowledgeeconomy isthatsuchrelationsarebreakingdownundertheimpacto
principalsbecomingincreasinglyuninformedabouttheactionsopentoagents(a
effectofAssumption1)andatthesametimebecomingincreasinglyreliantonth
knowledgecontrolledbyagents(i.e.,Assumption2).20Thesearethecharacteristic
ofHayekiansettings.
Distributed Knowledge, Delegated Rights, and Authority
Hayekmaywellhavebeenthefirsteconomisttoclearlyframetheissueofhowt
makebestuseofdistributedknowledge(1945:778;seealsoHayek,1937).Ash
explained:
Theeconomicproblemofsocietyis. . .notmerelyaproblemofhowto
allocate givenresourcesif givenistakentomeangiventoasinglemind
which deliberately solves the problem set by these `data. It is rather a
problemofhowtosecurethebestuseofresourcesknowntoanyofthemembers of society, for ends whose relative importance only these
individualsknow.Or,toputitbriefly,itisaproblemoftheutilizationof
knowledgewhichisnotgiventoanyoneinitstotality.
As the date of Hayeks paper suggests, the problem of making optimal use o
distributed knowledge is, of course, not a novel one, only brought about by th
emergenceoftheknowledgeeconomy;rather,any complexsocialsystemconfront
it(Hayek,1964).However,proponentsofthepositionthateconomicorganizatioisundergoingaradicaltransformationasaresultoftheemergenceoftheknowledg
i li i l h bl d b H ki di ib d k l d
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18 N. J. Foss
useofthem;asystemwithalienablepropertyrightssolvessimultaneouslybothth
assignment and the moral hazard problem. However, firms solve these problem
differently.Thus, resources within firms are directed (to a larger extent than i
markets), and motivation of employees is engineered (to larger extent than i
markets). From a Hayekian perspective, firms would seem to be inherentl
disadvantagedrelativetomarkets,forfirmsencounterafundamentalproblemthamarkets donot, namely `. . . the problem whichany attempt to bring order int
complexhumanactivitiesmeets:theorganizermustwishtheindividualswhoaret
cooperatetomakeuseofknowledgethathehimselfdoesnotpossess(Hayek,1973
49).Thefactthatfirmsdoexistisprima facie evidencethattheycansomehowcop
withtheproblem.21
One obvious way to handle the Hayekian knowledge-problem in firms is t
suppressdistributedknowledgeas far as possiblebydiscouraging local initiative
indoctrinatingemployeesharshly,andoperatingwithrigidroutinesandoperatinprocedures.22 The archetypal `machine bureaucracy fits this overall character
ization.However,totheextentthatcompetition isincreasinglyknowledge-based
this isaself-defeating strategy,becausesuppressingdistributedknowledge inthi
wayalso implies thatbeneficialexplorativeand innovativeeffortsare suppressed
Therefore, an often more attractive way to handle the presence of distribute
knowledgeinsideistodelegatedecisionrights(cf.Hayek,1945:834;Galbraith
1974: 314;Jensen and Meckling, 1992), balancing the resulting agency cost
against the benefits from improved use of distributed knowledge.23 An inter
pretationofinternalhybrids,suchasteamorganization,`molecularforms,andth
like,isthatthesemanifestattemptstodelegatedecisionrightsandstructurerewar
schemes so that such optimal tradeoffs are reached (Jensen andWruck, 1994
ZengerandHesterly,1997;FossandFoss,2002;Zenger,2002).
WhileHayekiandistributedknowledgemaybeanimportantcomponentinth
understandingofinternalhybrids,itdoesnotanswerthepuzzleofwhysuchhybrid
areorganizedinside firmsatall,beingsubjecttotheexerciseofauthority.Althoug
remuneration schemes are often adjusted to complementary changes in th
delegation of decision rights, implementing internalhybrids does, of course,noimplythatemployeesbecomefullresidualclaimants.Moreover,beingoverruledb
formalhierarchicalsuperiorsmayharmmotivation(AghionandTirole,1997;Frey
1997).Thus,moving internalhybrids,suchasteams,outoffirmswouldseemt
yieldefficiency gains, because this will strengthen incentives.24 In fact, spin-off
carve-outs,andlikepracticesmaybeexplainedinsuchterms,soweshouldaskwh
notall internalhybridsarespun-off.Addingtothepuzzle isthatauthorityinth
Coase-Simon sense appears to play at best a very limited role under Hayekia
dispersedknowledge.ThisisbecausetheCoase-Simon notionofauthorityassumethatadirectingprincipalisatleastasknowledgeableabouttherelevanttasksasth
b i di d
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Economic Organization and the Knowledge Economy 1
allocatedtoasinglepartythroughassetownership,meansthattheonlyroomleftfo
delegation is that agents receive well-specified rights to carry out well-specifie
actions.However,thisimpliesthatifagentscantakeactionsaboutwhichprincipa
have no knowledge or are better informed about how certain actions should b
carriedout,thesuperiorknowledgeofagentscannotbeutilized.Asecondreaso
whyHartianownership-basedauthoritymaybeirrelevantisthattheassetsthatiHarts scheme confer authority are physical assets (Hart, 1995). However, a
importantclaiminrecentdebateontheknowledgeeconomyisexactlythatphysica
assetsareofwaningimportance,andthatknowledgeassetscontrolledbyknowledg
workersarebecomingmoreimportant(Myers,1996;Boisot,1998;Neef,1998).O
course, the implication is that ownership over physical assets is an increasingl
ineffectivesourceofbargainingpowerandthat,therefore,authoritymustwanea
bargainingpowerincreasinglybecomesmoresymmetricallydistributed.
Narrow and Broad Notions of Authority
Although there are reasons to expect authority to be a highly inefficien
coordinationmechanismundertheconditionsdescribedbyAssumptions1and2
wedonotobservethewell-nighcompletebreakdownofauthorityrelationsthatthi
line of thinking may imply. One reason is the possibility of benefits of firm
organization that offset the knowledge-related inefficiencies of authority, a
mentionedearlier.Another reason is the simple one thatthere isa largedistanc
betweentherealphenomenonofauthorityandourmodelsofthatphenomenon.I
fact,boththosewhohavecriticizedauthorityforbeingan increasinglyinefficien
coordination mechanism intheemergingknowledgeeconomyandorganizationa
economists may be criticized for working with a too narrow understanding o
authority.Forexample,arepresentativeofthefirstgroup,AnnaGrandori(1997
35)arguesthat
. . . whateveritsbasis,authorityisafeasiblegovernancemechanismonlyif
information and competence relevant to solving economic action prob-lemscanbetransferredtoandhandledbyasingleactor,apositivezone
of acceptance exists, the actions ofother supervised actorsare observ-
able, and if the system is not as large as to incur an overwhelming
communicationchanneloverloadandcontrollosses.
ThiscritiqueseemstobedirectedattheCoase-Simon viewofauthority,andis,a
such,avalidcriticism.TheCoase-Simonview is(too)narrow,because it implie
thatthebossdirectstheworkersactionsindetail,basedonacompleteknowledgoftheworkersactionset,andbecauseitimplicitlyassertsthatthebossisalwaysa
l k l d bl b h i h ld i ll b i
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20 N. J. Foss
worktowardsaspecifiedgoal,forexample,backedupbysomesuperiorbargainin
power, is entirely consistent with Assumptions 1 and 2. Indeed, in most larg
decision rights are allocated by the top-management team and the board o
directors to lower hierarchical levels, presumably in order to cope better wit
distributedknowledge(JensenandMeckling,1992).However,typicallytheseright
arecircumscribed.Forexample,therightto use anasset incertainwaysmaybdelegated;however,itisunderstoodthatthatrightdoesnotentailtherighttous
the asset in theserviceof a competitor firm(Holmstrom, 1999).Thus, decisio
rights are delegated in firms, but they aredelegatedasmeans to anend(Hayek
1973);theiruseismonitored(JensenandMeckling,1992),andtop-managemen
reserves ultimate decision rights for itself(Baker et al., 2000).This suggests tha
authorityinthesenseofdirectionandcentralizeddecision-makingwhichdoesno
necessarilyrequiredetailedknowledgeaboutasubordinatesknowledgeoravailabl
actions may persist in Hayekian settings, including the emerging knowledgeconomy.Thefollowingsectiondiscussesthisingreaterdetail.
4. Authority in Hayekian Settings
Hidden Knowledge
This section examines the role of authority, understood in the broad sense o
directingsomebodytocarryoutanactivitysothatsomeendgoalisreached,unde
distributed knowledge.To increase concreteness, situations involving distributeknowledgeareapproximatedby`hiddenknowledge(Minkler,1993)inprincipa
agentrelations.Thatis,itwillbeassumedthattheproblemfacingaprincipalisno
justthatsheisuninformedaboutwhatstateofnaturehasbeenrevealedorofth
realizationoftheagentseffort(i.e.,hiddeninformation),asinthestandardagenc
paradigm. Rather, the agents knowledge issuperior to that of theprincipalwit
respect to certain productionpossibilities(i.e.,hidden knowledge).The principa
may be ignorantabout somemembers of the setof possibleactions open to th
agent,ortheagentmaybebetterinformedthantheemployerwithrespecttohow
certain tasks should (optimally) be carried out, or both. Given this, the issue
whetheritispossible,underhiddenknowledge,tomakesenseoutofthisnotiono
authorityongroundsofefficiency.Itturnsoutthatitisindeedpossibletoexplai
thepresenceofauthorityinsuchasetting.Thekeyfactorsthatwillbeconsidere
inthefollowingare(1)theurgencyofdecisions,(2)decisiveknowledge,and(3
monitoring, incentives,andexternalities.
The Urgency of Making Decisions
WhileHayek(1945)didmuchtoidentifythebenefitsofthepricewithrespectt
i i h h bl i d d b di ib d k l d d
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takenactionsoronlycoordinate these aftercostly trials anderrors(forareview
Foss,2001).Authoritymaybealeast-costresponsetosuchproblems.
In order to isolate the costs and benefits of centralized and decentralize
decision-making in a specific context, Bolton and Farrell (1990) study
coordinationproblemwithprivateinformationinthesettingofanaturalmonopo
market.The coordination problem concerns who should enter the market whecostsaresunkandthesizeofcostsisprivateinformation.Underdecentralization
whichisrepresentedasatwo-periodincompleteinformationgameoftiming(sin
costs/enterorwaitanotherperiod),eachfirmisuncertainaboutwhethertheothe
firmwillenter.However,theincentivetoenterdependsonagivenfirmscost,low
costfirmsbeinglessworriedthattheirrivalwillenter(andvice versa).Ifcostsar
sufficiently dispersed, the optimal outcome prevails, that is, the lowest-cos
producerentersandpreemptstherival(s).However,ifcostsareequalorarehighfo
both, inefficiencies may obtain, since firms will then enter simultaneousl(inefficientduplication)orwillwait(inefficientdelay).
Enteracentralauthoritywhosejobistonominateafirmforentry.Inthespir
of Hayek, Bolton and Farrell assume that this central authority cannot posses
knowledge about costs. In their model, the authority nominates the high cos
producer half of the time, which is clearly inefficient. However, this cost o
centralizationshouldbecomparedagainstthecostsofdecentralization(delayan
duplication). Bolton and Farrell show that . . . the less important the privat
informationthattheplannerlacksandthemoreessentialcoordinationis,themor
attractivethecentralplanningsolutionis(1990:805).Moreover,thedecentralize
solutionperformspoorlyifurgencyisimportant.Centralizationisassumedtono
involvedelayandistherefore,underthisstrongassumption,agoodmechanismfo
dealingwithemergencies,aconclusiontheyargueisconsistentwiththeobserve
tendenciesoffirmstorelyoncentralizedauthorityincasesofemergencies.25
The inefficienciesunder decentralization(duplication, delay) that Boltonan
Farrell point to may arguably be particularly relevant for much knowledge
intensive production.This isbecausemuchof this production is`pooled rathe
than`sequentialor`reciprocal(intheterminologyofThompson,1967).`Pooleactivities involve relatively decentralized efforts aiming at a common end
Research-based organizationswheremuchproductiontakesplaceindecentralize
project-groupsisaclearexample.Insuchorganizations,acentralizedauthorityma
benecessarytogiveprioritytocertainprojectsratherthanothers,eventhoughtha
authorityisbasicallyveryillinformedabouttheprojects(foranexample,seeFoss
2000).
Decisive Knowledge
E h h hidd k l d di i b i h i i l ill h l
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22 N. J. Foss
conditions(changing sales and/or tastes), it may pay to investigatesupply befor
investigatingdemand.Infact, ifsupplyvolatility isconsiderablyhigher, itmayb
evident what the firm should do in terms of its output and pricing decision
without checkingdemand conditions. Inboth cases, information aboutsupply
decisive(and more so in the lattercase).
AccordingtoCasson(1994),decisivenessandthecostatwhichknowledgecabe communicated explains the allocation of decision rights. In terms of th
examples, if furthermore the decisive knowledge is costly to communicate
decisiveness and costly communication suggest that decision rights should b
allocatedtowardstotheproductionsideofthefirm.Thisisaninstanceofthemor
generalprinciplethatdecisionrightswilltendtobeconcentratedinthehandsofth
individualwhohasaccesstothedecisiveinformation,andparticularlysothemor
costlyitistocommunicatethisinformation.Casson(1994)usesthisreasoningt
whyfirmsarehierarchicalandtoaddressotheraspectsoforganizationalstructureThereasoningnotonlycastslightovertheallocationofauthority,butalsooverwhy
under hidden knowledge, interacting parties may rationally choose an authorit
relation.Whenknowledgeishidden,butnotdecisiveandthecostsofanincorrec
decision are (on average) less than the costs of trying to communicate th
knowledgefromagenttoprincipal,directingtheagentthroughanauthorityrelatio
will beefficient.Also, themoredecisive theprincipalsknowledgerelative to th
agents,themoreattractive willtheauthorityrelationbe,allelseequal.Authorit
willbelessefficient,thegreaterthenumberofpartieswhoholddecisiveknowledge
and the lower the costs of communication. In such cases, partnerships ma
substitutefortheauthorityrelation.
Monitoring, Incentives and Externalities
Hidden knowledge would seem to introduce special problems for the use o
monitoringmechanismsandincentivepay,asdiscussedinthemainstreamagenc
literature(e.g.,Holmstrom,1979;Minkler,1993;AghionandTirole,1997;Fos
1999;FossandFoss,2002).WithrespecttomonitoringunderhiddenknowledgeMinkler (1993: 23) argues that `. . . if the worker knows more than th
entrepreneur, it is pointless for the entrepreneur to monitor the worker. In th
extreme case, both the agents type and actions may be fully observable by th
principal but the latter may still not understand the full set of productio
possibilities open to the agent. If monitoring is not workable, the problem is t
designacontractthatallowstheagenttousehissuperiorknowledgeex post,an
giveshimtheincentivetodosoefficiently.Thiswillamounttoallocatingdecisio
rightsaswellasrightstoresidualincomestreamstotheagent,26
asinapartnershipAuthorityseemstobeas`pointlessasmonitoring, sincetheexerciseofauthorit
ld i l d f i i ( h ki h h d
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reached,maybeentirelyworkableunderhiddenknowledge.Theholderofauthorit
cancheckwhethertheendgoalwas,infact,reached,andcanrewardorsanctionth
agentaccordingly.Thus, although thenarrow(Coase-Simon)notionofauthorit
may be compromised by hidden knowledge conditions, the broad notion o
authorityisnot.
Recent work in agency theory(Holmstrom and Milgrom, 1991; Holmstrom1999;Prendergast,1999)suggeststhat(loosely)themorewemovetowardsmult
tasking,costly-to-measureactivities,multipletypesofagents,etc.,themorelikely
itthattheprincipalwillchoosetorelyonmanydifferentincentiveinstrumentst
influencetheagentsbehaviour.Akeythemeinmuchrecentworkonorganizatio
in the knowledge economy is that tasks are becoming increasingly complex an
difficulttomeasurebecauseoftheirincreasing knowledge-content,andthatthisi
itselfisaforcethatisdestructiveofauthorityrelations(Hodgson,1998a).However
ratherthanreducingtheneedfortheexerciseofauthority,thesechangesimplyrenewedroleforauthority.Akeymanagerialtaskistobalanceincentiveinstrument
(Holmstrom, 1999), that is, design and maintain coherence between thevariou
ways in which an employee may be motivated so that negative spill-over effect
betweenthesewaysareminimized.27Thismanagerialtaskwillbecomeincreasingl
important, as firms have to use multiple incentive instruments to motivat
`knowledgeworkers.Inadynamiceconomy,maintainingcoherencebetweensuc
instrumentsmaybearecurrenttask.Theremaybeeconomiesofscaleandlearnin
economies in this task(Hermalin,1999),suggesting that it be centralized in th
handsofacentralauthority.
Summing Up
It has been argued that it is possible to give efficiency explanations of authorit
under conditions corresponding to Assumption 1, at least if authority is unde
stood in the broad sense of commanding somebody to work towards a specifie
goal. Admittedly, the narrow (Coase-Simon ) notion of authority at directio
basedonsuperiorknowledgeandaimedatthecarryingofspecificactionsonthpartofemployees,ishardertoalignwithdistributedknowledgeconditions.Thu
the limitsof Proposition 1 have beenclarified: the proposition at best applies t
thenarrow(`Coase-Simon)notionofauthority.Moreover,somedeterminantso
theuseofauthorityhavebeenisolated.Thus,theurgencyofdecisions,theexten
of decisiveness, the need to balance different incentive instruments and scal
activities in this activity are all forces that promote the use of authority, all els
equal.28
The increasing prevalence of internal hybrids that go beyond traditionahierarchieswithrespecttohowdecisionrightsandrewardschemesarestructure
(Z d H l 1997 Z 2002) b l d b h i
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5. Ownership and Firm Boundaries in Hayekian Settings
Ownership and Assets in the Knowledge Economy
Although the previous section argued that authority can exist under distribute
knowledge,littlewassaidthereaboutthesourcesofauthority.However,recallth
earlierargumentsthatownershipmayplayakeyroleasasourceofauthority.Th
purposeofthepresentsectionistogomoreintoownershipissuesparticularlyth
ownershipofknowledgeassetsandthereforethe issueof theboundariesof th
firm.Oneofthekeycharacteristicsoftheknowledgeeconomyisusuallytakentob
the increased importance in production of knowledge assets and the decreasin
importance of physical assets (Boisot, 1998). A further argument is that thi
transformation will also transform economic organization, because knowledg
assets have different implications forthe boundaries of firms thanphysical asset
(e.g.,Powell,1990;Zucker,1991;KogutandZander,1992;Boisot,1998;Mahnke2002).29
Thecategoryof`knowledgeassetsisabroadoneencompassingindividuall
heldtacitknowledge,firm-levelcapabilities(`organizationalknowledge),patents
client lists, etc. and, partly for this reason, difficult to analytically frame.3
Differentalbeitallsomewhatunderdevelopedmodelingstrategiesareavailable
One strategy is to stress problemsof appropriability as a key determinant of th
boundaries of the firm (Teece, 1987; Liebeskind, 1997). In this scheme, th
boundariesofthefirmreflectattemptstomaximizetherentstreamsfromthefirmvaluableknowledgeassets(rather than the hold-upproblem).Asecondone ist
stressthatmanyknowledgeassetsarecollectiveorpublicgoods(e.g.,capabilitieso
reputational assets) and that this creates free-rider problems, causing a need t
delimitaccesstosuchgoods(HolmstromandRoberts,1998;Osterlohet al.,2002
A third strategy is to argue that knowledge assets in the form of differentia
capabilitiesgiverisetocommunicationcostsandattemptstoeconomizewithsuc
costs help determining theboundaries of the firm(Langlois, 1992; Monteverde
1995). Finally, a fourth possibility is to rely on transaction cost economics an
incompletecontractstheoryargumentsabouttheneedtoprotectspecializedasset
and investmentsspecific tosuchassetsfromrent-captureattempts(Rabin,1993
Brynjolfsson,1994;Putterman,1995).Sincethelatterstrategyistheonethatmos
obviouslyconnectstothethemeofauthoritythathasbeenpursuedinsomucho
thispaper,Ibrieflyapplythisapproach.
Knowledge Assets and the Boundaries of the Firm
Following Brynjolfsson (1994), use will be made of the incomplete contract
d li h d l f H d M (1990) d di f h
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TheprimaryrequiredchangeinthebasicHartandMooreframeworkisamor
explicitintroductionofknowledgeassets(whichmaybealienableornon-alienable
In fact, we can dispense entirely with physical assets, and discuss a purel
knowledge-based firm.31 Itisassumedthatagents enter into productiverelation
withotheragentsbutthatsynergiesbetweenagentsoccuronlythroughtheasset
thattheycontrol(andnotthroughtheactionstheytake).Furthermore, althougassetsmayinfluencethevalueofactions,thereverseisnottrue(Brynjolfsson,1994
433).This means that wecanwrite the cost of agent is actionas c (xi) and th
marginalvalueofisactionswhenheisinaproductiverelationwithotheragent
simplyasvi (A),whereAisthesetofallassetsownedbyagents(andtheiraction
canbesuppressed).32
For simplicity, assume that two agents interact and that one of these, `th
entrepreneur, owns a knowledge asset, K, that is `inside his head (e.g., a
entrepreneurialidea)andtheotheragent,`thescientist,ownstheonlyotherasseintherelation,P,whichwemayassumetobea`patent.Bothassetsarenecessar
tothecreatevalueintherelation,andKandPare(strictly)complementary,sotha
theoneisofvalue0withouttheother.Itisprohibitivelycostlytocommunicateth
knowledgeembodiedinKfromtheentrepreneurtothescientist,soKiseffectivel
non-alienable,althoughtheservicesofKmayofcoursebetraded.Moreover,it
notpossibletowriteacomprehensivecontract,governingtheuseoftheassetsina
contingencies.Giventhis,wemayaskwhoshouldownthealienableasset,P,whic
intermsoftheHartandMoore(1990)analysis istantamounttoaskingwh
shouldownthefirm.
In this setting, if the entrepreneur makes an effort investment, xe, that is
elaboratesonhisideaandcreatesextravalue,thescientistcaneffectahold-upo
theentrepreneur,sincethelatterneedsaccesstothepatenttocreatevalue(andth
contract is incomplete). Of course, the reversealso holds, so that if the scienti
makesaneffortinvestment,xs,(e.g.,aspin-offpatent),theentrepreneurcanhold
upthescientistbythreatheningtowithdrawfromtherelation.Underthestandar
assumptionofNashbargaining,theentrepreneurandthescientisteachrealizesha
of the extra value created as a result of their efforts. Because of the externalitproblem,eachunderinvests;specifically,eachpartyinveststothepointwhereth
marginalcostofeffortinvestmentequals12 ofthemarginalvalue.
33Supposeinstea
thattheentrepreneurownsboth thepatentandtheentrepreneurialidea.Thiswi
strengthentheentrepreneursincentives(thescientistcannotholdhimupanymore
and it will leave thescientists incentives unaffected.34 Obviously, this ownershi
arrangementshouldbechosen.
Aconclusionatthisstageisthatitis possibletospeakoftheboundariesofth
firmintermsofownership(andthereforealsoinlegalterms)eveninasituatiowhereallassetsareknowledgeassets.However,thisdoesnotyetdemonstrateth
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26 N. J. Foss
of the other agents produce zero value.The coordinator may improve on thi
decisiveknowledge.EachagentneedsaccesstohisownpatentandtoCinordert
be productive. Given this assumption (which means that we need only conside
relations between any agent and the coordinator), we have the by now familia
under-investment problem for both the coordinator and the scientists.36 If th
coordinatorisgivenownershiptoallpatents,thingschange:Whiletheincentivesothe scientists are not affected,37 the incentives of the coordinator to invest i
augmenting his decisive coordination knowledge are strengthened. Thus, thi
ownershiparrangementshouldbechosen.
Summing Up
Althoughtheframeworkthathasbeenappliedinthissectionisextremelystylize
andinmanywaysquitelimited(Holmstrom,1999;FossandFoss,2001),itdoeprovideananswertoProposition2.Thereasoningshows,first,thatitmakesperfec
sensetoaddressownershipissuesintermsofknowledgeassets,and,second,tha
ownershiptosuchassetsmaybeimportantinsituationswhereagentsneedtob
providedwithincentives(andwherecontractsareincomplete),and,third,thateve
thoughknowledgeassetscontrolledbyindividualagents(`knowledgeworkers)ar
becoming increasinglyimportant inproductionintermsofcontributiontovalue
added (i.e., Assumption 2), it still does not follow from this alone that th
boundaries of firms will blur. The economically important distinction is nobetweenphysicalandknowledgeassets,asitisoftenasserted(e.g.,Boisot,1998)
butbetweenalienableandinalienableassets,andmanyknowledgeassetsareperfec
alienable.The implication is that to the extent that not all knowledge assets ar
inalienable,ownership-based(andthereforealsolegal)definitionsoftheboundarie
ofthefirmwillcontinuetobe important.Finally,thediscussiontiestogetherth
notionsofauthorityandownershipinthecontextofknowledge-basedproduction
sinceitsuggeststhatwhenthereisaneedforcentralizeddecision-making,itisofte
efficient to have this backed up by asset ownership. As will be argued in th
following section, this has implications for the issue of the extent to whic
coordinationmechanismscanbecombined,thatis,Proposition3.
6. Organization Design in Hayekian Settings
The Malleability and Combinability of Coordination Mechanisms
So far, ithasbeenargued that there isatight connectionbetweenauthorityanownershipandthatthisconnectionwillalsobemanifestinHayekiansettings.Th
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Economic Organization and the Knowledge Economy 2
In contrast to this, it has been argued that there are no compelling reason
why specific coordination mechanisms should necessarily cluster in a few idea
typical governance structures of the `firm-hybrid-market variety (particularl
Grandori,1997,2002).Inparticular,advancesinnetworkedcomputing,manage
ment informationsystems, andmethodsofmeasuring performancehavestrongl
expanded the setof feasible combinations of coordination mechanisms (Miles eal.,1997, 1998).`Cellular or `molecular forms,which are particularlysuited t
the requirements introduced by the knowledge economy, are examples.The fac
that these forms which much operate on market-like principles (Miles et al
1997; Cowen and Parker, 1997) are still organized inside firms just serve t
illustrate the malleable nature of coordination mechanisms. However, in th
following,Iargueconcentratingonfirmsinternalorganizationthatcoordina
tion mechanisms are not completely malleable, and that such mechanisms wi
cluster in discrete governance structures, also in the emerging knowledgeconomy.
Incentive Limits to the Use of Market Mechanisms
To an economist, the debate in the management and organization fields o
`combiningcoordinationmechanismsismirroredbydebatesoncombiningmarke
and hierarchy in the comparative systems and transfer pricing literatures. Fo
example,inthecontextofcomparativesystems,Mises(1949:709)longagoargue
thatthereareinherentcontradictionsinvolvedin`playingmarket,thatis,tryingt
simulate a market inside a hierarchy. His arguments anticipated later incentiv
arguments, including the importance of credible commitment for incentive
Referringtovarioussocialistschemesofhisdaythattriedtopreservesomemarke
relations while eliminatingcapital andfinancialmarkets,Misesargued thatthes
schemes would be unworkable. The concentration of ultimate decision-makin
rights and responsibilities, and therefore ownership, in the hands of a centra
planning board would dilute the incentives of managers.Thus, while plannin
authoritiescoulddelegaterights tomakeproductionandinvestmentdecisionstmanagers, these rights were likely to be used inefficiently. First, since manager
couldntbesurethattheywouldnotbeoverruledbytheplanningauthorities,the
werenotlikelytotakealongview,notablyintheirinvestmentdecisions.Moreove
since managers were not the ultimate owners, they were not the full residua
claimants of their decisions and, hence, would not make efficient decision
Therefore,Misesdeclared,theattemptto playmarketundersocialismwouldlea
to inefficiencies. In a related vein, the attempt to simulate markets in a firm
hierarchymayleadtoinefficiencies.As later research has clarified, the problem may be handled if the plannin
h i i dibl i i f li H d i
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28 N. J. Foss
Implications
Animplicationisthatmixingverydifferentcoordinationmechanismsmayleadt
efficiencylosses,andmaynotbesustainableforthisreason.39Thebasicproblem
thatemulatingmarketorganizationinsidefirmsamountsto playingmarket.Unlik
independent agents in markets, corporate employees never possess ultimat
decision rights. They are not full owners. This means that those who posses
ultimatedecisionrightscanalwaysoverruleemployees.Thus,therearefundamenta
incentivelimitstotheextenttowhichmarketprinciplescanbeappliedinsidefirm
Theseinsightssuggestthat,contrarytoProposition3,coordinationmechanismsd
cluster incertain predictable ways. Inparticular, there are incentive limits to th
extenttowhichtheintroductionofcoordinationmechanismscharacteristicofth
market can be introduced in firms. Advances in measurement methods an
networkedcomputingmayhaveeasedtheextent to whichdecision rightscanb
delegatedinsideacorporatehierarchy(ZengerandHesterly,1997).However,therareinherenttensionsbetweenauthority(asbackedupbyownership)anddelegate
rights which constrains the space of feasible combinations of coordinatio
mechanisms.Totheextentthatauthoritypersistsintheknowledgeeconomy,sowi
theselimits.
7. Conclusions
Addressing economic organization in the context of the emerging knowledg
economyisataskofalmostforbiddingcomplexity.Itisalsoinherentlyspeculative
suggesting to some that the use of scenario techniques is appropriate(Hodgson
1998a) orthatamulti-disciplinary approach is justified(Daft andLewin, 1993)
Thepresentpaperhastakenanarrowerapproach,beingfoundedonthenotiontha
organizationaleconomicsishelpfulforclarifyingthecentralissuesandforprovidin
tentativeanswers.Admittedly,therichnessoftherecentliteratureonorganizatio
intheknowledgeeconomymayhavebeensacrificedbytherelativenarrownesso
thepresentapproach.Howeverithastheadvantageofmakingissuesofcontentioandthetermsofthedebateexplicit,thuscontributingapossiblestartingpointfo
furtherempiricalandtheoreticalwork.
Thus,ithasbeenarguedthattherecentliteratureoneconomicorganizationi
theknowledgeeconomymaybesummarizedinahandywaybymeansoftwobasi
assumptionsandfourpropositions.Itwasfurtherasked:acceptingthatknowledg
has become increasingly distributed and that knowledge assets are increasingl
importantinproduction,isitthentruethatauthorityrelationswillwither,thatlega
andownership-baseddefinitionsoftheboundarieswillbecomeunimportant, anthatcoordinationmechanismscanbecombinedvirtuallyatwill?Theanswerstoa
h i i C i fi i i i i i
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obtainaneasyvictory.Tworesponsesarepertinenthere.First,theproponentso
Propositions (1) to(4) that have been cited are not unimportant extremists, bu
establishedandrespectedacademics.Second,evenifthestatementscontainedinth
Propositionsare,perhaps,extreme,investigatingthemisstillaworthwhiletask.Th
isbecausesuchanactivityhelpsestablishingtheboundariesofthediscussion.Fo
example,although it may be argued that nobody trulybelieves that all authoritrelationswilldisappearcompletelyintheknowledgeeconomy,westillneedtoknow
whyauthorityrelationswillpersistandhowtheywillchange.Thus,oneresultofth
present discussion is the clarification of the conditions under which authorit
relationswillexistwhenknowledgeisdistributed.
Notes
1. See,forexample,NonakaandTakeuchi(1995),Grant(1996),Myers(1996),BrownandEisenhard
(1998),DayandWendler(1998),Mileset al. (1997,1998)fordifferentperspectivesonthisoveraidea. The pedigree of this goes back a long time, including, for example, Burns and Stalke
(1961).
2. Forempiricalevidence,seeTomlinson(1999).
3. For example, Helper et al., (2000: 443) argue that `. . . firms are increasingly engaging i
collaborationswiththeirsuppliers,evenastheyarereducingtheextenttowhichtheyarevertical
integratedwiththosesuppliers.Thisfactseems incompatiblewithtraditionaltheoriesofthefirm
which argue that integration is necessary toavoid thepotentials forhold-upscreated whennon
contractibleinvestmentsaremade.
4. Itisalsotruethatorganizationaleconomicsneedstodevelopabetterunderstandingofparticular
internalhybrids(Zenger2002;Foss2000a).Notably,transactioncosteconomicsdoesnotserioustreatinternalhybrids.
5. The reasoning turning on the proposition that networks are particularly useful organization
arrangementsforsourcingandtransferringknowledgebecausetheyallegedlyavoidthecostsofpricin
knowledgeinamarketortransferringitinahierarchy(Powell,1990:304;Liebeskindet al.,1995:7
6. As Zucker(1991: 164) argues: `While bureaucratic authority is by definition located within th
firmsboundaries,expertauthoritydependsontheinformationresourcesavailable toanindividua
andnotontheauthorityofoffice.Thus,authoritymaybelocatedwithintheorganization. . .bu
whenanexternalmarket source canprovide information that leadsto greatereffectiveness, the
authoritytendstomigrateintothemarket.
7. SeeGrandori(1997,2002)forasophisticatedargumentthatbecausebothorganizationtheoryanorganizational economics have put too much of an emphasis on discrete, stable, `consisten
governancestructures,andtoolittleonmoremicro-analyticcoordinationmechanisms(e.g.,pric
norms,authority, teams,etc.),thenumberofwaysinwhichsuchmechanismsmaybecombinedha
beenstronglyunder-estimated.
8. The possible risk of constructing a strawman is admitted. This is discussed further in th
Conclusion.
9. `Distributedknowledge isknowledgethatisnotpossessedbyanysinglemindandwhichmayb
privateandtacit,butwhichitwillneverthelessbenecessarytosomehowmobilizeforthecarryin
outofaproductivetask(Hayek,1945).Manywritershavearguedthatsuchdistributedknowledg
isofincreasingimportanceinaninnovation-rich,knowledge-basedeconomy(e.g.,Ghoshal,Moraand Almeida-Costa, 1995; Hodgson, 1998a; Coombs and Metcalfe, 2000). Grant (1996: 378
th t H ki di t ib t d k l d i i l t th d t di f i ti
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30 N. J. Foss
12. `Itmaybedesiredtomakealong-termcontractforthesupplyofsomearticleorservice,Coasewrite
`Now,owingtothedifficultyofforecasting,thelongertheperiodofthecontractisforthesupplyofth
commodityorservice,thelesspossible,andindeed,thelessdesirableitisforthepersonpurchasingt
specifywhattheothercontractingpartyisexpectedtodo.. . .Therefore,theservicewhichisbein
providedisexpressedingeneralterms,theexactdetailsbeingleftuntilalaterdate.. . .Thedetailso
whatthesupplierisexpectedtodoisnotstatedinthecontractbutisdecidedlaterbythepurchase
Whenthedirectionofresources(withinthelimitsofthecontract)becomesdependentonthebuyerithisway,thatrelationshipwhichItermafirmmaybeobtained(Coase,1937:2423).
13. Apparently,someorganizationscholarsdisagreewiththis.Thus,Grandori(1997:37)notesthat
has been `well-documented in organization studies that `. . . authority is not very effective i
managinguncertainty.Itwilllaterbearguedthatthisdependsmuchonthecontext;forexampl
ifstronginterdependencies(`complementarities)betweenactivitiesareinvolved,authoritymayb
extremelyeffectivefor`managinguncertainty.
14. SeeHodgson(1998b)foraninterestingcriticaldiscussionofCoasesnotionsofauthorityandth
employmentcontract.
15. Inarecentcontribution,Wernerfelt(1997)elaboratesontheseCoasianandSimonianpremises.B
portrayinggovernancemechanismsasgameforms(spotcontracting,pricelists,hierarchy)chosentregulatetradeWernerfeltmakespreciseCoasesideathatthechoiceofagovernancemechanism
partlydeterminedbytheflexibilityaffordedbythatmechanismandheextendsSimonsanalysisb
explicitlycomparingalternativemechanisms.Specifically,gameformsdeterminehowplayersadap
tochangesintheenvironmentandcommunicateaboutthesechanges.Wernerfeltsconjectureisth
thesedifferentgameformswillbesystematicallycharacterizedbydifferentlevelsofcostsofmakin
adaptations.Forexample,authorityissimplyanimplicitcontractwhichstatesthatoneoftheparti
shouldhavetheauthoritytotelltheotherwhattodo(asinCoase,1937).Thisgame-formrequire
lessbargaining overpricesthanthemarketgame-form,andisselectedtosavetooncommunicatio
(adaptation )costs.Theagreementtoplaybytheleastcostlyadaptation-mechanismisupheldbyth
partiesconcernforreputationinarepeatedgame.16. Notethatthis`nexusofcontractspositionisremarkablyclosetothepositionthatinaknowledg
based economy, the firm/marketboundary isunclearand thenotionofauthority elusiveatbes
although itsconceptualbasisisratherdifferent.
17. Foracritiqueoftheseaspectsoftheincompletecontractliterature,seeFossandFoss(2001).
18. ThisisnottosaythattheHartapproachisentirelyunproblematicasanapproachtotheemploymen
contract or the firm. For example, thebargaining power possessed bya principal whoowns th
complementaryphysicalassetsinarelationmaybeexercisedoveranemployeeoritmaybeexercise
overalegallyindependentpartywhojusthappenstohavegivenupownershipofalienableassetst
strengthenincentives(i.e.,verticalquasi-integration)(FossandFoss2001).Inotherwords,there
no one-to-one correspondence between the firm and the Hart understanding of the exerciseauthority.Infact, asBengtHolmstrom(1999:87)hasrecently argued, the incompletecontrac
literature`. . .isatheoryaboutassetownershipbyindividualsratherthanbyfirms.
19. ThisisexplicitlyarguedinDemsetz(1988)andConnerandPrahalad(1996).
20. Of course, thereare many other reasonswhy economic organizationmay differ in the emergin
knowledgeeconomy.Forexample,totheextentthat increasedinnovative activityistakentobe
hallmarkoftheknowledgeeconomy(BrownandEisenhardt,1998;CoombsandMetcalfe,2000
thismayrequirechangesinthedistributionofdecisionrightsandrewardschemesinorganization
SuchchangesdontturnontheHayekianproblemofdistributedknowledgeper se.
21. And/orthatthereareoffsettingbenefitsoffirmorganization,suchasthesuperiorabilityoffirmst
organizetransactionscharacterizedbyhighlevelsofrelation-specificinvestments(Williamson,1981996;GrossmanandHart,1986;HartandMoore,1990).
22 M li (1974) t ll h t f th f it li t th it ( lth h h
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Economic Organization and the Knowledge Economy 3
24. Somewritersdrawwhatappearstobe the logicalconsequenceofaHayekianstartingpoint,an
flatlyarguethatonlyfirmsthatexplicitlyemulatemarketorganizationtothelargestpossibleexten
cansurviveandprosperintheknowledgeeconomy(CowenandParker,1997).However,theyfa
toexplainwhyfirmsshouldexistunderthesecircumstances.
25. AlthoughBoltonandFarrelldonotnotethis,theexampleisvulnerabletothecritiquethatthetw
firms may enter a court-enforceable contract that let entry depend on the flipping of a coin
However,inmanyrealisticsituations,particularlywhenurgencyisinvolved,contractsmaynotbcourt-enforceableorthepotentialdelayintroducedbyusingthecourtsystemmaybe intolerable
26. Theprecisearrangementsmayalsoinvolvethepaymentofalumpsumfromtheagenttoprincip
(as in franchisingrelationships), and it will beshaped by the risk-preferencesof theparties an
whetherliquidityconstraintsarepresentornot.
27. Forexample,ifmotivationismainlysecuredbypecuniarymeans,thismayharmotherinstrument
suchastryingtomotivatebyfosteringaculturethatemphasizestrustandsharing.
28. These reasons also seem broadly consistent with organization theory work on authority in th
contextofflathierarchies(whereHayekiandistributedknowledgeisparticularlytoexist).Inastud
of authority in newspaper publishing companies, Brass (1984) identified the determinants o
authority as `criticality (i.e., decisive knowledge), `centrality (i.e., centralized decision righbecauseofeconomiesofscaleincertaintasks),and`thefriendshipnetwork.
29. Infact,twooftheflagbearersofmodernformalcontracteconomics,HolmstromandRoberts(199
90),recentlyobservedthat`Informationandknowledgeareattheheartoforganizationaldesign
becausetheyresultincontractualandincentiveproblemsthatchallengebothmarketsandfirms.
Inlightofthis,itsurprisingthatleadingeconomictheories. . .havepaidalmostnoattentiontoth
roleoforganizationalknowledge.
30. Forexample, it is not clearwhat itmeans tospeakof ownershipof firm-levelcapabilities. For
discussionofthisandrelatedissues,seeZingales(2000).
31. Thisisbecausethekeyissueisnotwhetherassetsarematerialorimmaterial,butwhethertheyar
alienableornon-alienable.32. OnemaywonderwhathashappenedtothenotionofHayekiandistributedknowledgeinthissettin
(i.e.,Assumption1).However,although it isanecessaryassumption thattheagentscanobserv
eachothersmarginalproductvalues, theydontneed to observeeachothersspecific actions o
know the underlying knowledge.Thus, Hayekian distributed knowledge is consistent with th
assumptionsbeingmadehere.
33. Thefirst-orderconditionsaregivenby12ve(K,P) +
12 v
e (K) = c(xe)and12 v
s (K,P) +12 v
s (P
= c(xs).Since ithasbeenassumedthat thevalueoftheassetsoutside therelation iszero,th
secondterminthesetwoexpressionsequalszero.
34. ThismaybeseenfrominspectingthefirstorderconditionswhentheentrepreneurownsbothKan
P:1
2 ve
(K,P) +1
2 ve
(K,P) = c(xe)and1
2vs
(K,P) = c(xs).35. Thissuggeststhatincentivesarelikelytobestrengthenedbyspinningoffemployeeswhocomeupwit
idiosyncraticentrepreneurialideasthatarecostlytocommunicatetotherestofthefirm.
36. Thisisastrongassumption,butonethatismadeforanalyticalconvenience.Themainpointsimp
isthatthereisacentralagentwhosecentrality intheinformationnetworkiscrucialtothevalu
creatingeffortsofotheragents.
37. Forexample,thefirst-orderconditionforanyindividualscientistis:12 v
i (P,C) +12 v
i (P) = c(xiwherethesecondtermiszero.
38. Thefirst-orderconditionforanyindividualscientistisnow:12vi (P,C) = c(xi),whichisthesam
asasthepreviousfirst-ordercondition.
39. Williamson(1996)referstothesekindsofproblemswithhisconceptofthe impossibilityof(efficienselectiveintervention.Themainproblemisthatincentivesarediluted.Thisisbecausetheoptiont
i t ` b i d b th f d (t t t d t i ) d f b d (t
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