Theories of the firm: Contractual & Holistic Approach
-> Firms are blackbox => we need to explain some detail
- Explain firm existence
- Describe how firms transform input to output
- Resource Based View: allow to undesrtand the direction where to go in order to be better than the competitors.
- Firm behavior
- Firm goals
Neoclassical:
-> DEF: Firms looks like rational agents -> but people in firms could have contrary objs.
- Analytical result
- Idealized scenario of competition
- Can’t account some complexity that happen in the real world.
-> Firms consist of different kinds of agents
- Owner(s)
- Providers of inputs: managers, workers
1. The contractual approach
- Bundle of contracts
- Diverse objectives within
- No firm-level objectives
2. The holistic approach (including the neoclassical view)
-> Firm is a unique agent, the firm viewed as a series of routines.is like a boundle of resources and capabilities =>
- Beyond linkages
- Anthropomorphic vision
- Firm-level objectives (no diverse objectives within)
1.Contractual Approach
-> PROBLEMS:
- Principal-Agent Problem:
-> In firms we have a form of delegation (Owners & Managers -agents that should act in the interest of owners- )
- Contractual Imperfections:
-> Explain why firms exist.
Principal-Agent Problem:
-> Separation Manager & Control is better for the company:
- Owner-controlled firm: ownership = control (personal health is involved)
- Managerial firm: ownership ≠ control (Are specialized in managing tecniques)
-> Shareholders (principals) vs. managers (agents)
=> RESULT:
- In Perfectly informed world => same outcomes, but in
- Reality => asymmetric information (the one of the manager is much deeper) => discrepancy
-> Ownership fragmentation is negatively correlated with the incentive and ability to overcome these difficulties
-> Most large firms are owned by a large number of (relatively small) stakeholders.
-> MITIGATION:
- Monitoring: there are some oganization advicers that monitor that managers are acting in the interest of stakeholders (BoD, board of directors)
- Partial Alignment of incentives (profit-contingent compensation)
-> EX: stock option,
Managerial Theory:
-> FOCUS: managers may have different obj with respect of stakeholders => Managers don’t aim to maximise profit.
=> Managers’ Goals (sales maximization) ≠ Owners’ Goals (profit maximization)
-> The two goals are not perfectly correlated.
- Acceptable levels of profit
- Maximisation of their own utility
-> Managers prefer to maximize revenues bcse:
- Compensation is often linked to revenues
- Personal prestige & visibility
- Strategic & financial freedom
- Profit maximization may entail cost-cutting, which is often a difficult decision.
Bamoul Model
| -> During decision-making period, CEO attempts to maximize sales. => Sales maximization is subject to the provision of a minimum required profit to ensure a fair dividend to shareholders. => CEO’s job stability is assured. => Conventional cost and revenue functions are are assumed Total costs increasing Demand curve is downward sloping -> DYNAMIC: TC 🔺 for economy of scale max would stop the production when we reach total profit. |
true) bcse is true that the separation btw ownership and managing create this phenomenon, but there are too some advantages (in some cases ✔️>>❌, in others ✔️<<❌).
📌1959, Business Behavior, Value & Growth
Team Productivity Theory:
-> FOCUS: team production has some tension aswell as the free riding tendency.
- The theory try to solve it.
-> HP: firms production is a team endeavor.
- Individual contribution can’t be always measured => The economic theory says that if we can’t measure people effort => Thery are going to free riding (-> Less profit).
=> Developing hierarchy and incentives we can monitor lower levels.
=> The Residual Claimant, owners of the firms that receives the remains of the budget, monitor who monitor.
=> Efficient Tema => Bigger Residual => Monitor has interest to promote efficiency of the tema.
Contractual Imperfections:
Transaction Cost Theory:
-> DEF: firms arise as a result of efficiency considerations, when
Production Cots + Coordination Costs < Market Price + Transaction Costs
PC: Cost like raw materials
CC: Coordinating the internal part of production.
MP:
TC: cost associated to each transactions:
- Search and information costs
- Bargaining costs
- Policing and enforcement cost
=> Firms arise whenever the cost of transacting throught the market is greater than the cost of organizing transactions internally. Relevant determinants:
- Bounded rationality: we are not perfectly rational => we can’t really maximize our function and find the best bargaining
- Opportunism
- Relationship–specific investments: if I enter a transaction is not always easy to exit it.
- Frequency of transactions: the more frequent a transaction the more i’m likely to economize a transaction with the boundaries of a firm.
-> HP: contact are not perfect => create problems in market transactions => we can’t perform every transaction in the market.
Property Rights Theory:
-> FOCUS: incompleteness of contracts
-> HP:
- Contracts are necessarily incomplete: it is impossible to specify provisions for any possible state of the world
- Renegotiations are likely to occur ex-post
- Property rights influence the relative bargaining position of parties during renegotiations, as they allow residual rights of control
-> Ex-ante incentives to transact may suffer, especially when a relationship-specific investment is required
-> Transactions may not happen even when mutually beneficial
-> Firms solve the problems arising from contract incompleteness
-> Like transaction costs theory, property rights theory is well-suited to explain both firm existence and vertical integration
2.Holistic Approach:
Resource Based View, RBV:
-> DEF: firms are seen as a set of boundles that define its performance.
-> FOCUS: profits are heterogeneous and sticky within markets & industries.
- Doesn’t change the neoclassical profit max assumption
- Is intrested in…
- What is SCA,
- How can SCA be achieved.
| SCA: Sustainable Competitive Advantage (SCA) => Presistently high profit levels over time. One or more resources that other firms don’t have. Possession af a way to combine or deploy resources that other firms can not replicate. Possession of a combination of resources that are create the best “strategic fit” with the external environment. <— DIFFERENCES with neoclassical theory |
-> RESOURCES:
- Physical: cash, plants, equipment, technology, access to raw materials.
- Human: training, experience, judgment, decision-making skills, intelligence, relationships, knowledge.
- Organizational: Culture, reputation, formal reporting structures, control systems, coordinating systems, informal relationships.
| -> To understant if resources create a competitive advantage we can use this test |
-> CAPABILITIES: boundles of routines that allow a target deployment of resources to achieves some outcomes.
- Ex: design, engineering, high-quality manufacturing fast product development.
📌Knowledge may lead to a peculiar kind of competitive advantage denoted as knowledge-based competitive advantage
- Ability to accumulate knowledge is given by the firm’s absorptive capacity.
-> DYNAMIC CAPABILITIES: high-order capabilities related to the reconfiguration of resources and (lower-order) capabilities.
- Intersection btw RBV and Revolutionary Review.
- Underlie the abilty to sense opportunities and threats, seize opportunities and transform extant resources and capabilities.
-> TAKEAWAY:
- External environtment matters
- Some resources are key for a wide range of environments, others are not.
- Sometimes it is a matter of combining resources rather collecting resources.
Isolating Mechanisms:
-> Needed to prevent other firms from acquiring core resources. They are:
- Path-Dependence: idea that context matters along time.
- Intellectual Property Rights (IPR) mechanisms (e.g. patents, secrecy (you have a way to keep a boundle of technology hdidden))
- Casual Ambiguity: it’s difficult to undestant where the advantage is coming from.
Evolutionary View of the Firm:
| -> DEF: firms is a boundle of routines defined by straetgies & practices. Not accepted everywhere. Static equilibrium is the final point of a dynamic reaction (Firms are continuously investing in resources). -> IDEA: even assuming profit maximization, the… Bounded rationality, and the Unfeasible maximization => Need for satisfactory (imperfect) criterion. -> Routines are genetic heritage => we have to search for new practices and strategies. |
Firm Growth:
-> DEF: strategy adopt by firms in order to become bigger.
- Direction in which become bigger is arbitrary, depends on the variety of strategic factors.
- Each direction has different value and different drivers.
- Short-run: small period in which we can’t change productivity factors.
- Long-run: we can change it
Introduction:
Boundaries:
| -> When the firm decide to grow could meet different boundaries: HORIZONTAL: quantity of products -> Ex: open new facilities LATERAL: variety of products -> Ex: diversify in different businesses, creating new products VERTICAL: # of integrated steps along the supply chain -> Concern the supply chain (chain of operations carried out by different firms to elaborate the RM into final product and meed the customer). -> Ex: meet own supplier/ customer. INTERNATIONAL: geographical span of firm activities. |
Diversification:
-> DEF: act to enter in industries in which the company is not yet.
- Finance it: balance btw Internal Capital Market vs External Capital Market (debt & equity markets)
-> CHOICE depend on cost vs benefit analysis:
| BENEFITS | COSTS |
| ECONOMIES of SCOPE: spreading the firm’s resources, capabilities and managerial talent over many uses Sharing of resources is the main driver. | EX-ANTE COSTS: implicit and explicit costs incurred to acquire a company or to set-up an entrepreneurial venture |
| OTHER SYNERGIES: Addition of value to extant businesses, transfer of skills and knowledge, cross-business collaboration | EX-POST COSTS: coordination costs, reduction in incentives, slower information flows |
=> Three conditions should be satisfied:
- Attractiveness test: the target industry should be structurally attractive
- Cost of entry test: the cost of entry should not exceed (expected) future profits stemming from the target industry
- Better-off test: strong synergies should be present between the two businesses (2+2->6)
-> AIM: understanding where are very strong synergies.
Benefits:
- Social Prominence, public prestige & political power
- Limit managerial risk: deiversifying limits managers’ risk of achiving a poor profitability overall (Corporate Governance issues).
-> How Mitgates Corporate Governance Issues?
- Monitoring (e.g. board of directors)
- Incentives to managers (e.g. profit-based compensation)
- Capital market discipline (e.g. takeovers risk)
- Labor market discipline (e.g. managers reputation)
1)Board of Directors:
-> OBJ: Monitor management to ensure that actions are taken to increase shareholder value.
- High-level managers may exert considerable control over the selection of new directors => Important to have external/ independent members of BoD.
2)Incentives to Managers:
-> OBJ: link compensatoin of manager to the value of shares of the company they direct
- To realign managerial incentives.
- Employee stock options.
3)Capital Market Discipline:
-> IDEA: if bad managers are running a company:
- Tends to overpay for diversifying acquisitions
- Market ends up internalising this information, expecting this managers to overpay for additional acquisitions in the future.
=> Firm’s shares’ market price falls immediately
-> The opportunity arises for another entity (raider) to try a hostile takeover and appoint its own managers, with the potential to increase profitability thanks to a better management
-> Capital market discipline deters inappropriate management
4)Labor Market Discipline:
-> Managers’ reputation circulates in the labor market
- Potential employers know whether managers pursue personal goals or organizational ones
-> TAKE AWAY:
- Diversification allow the business to grow and benefit from synergies
- Diversification is optimal only when its beneits (i.e. economies of scope & other synergies) outweigh its costs (both ex-ante and ex-post)
- Empirical Studies show that the performance of diversified firms is, on average, lower than the one of more focused firms: this is probably due to the fact that diversification happens more often than it should, due to self-interested managers
1.Vertical Integration:
-> DEF: the combination in one firm of two or more stages of production normally operated by separate firms.
- If there are two firms independent to those different stages => is a non-integration example.
PTD, Property Rights Theory:
-> Integration determines:
- Who control resources
- Who makes decisions
- Whom profits are allocated.
-> Appropriate Ownership Structure is conducive to Efficiency
Residual Right of Control:
-> DEF: right to decide on all the situations that are not included in the contract
- Residual Rights of Control over assets belong to the owner of such assets
- Vertiacal integration transfer the redisual rights of control over the assets of the vertically integrated firm to the vertically integrating firm.
Transaction Costs:
-> They decrease (higher strategic control, no hold-up problem)
-> ❌ Coordination costs rise!!
| ✔️ Advantages: | ❌ Disadvantages: |
| Lower transaction costs (search, negotiating, enforcement and monitoring costs) Strategic independence Better control on multiple business dimensions (e.g. quantity, quality and timing of supply) Know-how protection (e.g. protection against potential intellectual property losses and knowledge spillovers) | Often lower technical efficiency (especially at the beginning): external providers usually benefit from strong economies of scale and learning, due to specialization and demand aggregation of several customers Higher coordination costs Higher commitment: it is typically more difficult to divest a business than to terminate a contract |
-> Example: Case PepsiCo
-> PC has two types of bottlers:
- Independent (no PC authority on how operations are managed)
- Company owned (PC has the ultimate authority over how the bottling assets are deployed)
2.Make-or-Ally-or-Buy choice:
Intermediate Forms:
- Tapered integration (making some and buying the rest)
- Licensing (e.g. franchising, the right to use a firm’s business model and brand for a prescribed period of time)
- Joint ventures (cooperation on a new joint firm) and strategic alliances (cooperation on a joint project)
1.Tapered Integration:
-> DEF: Mixture of vertical integration and market exchange (i.e. co-sourcing, making some and buying the rest)
| Advantages | Disadvantages |
| Additional input/output channels without massive capital investments | Loss of economies of scale |
| Credible threat of substituting internal channels with the market in case of poor performance (and viceversa) | Coordination between the two production units (product specs, delivery times…) |
| Information about costs and profitability from internal operations -> better negotiations with market firms | Possible bias in judgement (e.g. the firm may mistakenly establish the performance of an inefficient internal supplier as the standard) |
| Internal supply capabilities -> protection against potential hold-up |
2.Licensing > Franchising:
-> EX: McDonald’s
✔️ Pros:
- Split Tasks:
- Franchision performs tasks involving substantial scale economies: spreed costs with franchisees
- Franchisees build and operate the business
- Underperformance is limited thorugh tight quality controls and frequent surprise inspections
❌ Cons:
- Damage to brand reputation => everything have to be defined in each particular
3.Strategic Alliances & Joint Ventures:
-> DEF: Organizing complex business transactions collectively without sacrificing autonomy:
- Strategic alliance: cooperation, coordination, information and resource sharing for a joint project by the participating firms
- Joint venture: particular type of strategic alliance where a new independent organization is created and jointly owned by the promoting firms.
-> TYPE:
- Horizontal (firms in the same industry)
- Lateral (firms in different industries)
- Vertical (firms at different stages of the supply chain)
-> Alliances rely more on trust, reciprocity, cooperation and information sharing than arm’s length contracts do
- Disputes are rarely litigated and tend to be resolved through negotiation
- Risk of knowledge spillover effect
-> CHAR of SA & JV:
- Impediments to comprehensive contracting
- Relationship-specific assets by both parties
- Complementarities between the resources and capabilities of the parties involved
- Advantages in terms of information, knowledge sharing and contextual adaptation (e.g. internationalization)
- Transitory nature of the collaboration opportunity
-> DRAWBACKS:
-> Risk of losing control over proprietary information:
- Intensive knowledge sharing necessary
- Intellectual property protection mechanisms may be ineffective
-> Agency & Influence costs
- Coordination issues
- No formal mechanisms for making decisions
- No formal mechanisms for resolving disputes
2.Internationalization:
-> DEF INTERNATIONALIZATION: firm involvement beyond the home coutry boundaries. When firm expanding beyond our national boundaries & it is a key decision in the business & wide area of research in business & management.
- Connected with the decision to keep the business in the country or moving in others.
Stylized Facts:
-> ENABLERS:
- Improved coordination & tecombination capabilities due to advances in ICT
- Modularization & standardization of complex tasks
- Improvement in thecapability of emerging economies.
The smile of Value Creation:
-> AFTER OFFSHORING some companies decide to re-shore, backshore & near-shore, bcse:
Definitions:EXPORT: simple trade flows between conutries INTERMEDIATE FORMS: garant indirect presence in other countries (e.g. osme types of licensing agreements & strategic alliances) FOREING DIRECT INVESTMENT (FDI): establishment of a controlling interest into another country:
CONTROLLING INTEREST: control the production activity in the other country, not just to import some final goods produced by another company. MNEs Multinational Enterprises: are directly linked to multinational corporations, bcse they need a controlling interest. FDI: Foreign Direct Investments MNCs: Multinational Corporations Economic Theories of MNCs-> There was lot of betrade about trade.
-> DRIVERS:
=> Each country has to specialize in the economic activity that it’s doing best regarding to the factor endowments. -> The Economic Theories of MNCs are:
A.Hymer’s Seminal Controbutions:-> DEF: FDI (Foreign Direct Investments) are more important than the movement of funds & goods from a business stand point.
-> Hymer distinguishes btw:
-> Liability of Foreignness (FDI extra costs & risks):
=> MNC’s competitive advantage must be so strong as to overcome the liability of foreignness B.Dunning’s Eclectic Paradigm:-> DEF: synthesis of previous approaches to study why firms become MNCs in a comprehensive framework. -> Degree & structure of foreign activities depend on the existenc of 3 types of advantage:
-> Firm’s specific factors of CA. -> Essential to enable internationalization bcse if a firm don’t have them => Can’t compete in its country.
Internalization advantages:-> DEF: when there are activitites that are runned inside and bring a CA:
Problems:
C.Verbeke’s Dynamic Framework:-> DEF: framework that conceptualize the driver of international expansion. -> Passive COMPONENTS:
-> We are incentivised to recombined resources. Competing internationally we have a variety of knowledge and we have to make an effort to adapt to those new location, that as as output the know-how that we can adapt to our company.
-> Non-location bound FSAs, location-bound FSAs and location advantages refer to the bundle of resources in the firm’s possession. -> They can be distinguished based on
-> Location advantages can be exploited by any firm operating in that location. However, they do not benefit every firm in the same way -> By expanding internationally, a MNE relinquishes its location-bound FSAs and its home country location advantages. However, it benefits from the host country location advantages Future Prospects:
-> Not all the information are available. -> Bounded reliability: besides including opportunism intended as “self-seeking interest with guile” (Williamson, 1979), it includes sources of benevolent preference reversal, such as reprioritization in good faith and failure to deliver on overcommitments Advantages:
Sum Up:
R&D sites in IB:-> Knowledge is mainly generated in R&D sites:
-> Graphical rappresentation of the blow of knowledge:  AI and IB:-> AI reduces the sources of uncertainty plaguing IB.
-> At the same time, it makes it easier to find and integrate complementary resources of external actors, by facilitating the identification of resource (particularly knowledge) gaps. FSAs:-> AI generates new key FSAs:
Location Choices:-> AI enables more accurate and fruitful location choices:
Results:=> Home-based Augmenting Sites become even more important.
=> Home-based Augmenting & Home-Based Exploiting Sites is likely to become more blurred:
=> However, lack of adequate complements has dangerous consequences:
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