Lecturecast 3
Economics for Managers
Business
Organisations
The Nature of Firms
What is a firm? What determines ‘the nature of firms’
▪ organising activity through markets
▪ organising activity through hierarchies
▪ organising activity through networks and alliances
Sometimes characterised as the make or buy decision
Organising by entering into market relationships brings certain benefits but involves certain
costs for example of acquiring good information, bargaining, contracting, policing and enforcing
agreements
This creates an incentive to organise activity internally (DIY production) thus saving on these
transaction costs. But this can also create problems especially as organisations get bigger and
hierarchies and bureaucracies emerge.
• Markets: interaction between the firms.
• Coordination through prices and contracts.
• Hierarchies: interaction within firms.
• Coordination by command and co-operation
Optimum Size of Firm
Strategic
More integrated networks/alliances Less integrated
and joint venture
• Perform activity • Market
internally transactions
Transactions cost theory examines whether firms should make something or buy it
instead (Coase, 1937; Williamson, 1998).
If markets are so ‘efficient’ why do firms exist?
“….there were costs of using the pricing mechanism. What the prices are has to be discovered.
There are negotiations to be undertaken, contracts have to be drawn up, inspections have to
be made, arrangements have to be made to settle disputes, and so on. These costs have
come to be known as transaction costs. Their existence implies that methods of co-ordination,
alternative to the market, which are themselves costly and in various ways imperfect, may
nonetheless be preferable to relying on the pricing mechanism, the only method of co-
ordination normally analysed by economists. It was avoidance of the costs of carrying out
transactions through the market that could explain the existence of the firm in which the
allocation of factors came about as a result of administrative decisions…”
(Ronald H. Coase)
The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1991
http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/1991/coase-lecture.html
The Nature of Firms
• Goals of the firm
• The traditional theory of the firm
• assumption that firms aim to maximise profit
• Alternative theories
• the divorce of ownership from control
• the development of the joint-stock company
• managerial objectives
The Nature of Firms
• The Principal – Agent relationship
• Asymmetric information
• Dealing with imperfect information
»monitoring
»incentives
• The goal of staying in business
• problems of taking on too much risk
• problems of being overly cautious
The Firm as a Legal Entity
• The sole proprietor
• unlimited liability
• The partnership
• unlimited and limited liability partnerships
• Companies
• limited liability
• public limited companies (plc)
»public issues of shares
»shares traded on the Stock Exchange
• Private Limited Companies
• Consortia
• Co-operatives: producer and consumer
• Public Corporations
The Internal Organisation of the Firm
• Features of organisations
• Centralisation/ decentralisation, scalar chain, hierarchy, span of control,
formal/informal, mechanistic/organic structures
• The flat vs. the tall organisation
• National/domestic organisations
• Integrated international enterprises
• Multinationals transnational associations and business
organisation
The Internal Organisation of the Firm
• U-form (unitary form)
• Advantages
• problems when firms expand beyond a certain size
»bounded rationality
»communications costs
»distorted information
»decline in organisational efficiency
• M-form (Multidivisional form)
• advantages and disadvantages
• H-form (Holding Company)
• advantages and disadvantages
Key Ideas
Principal-agent (agency) problem
Eisenhardt, K. M. (1989). Agency theory: an assessment and review. Academy of
management review, 14, 57–74.
Winkler, h and kraus, (2011) management of principal-agent problems in supply chains,
international journal of business research, volume 11, number 2, 2011 2): 45–66.
Transactions costs
Coase, R. H. (1937, november). The nature of the firm. Economica, 4, 386–405.
Williamson, o. E. (1975). Markets and hierarchies: analysis and antitrust implications. New
york: free press.
Williamson, o. E. (1985). The economic institutions of capitalism. New york: free press.
Williamson, o. E. (2002). The theory of the firm as governance structure: from choice to
contract. Journal of economic perspectives, 16(3), 171–195.
Economics for Managers
That concludes this lecturecast
Thank you
I hope you found it useful
