Changes in the Transactions Cost Problems - Assignment Example

 Economics of Organizations Q1 Assess the view that the history of business organization is explained by changes in the transactions cost problems faced by their managers. One of the prominent views of the business organization is the view that considers its history as explained by the transaction cost problems faced by its managers. From an overarching perspective one considers that a transaction cost is one incurred as organizations or individuals make an economic exchange in the market (Williamson 1981, p. 87). While transaction costs may involve actual fees that are placed on the transaction, they additionally include time spent on research or other abstracts elements related to the transaction is also recognize as a cost incurred; these forms of transaction costs fall under the names of search and information costs, bargaining costs, and politicking and enforcement costs (Williamson 1981, p. 87). The cumulative perspective on these elements then has emerged in what is termed transaction cost economics. Transaction cost economics considers that the cost of transactions has a direct impact of the choices of growth strategies that firms adopt or internalize (Williamson 1981, p. 87). These transaction costs emerge, as individuals do not have perfect knowledge of all elements involved in the transaction. What occurs then is that the organization that adopts these transaction costs most effectively is the organization that gains the most success (Williamson 1981, p. 87). To a large extent, such transaction perspectives on the history of business seem to be valid from certain perspectives. One considers that transaction cost problems greatly reflect current business practices. The transaction cost perspective on the history of business organization then emerges largely in contrast to the neoclassical model. Williamson (1981, p. 87) argued that there were a variety of distinguishing elements between the transaction perspective and the neoclassical approach. One of the most notable differentiating elements is governance structure; while transaction perspectives emphasizes governance structure, neoclassical perspectives emphasize the firm as a production function. This is a notable consideration as the production function perspective had received a strong amount of criticism as too simplistically considering the way that factor input capital was measured (Burmeister 2000, p. 27). It would seem then that the transaction implementation of governance structures more comprehensively explains business organization. Another of the prominent supports of the transaction cost perspective has been in terms of behavioral assumptions. And indeed, Daniel Kahneman was recently awarded the Nobel Prize for his work in behavioral economics, attesting to the general academic acceptance of transaction perspective on the history of organizations (‘Maps of Bounded Rationality’, 2012). While previous economic theories emphasized rational markets, transaction market perspectives consider that markets must be understood in terms of bounded rationality. Bounded rationality assumes that individuals or organizations will operate within the bounded structures of their minds. The recognition that markets to a degree are irrational attests to the recognition that transaction costs have perhaps been a more accurate determinant of business organization than previous models, namely the neo-classical emphasis on hyper-rationality. Essentially, these classical perspectives, as evidenced in Adam Smith’s invisible hands of the market, as well as comparative advantage theories, argued that the market functions in rationally determined ways. The transaction cost perspective takes on a view of business organization and markets as subject to more modern perspectives, including behaviorism. In addition to corporate governance, and behavioral assumptions, the view that transaction costs explain the history of business organization is supported by a number of other elements. One such element is remediableness. Within this spectrum of investigation, the neoclassical model view considers the notion of organizational efficiency in terms of either profit maximization or cost minimization (Cheung 1987, p. 430). While profit maximization oftentimes is a determining element of organizational efficiency, it seems that the transaction cost view is more nuanced as it considers that there is no optimal efficiency solution (Cheung 1987, p. 430). Keeping with this theme, the transaction view of the history of business organization also considers contracts and property rights in more nuanced terms than the neoclassical model. While the neoclassical model viewed contracts and property rights as clearly defined and maintained by the courts, transaction perspectives instead argue that these elements are often problematic (Roberts 1992, p. 76). Still, perhaps an even more seminal consideration is the recognition that neoclassical economics is only concerned with composite goods and services, while the transaction model measures the transaction cost (Roberts 1992, p. 90). This is notable as it more accurately and comprehensively recognizes the adaptations that organizations have had to make historically in response to transaction costs. Ultimately, it seems that while the neoclassical model may have contributed significant insights to the process of business organization, ultimately transaction costs constitute a more comprehensive and nuanced understanding of the history of business organization. Q2 What distinguishes Williamson’s M-form from other divisional structures? To what extent do Williamson’s requirements for the M-form place limitations on its widespread adoption? The M-form refers to the multidimensional organizational structure. While Williamson would articulate later models, the form was originally established by Chandler (1962). The M-form considers organizational structure as divided into separate, semi-autonomous units that are controlled by a singular financial entity. This form became a prominent organizational structure in the 1920s, leading Williamson (1985, 279) to declare, "The most significant organizational innovation of the twentieth century was the development in the 1920s of the multidivisional structure." There are a variety of ways that this divisional structure is distinguished from other forms. Generally, the M-form has been distinguished from the U-form and H-form models. The U-form organizational structure refers to the unitary means of organizing business operations (Ville 2002, p. 40). This is a hierarchical form of organizational structure where there is a director at the top followed by a chief executive and then a division of sub-units. The pervading understanding, however, is that this hierarchical organizational structure is fundamentally concerned with a singular business entity, rather the multi-dimensional units that are contained within the M-form divisional structure. The H-form structure is named after a holding company. This form of organizational structure can be slightly read as an evolution from the earlier U-form method as it assumes a board of directors, followed by legal and financial officers, and then a series of different companies; it’s recognized that this form was implemented in the early General Motors model (Ville 2002, p. 44). To an extent, the H-form has comparative elements with the later M-form model in that it abandons the singular business model for greater degrees of vertical integration. Still, the U-form model necessitates that inputs from the lower-tier entities flow up through the board of directors; this places challenges on decision-making as it necessitates that great amounts of information by synthesized by a limited amount of managers. The D-form organizational structure is still a further evolution along this scale, yet not entirely as multi-dimensional as the M-form structure. The D-form model is recognized as an intermediate between the H-form and the M-form models (Ville 2002, p. 45). In this structure there is a broad of directors, then a central office, and finally a series of product divisions. These elements are contrasted with the M-form model, as the multidimensional model functions largely through semi-autonomous units, yet implements the cumulative financial leverage of the overarching organizational structure. Williamson’s consideration of the M-form hypothesis argued that firms that implement the M-form have a competitive advantage against other firms. This argument necessarily placed requirements on the M-form that limited its widespread adoption. Hill (1983) articulated some of the greatest limitations to the widespread adoption of Williamson’s M-form model. One of the prominent considerations regards the notion of capital markets. Williamson considered that one of the key areas of efficiency for M-form organizations was the information disparity between manager and shareholders; it was thus reasoned that through removing this disparity with the M-form model, organizations gained greater efficiency. Hill (1983, p. 12) argued that this consideration may be inaccurate and instead H-form models may hold a significant advantage in terms of capital allocation, creating a significant limitation on the widespread adoption of this organizational model. One considers that the recent example of the initial public offering (IPO) of Facebook. While the organization had greatly diversified ownership, through entering into the public markets it was possible for the company to largely maintain its H-form model and at the same time raise significant capital for future business operations that otherwise might not have been possible through assuming an M-form structure. Another prominent limitation to the widespread adoption of Williamson’s M-form model is the notion of control systems. Williamson assumed that managers within M-form organizations implement profit-maximizing behavior. To a large extent, however, there is recognition that such notions of profit maximizing may become problematic in some M-form organizations. In these regards, it is possible that the semi-autonomous organizational structure of the M-form model allows for instances where managers work to gain short-term profit gain at the expense of long-term organizational efficiency. While it would be possible to adopt metrics that incentivize different performances, Hill (1985, p. 7) notes, “the bounded rationality of top managers, and top managers tend to fall back upon a reactive ‘management by the numbers’ approach to controlling divisions.” Ultimately then this creates a significant limitation on the M-form model and creates instances where other divisional structures can succeed. Q3 Do long-term contracts between an employer and an employee constitute the hallmark of the organisation known as the firm? Give reasons for your answer. There are a number of considerations regarding the extent that long-term contracts between an employer and an employee constitute the hallmark of the organization known as the firm. This mode of understanding is referred to as the contracting paradigm. This perspective argues that the ‘nexus of contracts’ is at the center of the modern firm. One of the underlining perspectives in these regards considers the very nature of market economies. Economic theorists, most prominently Karl Marx, noted that capital markets function through the exploitation of the employer by the employee (Lee 1990, p. 21). While Marx articulation of this contractual relationship is ideologically loaded and critiques the system, the process with which Marx describes is clearly witnessed in contemporary busy organization. Indeed it’s noted, “The main object of labour law has been, and...will always be a countervailing force to counteract the inequality of bargaining power which is inherent and must be inherent in the employment relationship" (Freeland 2003, p. 99). That is, the organization -- while motivated a multitude in in-puts out out-puts determined by stakeholder interest, supply and demand, and varying market elements – is foundationally operative on long-term contracts with its employers. This is an understanding of the contract as constituting the very fabric of the organization. While the contract is recognized as the fabric of the organization there are further considerations that further establish long-term contracts as the hallmark of the organization. While Marx examined the employer/employee relationship within the neoclassical model, one considers that when viewed from the transaction cost approach to economics the notion of contracts assume an equally prominent role in the organization. The transaction cost approach, as noted earlier, considers that largely the structure of an organization can be determined by its transaction costs. The transaction cost considers that the cost of the contract between the employee and the organization operates as a determining factor of the very structure of the organization (Dourma 1992, p. 220). Specifically, within the transaction cost perspective of markets organizations adapt and form in relation to the specific cost of transactions. While transactions involve a variety of elements and are generally centered on the sale of goods to customers, they also involve the transaction between the organization and its very employees (Dourma 1992, p. 225). In this spectrum of understanding, contracts function within the same mode of operations as goods or even customers. Just as a customer is able to choose one organization over another based on a variety of elements, so is an employee able to choose one organization over another based an employment concerns. The extent that the employee is content working for the organization in a sense functions as the engine of the operation. Ultimately, then one considers that long-term contracts with employees to an extent determine the very structure of the organization. While from the transaction cost perspective it’s clear that long-term contracts with employees represent a hallmark of the organization, there are also considerations regarding the nature of the long-term contract as contributing to innovation or ‘true’ organizational development. One of the prominent perspectives on employee labor is that established by Frederick Taylor. Taylorism, or scientific management, as it has been termed considers the ways that employees can be utilized to the greatest utility (Taylor 2001). The fundamental realization that Taylor established was that employees, no matter their qualifications or aptitudes, will work to the greatest capacity wherein they will not be punished (Taylor 2001). Taylor made further realizations regarding things such as work breaks; namely, allowing employees break times would ultimately increase productivity because the employee would have more strength to operate (Kulliver 2001, p. 65). While Taylor devised ways to improve productivity one of the central failures was that it didn’t go far enough in considering the individual humanity of the employees (Rinehart 1975, p. 40). As a result scientific management practices, while contributing to short-term organizational efficiency, have drawbacks of employee turnover. This leads one to consider that long-term contracts and the necessary concessions made therein, including employment advancement opportunities, benefits, and other such human considerations, contributes to deeply entrenched organizational success. The reason for this organizational success is because the employees that are under these long-term contracts are the same employees that will contribute to the innovation, leadership, and management practices that form the hallmark of organizational success. Ultimately, then without these long-term contracts organizations will be at a significant competitive disadvantage. Q4 Critically compare any two of the following accounts of why firms may pay above-market wages: efficiency wages, gift exchange, organisational investment, contested exchange. There are a variety of reasons why firms may pay above-market wages. Two of the most prominent considerations within this context of understanding are the notions of efficiency wages and gift exchanges. A prominent way that organizations implement above-market wages is through gift exchanges. While gift exchange is traditionally associated with non-market based economies, the gift exchange form often occurs within the context of market-based organizations in a variety of forms. While efficiency wages are largely paid as a means of gaining specific efficiency gains the notion of the market wage considers organizational gains in a more abstract context. One considers prominent sociological and anthropological theories that have investigated gift exchange. In these regards, the gift exchange functions in the recognition that gift giving establish increased levels of trust and exchange with other members of the community (Eisenstein 2011, p. 49). While gift exchange in the Western market economy is largely abandoned for more directly recorded method of exchange – for instance efficiency wages --- the context of the organizational environment poses a particular setting where non-traditional economic forms can emerge. What occurs then is the organizational recognition that gift giving, perhaps in the form of extra-vacation time, Christmas bonuses, or small-scale items such as lunch or dinner, enhance organizational culture or create a situation where the employee is expected to tacitly engage in reciprocity. While reciprocity is largely an anthropological understanding of gift exchanges, sociologists have considered that organizational gift exchanges result out of traditions (Akerlof 1982, p. 543). In these regards, the organizational tradition of the gift exchange has developed in conjunction with organizational success, such as higher morale and higher productivity that accompanied these gift exchange processes. While gift exchanges largely occur through informal processes, efficiency wages occur within the traditional confines of the market economy in that it is a recorded a structured process. The efficiency wage recognizes that wages are determined by more than simply supply and demand. Rather than simple supply and demand considerations, efficiency wages pay above the general equilibrium as a means of maintaining greater organizational productivity or efficiency. While it’s generally understood that organizations implement efficiency wages as a means of achieving this higher organizational efficiency further consideration is given to the specific means of productivity or efficiency. This is contrasted from gift exchanges that operate as a means of above market wage to gain abstract, yet tangible organizational aims. Indeed, there are a variety of such ways that organizations tangibly implement efficiency wages. One of the major such considerations is the notion of shirking (Weisbrod 1988, p. 345). Shirking refers to the potential of the employee to work less than they should be or ‘shirk’ their duties (Weisbrod 1988, p. 345). The efficiency wage then constitutes a method of creating a significant risk to the employee if they are fired from their position; this thus increases employee efficiency. Another way that efficiency wages work in tangible ways – as compared to the intangible forms of gift exchange – occur in terms of avoiding turnover. The implications of this process are largely simple. Companies that pay above market wages will be more attractive than other companies simply because these companies pay more. Still, there are further concerns inherent in this process that constitute significant contrasting elements from the gift exchange process. While gift exchanges are fundamentally concerned with the human element of employment, such as employee morale, the efficiency wages operate in terms of pure market concerns. These contrasting elements are greatly witnessed in the process of implementing efficiency wages to reduce turnover (Weisbrod 1988, p. 346). One of the overarching considerations is that reducing organizational turnover through paying efficiency wages actually benefits the organization as it allows them to save money on training and other costs associated with the hiring process (Weisbrod 1988, p. 346). Still, another consideration is that through paying efficiency wages, the organization is able to create work situations that are able to remove many of the human elements from the work environment. In this sense, efficiency wages do not merely operate in contrast to gift exchanges, but instead are the complete antithesis. An example of this process can be witnessed in an Indian call centre or Chinese manufacturing plant. While traditional Western organizations must implement an organizational structure that takes into account human concerns, including advancement opportunities, the organization’s operations in these outsourced regions can refrain from offering these options as they instead offer efficiency wages that gain employee efficiency despite the subpart organizational culture. References Akerlof, G. (1982). “Labor Contracts as Partial Gift Exchange,” Quarterly Journal of Economics, 97. Burmeister, E. (2000). "The Capital Theory Controversy", in Critical Essays on Piero Sraffa's Legacy in Economics (edited by Heinz D. Kurz), Cambridge: Cambridge University Press. Chandler, A. (1962). Strategy and Structure: Chapters in the History of the American Industrial Enterprise. Cambridge, MA: MIT Press. Cheung, S. (1987). Economic organization and transaction costs. New York: Desnee Press. Douma S. (1992). Economic Approaches to Organization, New York, Prentice Hall. Eisenstein, C. (2011). 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