Acquisition of Fisher Body by General Motors - Case Study Example

Acquisition of Fisher Body by General Motors (GM affiliation Acquisition of Fishers Body Introduction Benjamin Klein in 1978 revisited the acquisition of fisher Body by General Motors (GM) in 1926 describing it as the most discussed example of economic literature. Fisher Body is a company that produced automotive body parts for GM and other car companies. The emergence of closed metal car bodies in the 1910s and their being seen as a direction to the future, GM sought to enter into a long-term contract with Fisher Body. The contract specifics were that GM would but car bodies from Fisher body at a fixed price which was set on a cost plus 17.6% basis (where cost was defined exclusive of interest on invested capital)” (Klein, 1978, p. 309). This contract was to run for ten years from 1919 (Coase, 2000). In return, the Fisher Body company would make specific investments and increase the production capacity to feed the expanding market for closed metallic body parts. With market changing Fisher Body invested in expanding their production capacity, thereby holding their end of the bargain. As the demand for body parts increased as predicted, the company was producing enough bodies to take significant advantage of the deal and reduce the production cost since all the bodies produced were sold to GM at the agreed fixed price per unit. This realization troubled General Motors who in 1924 requested for relocation of Fisher Body to a site near GM factory. This was an effort to reduce the cost of transportation and transfer and make the companies appear as operating as a single entity. However, Fisher Body held up GM and rejected the request (Coase, 2000). With the request refused, GM negotiated for a merger to overcome the intolerable economic situation. Since during the signing of the contract GM had purchased 60% of interests into Fisher Body, the merger was not refused, and it became effective in 1926. This paper will focus on the economic factors that characterized the acquisition, guided by the thesis statement that the acquisition of Fisher Body by GM was a response to the hold-up that characterized their relationship and it was the only way that GM could save itself from the pressure. Transactional Cost Characteristics in the Acquisition Transaction cost in economics refers to the cost incurred in making any exchange that involves money. The main contributors to this development were Commons (1934) and Coase (1937). According to Commons, transactions ought to be made the basic unit of economic analysis (Commons, 1934). There are many categories of transactional cost that are identifiable in the acquisition of Fisher Body by General Motors in 1926. The categories are related to the realization of human behavior and ‘man as he is’ (Knight, 1965 The notion of bounded rationality was developed by Simon Herbert. (Simon, 1961). The notion describes a situation whereby a party in a contract intends to be rational during the signing of the contract, but acts limitedly so afterwards. The self-interest-seeking attribute is described in transactional economics as opportunism, moral hazard and agency. In the acquisition of Fisher Body by General Motors, the initial opportunism is seen as the action of Fisher Body, which seeing that the market for closed metal bodies was increasing, sought to enter to a contact with GM, making it long-term (Klein, 2008). Although the companies entered into a contract with the intentions to act rationally, Fisher does not do this initially. The company refuses the relocation request. However, with this request refused, GM decides to get opportunistic, they use their higher share of interests in Fisher Body to negotiate for a merger that at last benefit them more. However Coase in his paper criticizes this view. Focusing on the Fisher brothers and their relationship with GM prior to the contract, he claims that it would not be in the interest of Fisher Body to hold up GM (Coase, 2006). In entering into a contract, most companies observe for the likelihood that the partner will be capable of taking undue opportunism to their expense. One indication of the viability of the contract is a transaction history between the two parties. The frequency of transaction is, therefore, a category that should be considered. In this case, how frequent there is a new negotiation of terms is important. When entering into a contract, GM and Fisher Body did not make the consideration. As the demand increased, prices were supposed to reduce but the contract unintentionally bound the company (Casadesus‐Masanell & Spulber, 2000). Using this category as an argument, Coase dispels the notion that Fisher Body was opportunistic in its dealing with GM. He again revisits the Fisher brothers’ long-term transactions with GM as a partnership that had no room for opportunism hold-up (Coase, 2006). Asset specificity is another important category of transaction cost economy. This concept has reference to the extent to which a tangible asset in a transaction can be deployed and used in a variety of ways and by various players without putting the productive value at risk. One kind of asset specificity that is observable in this case is site specificity. On realizing that they are losing in the agreement in its form, General Motors in 1924 requested that Fisher Body relocate to a site just next to GM. This was in order to ensure that as GM abides by their side of the contract, the changes in the market do not lead to maximum losses. However, according to Klein, Fisher Body refused the request and conferred undue bounding to GM, a position that is disqualified by Coase as unprofessional and unexpected (Coase, 2006). Another category of transactional cost that we need to look at in relation to the acquisition of Fisher Body by GM is uncertainty. This is a core problem in economic organization. In as much as any organization can plan for the future, there are always uncertainty that threaten long-term planning. Uncertainty in transactional economics is of two kinds, primary and secondary. In primary transactional uncertainties, the threat arises from state-contingency. This means that it does not arise from the failure of any of the parties in a transaction to hold their end but on prevailing conditions (Freeland, 2000). Secondary uncertainty, on the other hand, arises directly from communication failure, intentional or unintentional between the parties. This makes one party suffer from the decision of the other. The acquisition of Fisher Body by GM in 1926 saw a combination of the two kinds of uncertainty. First, the changes in demand for metal car bodies that followed the contract was not the making of any of the partners. This is a primary uncertainty that GM failed to consider while entering into a long-term contract. When the returns for Fisher Body increased with investment, operational expansion and market change, the company decided to ensure they bound General Motors to the contract and refused their relocation request. This was a secondary uncertainty that resulted to losses to GM and the decision to negotiate for a merger. However, Coase regards these uncertainty as a normal concept in business and had nothing to do with an intention by Fisher Body to make GM have intolerable situation (Coase, 2006). His claims are that Fisher Body encouraged the merger for the benefit of both companies. Comparison of arguments of Klein and Coase Benjamin Klein observes that the merger was a result of market pressure and the uncertainty of having an inflexible contract. The merger came after the request for Fisher Body to relocate was refused. It proved the analytical nature in business as it benefitted GM more than a relocation would in the long term. GM gained competitiveness from this merger and Fisher Body was almost lost in the process. According to Klein, the hold-up that Fisher Body used against GM was in a way to take advantage of the uncertainty and constraints that were as a result of the initial long-term contract (Klein, 1998). However, this potential threat for sustained hold-up was removed by the merger that appears to be the wisest move that GM could make at that moment. Langlois & Robertson (1989) in support of Klein’s description brought in the concept of vertical integration. The vertical integration was observed as the demand for car bodies and the prices changed with the contact still in place (Langlois & Robertson, 1989). The merger, therefore, was effected by MG to protect its own interests. Coase (2000) discredits these claims strongly making a counter argument that makes Klein and other economists look like a factual tale with no basis. Coase’s gives two claims on the issue. First, there was nothing like a ‘hold-up’ situation and second, the situation that resulted to the merger was not intolerable. Coase’s argument revolves around the Fisher brothers and their relationship with GM to the point that each of the players wanted a merger and that a friendly relationship that existed could not allow for hold-up or intolerance. Coase describes the merger as a mutual understanding between the two companies who had maintained a close relationship for a long time. Coase described the need to obtain and retain the specialized knowledge that was available in Fisher Body was the main drive for the merger (Coase, 2006). Following this counter argument, Klein sought to clarify some of the issues in a different article. According to Klein (2007), what Fisher Body did was to resist a relocation that to them had no economic benefits but would reduce the cost incurred by GM. This was a hold-up in that GM could not get off the contract, and yet they were losing from the uncertainty that characterized the contract. This is the situation that Klein regards as intolerable and the result of the merger. Conclusion The acquisition of Fisher Body by GM was characterized by massive uncertainty in the contract. First, the contract had a fixed price tag that was inconsiderate of market changes. The length of time also increased the level of uncertainty leading to a major partner GM losing on one side. The other partner took undue advantage of the situation and refused to ease the intolerable situation as requested (Freeland, 2000). This increased pressure on General Motors and the merger was the only way that GM could save its chances in business. I, therefore, stay in support of Klein’s arguments of the events that led to the merger and more specifically from his recent article in response to Coase’s claims. The fact the Coase focus on one side, the Fisher Body makes his claims less strong. References Casadesus‐Masanell, R., & Spulber, D. F. (2000). The Fable of Fisher Body*. The Journal of Law and Economics. doi:10.1086/467448 Coase, R. H. (2000). The Acquisition of Fisher Body By General Motors*. The Journal of Law and Economics. doi:10.1086/467446 Coase, R., (2006.) ‘The Conduct of Economics: the example of Fisher Body and General Motors’, Journal of Economics and Management Strategy, Vol 15, No 2, 255-278. Commons, J., (1934). Institutional Economics. University of Wisconsin Press. Madison. Freeland, R. F. (2000). Creating Holdup Through Vertical Integration: Fisher Body Revisited*. The Journal of Law and Economics. doi:10.1086/467447 Klein, B. (2008). The enforceability of the GM-Fisher Body contract: comment on Goldberg. Industrial and Corporate Change. doi:10.1093/icc/dtn032 Klein, B., (1998), ‘Hold up Problem’ in Peter K Newman ed, The New Palgrave Dictionary of Economics and Law, Vol 2, MacMillan, London. Knight, F., (1965). Risk, Uncertainty and Profit. Harper and Row. New York. Langlois, N. & Robertson, L. (1989) “Explaining Vertical Integration: Lessons from the American Automobile Industry,” Journal of Economic History 49: 361-375. Simon,H. (1961). Administrative behavior, 2nd Ed. Macmillan. New York. Williamson, O.,(1970). Corporate control and business behavior. Eaglewood Cliffs, N.J.: Prentice-Hall Williamson, O., (1981), ‘The Economics of Organization: The Transaction Cost Approach’, American Journal of Sociology. 87(3). Read More