Barzel on the market for blood

Image

A Conversation with Harold Demsetz

Via https://www.econlib.org/videos/a-conversation-with-harold-demsetz/

Richard Epstein on Harold Demsetz and the theory of the firm

Image

Ronald Coase’s Theory of the Firm and the Family

Ronald Coase speaking about George Stigler’s Coase Theorem

Forever Contemporary – The Economics of Ronald Coase | Free book from Institute of Economic Affairs

Summary:

  • R. H. Coase (1910–2013), a leading modern figure in the classical liberal tradition, was awarded the Nobel Prize in Economics in 1991 for his analysis of the significance of transaction costs and property rights for the functioning of the economy.
  • Before Coase’s work in the 1930s, there was no real understanding of the relation between the theory of the firm and the theory of markets. Coase showed that the size and structure of firms, and the location of the border between internal exchange within the firm and external exchange through markets, are systematically related to the costs of transactions.
  • These transaction costs, which Coase termed ‘costs of using the price mechanism’, include search and information costs (those involved in finding business partners, rather than having to produce your own inputs), bargaining costs (which rise sharply with the number of contractual partners) and enforcement costs (which, in the absence of a strong and effective legal framework, depend largely on trust in partners). When these costs alter dramatically, for example, as a result of introducing innovative technology, we can expect substantial alterations in firm and market structures.
  • Coase was a pioneer in the modern analysis of environmental issues. He showed that, with clear property rights and low transactions costs, private solutions to many environmental problems can be achieved without government regulation. Such solutions were logically independent of the initial distribution of property rights. This is highly relevant to a number of modern economic problems which the government currently handles badly, such as land-use planning.
  • His work has had a profound effect on later generations of economists, several of whom themselves won Nobel Prizes. His work on environmental issues, for example, influenced another Nobel Prizewinner in Elinor Ostrom, whose work focused on how common pool resources could be used effectively with minimal government intervention. This is especially relevant to debates about environmental and ecological degradation in forestry, fishing and game animal resources – perhaps particularly in developing economies.
  • Similarly his work on the firm led to the development of the ‘New Industrial Economics’, now associated with Oliver Williamson, which has changed our understanding of issues of economic governance. This is relevant to current concerns over corporate social responsibility.
  • Coase’s editorship of the Journal of Law and Economics over many years did much to stimulate economic analysis of legal institutions, an innovation which has had a major influence on public policy, particularly in the US. It has fed, for instance, into recommendations for accident compensation.
  • Coase’s insights have challenged economists’ assumptions about the nature of public goods, which he demonstrated could often be provided more effectively by various forms of private initiative. He also illuminated such varied topics as the allocation of spectrum bandwith, the regulation of financial institutions and water resource management.
  • Methodologically, Coase was opposed to ‘blackboard economics’ which relied on theory or econometric analysis at the expense of more practical investigation. He favoured careful examination of case studies and the history of industries when analysing economic policy issues.
  • His work retains considerable significance in the twenty-first century. Coase’s analysis of China’s economic advance, published shortly before his death, sheds light on its future prospects, while his transaction cost approach can be argued to explain the new phenomenon of the ‘sharing’ economy which is reshaping businesses and employment. Furthermore his work should continue to be at the forefront of debates surrounding regulation, broadcasting and the environment. If policymakers and the economists who advise them ignore Coase, they are in danger of perpetuating policies which may work ‘in theory’ but do not work effectively in practice.

Source: Forever Contemporary – The Economics of Ronald Coase | Institute of Economic Affairs

Ronald Coase on the emergence of the firm

Image

Richard Epstein on getting environmental law right

Image

“Trapped” in Rental Contracts | Organizations and Markets

  • Mercedes and BMW drivers trapped in lease contracts, rather than buying their cars with cash or credit
  • Individuals trapped in wage and salary contracts, rather than raising the capital, arranging the inputs, and bearing the uncertainties to be sole proprietors
  • Companies trapped in outsourcing agreements, rather than owning all upstream and downstream production processes directly, as vertically integrated firms
  • Vacationers trapped in resort hotels, rather than owning their own vacation condos or timeshares
  • Readers trapped by downloading and reading books on their Kindles, essentially “renting” them from Amazon, rather than buying physical books
  • Movie fans trapped in DVD rental agreements with Netflix, rather than owning massive DVD libraries

via “Trapped” in Rental Contracts | Organizations and Markets.

The separation of ownership from control

Eugene Fama divides firms into two types:  the managerial firm,  and the entrepreneurial firm.

The owners of a managerial firm advance, withdraw, and redeploy capital, carry the residual investment risks of ownership and have the ultimate decision making rights over the fate of the firm (Klein 1999; Foss and Lien 2010; Fama 1980; Fama and Jensen 1983a, 1983b; Jensen and Meckling 1976).

Owners of a managerial firm, by definition, will delegate control to expert managerial employees appointed by boards of directors elected by the shareholders (Fama and Jensen 1983a, 1983b). The owners of a managerial firm will incur costs in observing with considerable imprecision the actual efforts, due diligence, true motives and entrepreneurial shrewdness of the managers and directors they hired (Jensen and Meckling 1976; Fama and Jensen 1983b).

Owners need to uncover whether a substandard performance is due to mismanagement, high costs, paying the employees too much or paying too little, excessive staff turnover, inferior products, or random factors beyond the control of their managers (Jensen and Meckling 1976; Fama and Jensen 1983b, 1985). Any paucity in knowledge slows the reactions of owners in correcting managerial errors including slip-ups in the recruitment and the retention of experienced older employees.

The entrepreneurial firms are owned and managed by the same people (Fama and Jensen 1983b). Mediocre personnel policies and sub-standard staff retention practices within entrepreneurial firms are disciplined by these errors in judgement by owner-managers feeding straight back into the returns on the capital that these owner-managers themselves invested. Owner-managers can learn quickly and can act faster in response the discovery of errors in judgement. The drawback of entrepreneurial firms is not every investor wants to be hands-on even if they had the skills and nor do they want to risk being undiversified.

Many of the shareholders in managerial firms have too small a stake to gain from monitoring managerial effort, employee performance, capital budgets, the control of costs and the stinginess or generosity of wage and employment policies (Manne 1965; Fama 1980; Fama and Jensen 1983a, 1983b; Williamson 1985; Jensen and Meckling 1976). This lack of interest by small and diversified investors does not undo the status of the firm as a competitive investment.

Large firms are run by managers hired by diversified owners because this outcome is the most profitable form of organisation to raise capital and then find the managerial talent to put this pool of capital to its most profitable uses (Fama and Jensen 1983a, 1983b, 1985; Demsetz and Lehn 1985; Alchian and Woodward 1987, 1988).

More active investors will hesitate to invest in large managerial firms whose governance structures tolerate excessive corporate waste and do not address managerial slack and error. Financial entrepreneurs will win risk-free profits from being alert and being first to buy or sell shares in the better or worse governed firms that come to their notice.

The risks to dividends and capital because of manifestations of corporate waste, reduced employee effort, and managerial slack and aggrandisement in large managerial firms are risks that are well known to investors (Jensen and Meckling 1976; Fama and Jenson 1983b). Corporate waste and managerial slack also increase the chances of a decline in sales and even business failure because of product market competition (Fama 1980; Fama and Jensen 1983b). Investors will expect an offsetting risk premium before they buy shares in more ill-governed managerial firms. This is because without this top-up on dividends, they can invest in plenty of other options that foretell a higher risk-adjusted rate of return.

The discovery of monitoring or incentive systems that induce managers to act in the best interest of shareholders are entrepreneurial opportunities for pure profit (Fama and Jensen 1983b, 1985; Alchian and Woodward 1987, 1988; Demsetz 1983, 1986; Demsetz and Lehn 1985; Demsetz and Villalonga 2001). Investors will not entrust their funds to who are virtual strangers unless they expect to profit from a specialisation and a division of labour between asset management and managerial talent and in capital supply and residual risk bearing (Fama 1980; Fama and Jensen 1983a, 1983b; Demsetz and Lehn 1985). There are other investment formats that offer more predictable, more certain rate of returns.

Competition from other firms will force the evolution of devices within the firms that survive for the efficient monitoring the performance of the entire team of employees and of individual members of those teams as well as managers (Fama 1980, Fama and Jensen 1983a, 1983b; Demsetz and Lehn 1985). These management controls must proxy as cost-effectively as they can having an owner-manager on the spot to balance the risks and rewards of innovating.

The reward for forming a well-disciplined managerial firm despite the drawbacks of diffuse ownership is the ability to raise large amounts in equity capital from investors seeking diversification and limited liability (Demsetz 1967; Jensen and Meckling 1976; Fama 1980; Fama and Jensen 1983b; Demsetz and Lehn 1985).Portfolio investors may know little about each other and only so much about the firm because diversification and limited liability makes this knowledge less important (Demsetz 1967; Jensen and Meckling 1976; Alchian and Woodward 1987, 1988).

It is still unwise to still suppose that portfolio investors will keep relinquishing control over part of their capital to virtual strangers who do not manage the resources entrusted to them in the best interests of the shareholders (Demsetz 1967; Williamson 1985; Fama 1980, 1983b; Alchian and Woodward 1987, 1988).

Managerial firms who are not alert enough to develop cost effective solutions to incentive conflicts and misalignments will not grow to displace rival forms of corporate organisation and methods of raising equity capital and loans, allocating legal liability, diversifying risk, organising production, replacing less able management teams, and monitoring and rewarding employees (Fama and Jensen 1983a, 1983b; Fama 1980; Alchian 1950).

Entrepreneurs win profits from creating corporate governance structures that can credibly assure current and future investors that their interests are protected and their shares are likely to prosper (Fama 1980; Fama and Jensen 1983a, 1983b, 1985; Demsetz 1986; Demsetz and Lehn 1985). Corporate governance is the set of control devices that are developed in response to conflicts of interest in a firm (Fama and Jensen 1983b).

Previous Older Entries

Darwinian Business

A blog exploring business from an evolutionary perspective, by Max Beilby

Spin, strangeness, and charm

Politics, media bias, science, and psychology

Moneyness

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

Family Inequality

by Philip N. Cohen

What Paul Gregory is Writing About

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

Woman's Place UK

Violence against women and sex discrimination still exist. Women need reserved places, separate spaces and distinct services.

TVHE

The Visible Hand in Economics

Kids Prefer Cheese

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

PILEUS

A Classical Liberal Blog on Political Science, Economics, Philosophy, Law, and More

George Mason Economics Society

Provoking discussion by publishing economic writing

Club Troppo

Economic, legal, political and social commentary

Offsetting Behaviour

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

JONATHAN TURLEY

Res ipsa loquitur - The thing itself speaks

single sex spaces

Single sex spaces are a question of consent

Adventures of a Tudor Nerd

Tudor History from the Wars of the Roses to the Death of Elizabeth I

Weapons and Warfare

History and Hardware of Warfare

Escape Velocity

Visions Of A Freer Future

Economist's View

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

No Punches Pulled

Laughter – the best medicine

TannerOnPolicy

Politics and Policy with a Libertarian Twist

Notes On Liberty

Spontaneous thoughts on a humble creed

Mostly Economics

This blog covers research work in Economics with focus on India.

Map Dragons

Written by map lovers for map lovers

New Historical Express

(Formerly Hatful of History)

FondOfBeetles

a developmental biologist in a gendered world

CONVERSABLE ECONOMIST

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

Barrie Saunders

Thoughts on public policy and the media

The Victorian Commons

Researching the House of Commons, 1832-1868

Coyote Blog

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

American Enterprise Institute – AEI

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

The History of Parliament

Blogging on parliament, politics and people, from the History of Parliament

Catallaxy Files

Australia's leading libertarian and centre-right blog

Climate Audit

by Steve McIntyre

Books & Boots

reflections on books and art

Legal History Miscellany

Posts on the History of Law, Crime, and Justice

Sex, Drugs and Economics

Celebrating humanity's flourishing through the spread of capitalism and the rule of law

The Long Run

the EHS blog

The Undercover Historian

Beatrice Cherrier's blog

Vincent Geloso

Economics, History, Lots of Data and French Stuff

Climatism

Tracking Anthropogenic Climate Alarmism

%d bloggers like this: