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The Handbook of Organizational Economics

The Handbook of Organizational Economics

Copyright Date: December 2012
Pages: 1368
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  • Book Info
    The Handbook of Organizational Economics
    Book Description:

    In even the most market-oriented economies, most economic transactions occur not in markets but inside managed organizations, particularly business firms. Organizational economics seeks to understand the nature and workings of such organizations and their impact on economic performance. This landmark book assembles the leading figures in organizational economics to present the first comprehensive view of both the current state of research in this fast-emerging field and where it might be headed.

    The Handbook of Organizational Economics surveys the major theories, evidence, and methods used in the field. It displays the breadth of topics in organizational economics, including the roles of individuals and groups in organizations, organizational structures and processes, the boundaries of the firm, contracts between and within firms, and more.

    The defining book on the subject, The Handbook of Organizational Economics is essential reading for researchers and students looking to understand this emerging field in economics.

    Presents the first comprehensive treatment of organizational economics Features contributions by leaders in the field Unifies and extends existing literatures Describes theoretical and empirical methods used today

    eISBN: 978-1-4008-4535-4
    Subjects: Management & Organizational Behavior, Economics

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-viii)
    (pp. ix-xiv)
  4. Introduction
    (pp. 1-8)
    Robert Gibbons and John Roberts

    Organizational economics involves the use of economic logic and methods to understand the existence, nature, design, and performance of organizations, especially managed ones. As this handbook documents, economists working on organizational issues have now generated a large volume of exciting research, both theoretical and empirical. However, organizational economics is not yet a fully recognized field in economics—for example, it has no Journal of Economic Literature classification number, and few doctoral programs offer courses in it. The intent of this handbook is to make the existing research in organizational economics more accessible to economists and thereby to promote further research...


    • 1 Complementarity in Organizations
      (pp. 11-55)
      Erik Brynjolfsson and Paul Milgrom

      According to the American Heritage dictionary, a synergy is “the interaction of two or more agents or forces so that their combined effect is greater than the sum of their individual effects” or “cooperative interaction among groups, especially among the acquired subsidiaries or merged parts of a corporation, that creates an enhanced combined effect.” Complementarity, as we use the term, is a near synonym for “synergy,” but it is set in a decisionmaking context and defined in Section 1.2 with mathematical precision.

      Complementarity is an important concept in organizational analysis, because it offers an approach to explaining patterns of organizational...

    • 2 Economic Theories of Incentives in Organizations
      (pp. 56-99)
      Robert Gibbons and John Roberts

      Managed organizations serve both to coordinate the decisions and actions of individuals and groups and to motivate these people to perform the needed activities. This chapter considers the nature of motivation problems in organizations and summarizes theories of the means to address these problems, focusing on the literature in economics but drawing ideas and observations from such fields as economic sociology and accounting where possible.

      Both in well-functioning competitive markets and under efficient Coasian bargaining, the motivation problem is fully solved. But familiar sources of contracting problems—precontractual private information leading to adverse selection, observability problems leading to moral hazard,...

    • 3 Property Rights
      (pp. 100-158)
      Ilya Segal and Michael D. Whinston

      Every organization, whether a firm, a nonprofit organization, or a society, must confront two basic problems. The first is the creation of incentives for efficient behavior among its members. The second is the efficient allocation among those members of the resources available to and produced by the organization. These problems are closely related, because the rule for allocating resources generally affects individuals’ incentives.

      Organizations have many ways of trying to achieve these goals. Sometimes they use contracts. These may explicitly specify behavior or attempt to indirectly encourage desirable behavior through incentive pay. At other times they allocate decision rights to...

    • 4 Transaction Cost Economics
      (pp. 159-190)
      Steven Tadelis and Oliver E. Williamson

      The study of the governance of economic organization has become a lively and diverse field of research over the past four decades. This chapter describes the fundamental ideas of transaction cost economics (TCE) as these evolved in the 1970s and since to offer a methodology through which to analyze how the governance of economic organization has economizing consequences. Our view, as well as the general outlook of TCE, is that organization matters for economists if and as organization is made susceptible to analysis by the application of economic reasoning.

      As such, TCE is part of a broader effort to study...


    • 5 Clinical Papers in Organizational Economics
      (pp. 193-212)
      George P. Baker and Ricard Gil

      The story of General Motors’ acquisition of the Fisher Body company in 1926 constitutes one of the more influential anecdotes in economics. Along with Adam Smith’s pin factory, Ronald Coase’s lighthouse, and George Akerlof’s used-car market, the story of how General Motors first contracted with, then got held up by, and finally bought out Fisher Body has influenced the way economists have thought of agency problems, transactions costs, and make-or-buy decisions for more than 30 years. The paper that first told this story—Klein et al. (1978) in the Journal of Law and Economics—stands as the fourth most highly...

    • 6 Experimental Organizational Economics
      (pp. 213-262)
      Colin F. Camerer and Roberto A. Weber

      This chapter is about experiments that study aspects of organizational structure and economic performance. Relative to field studies using empirical data, experiments often have obvious advantages, especially that of control and randomized assignment to implement theoretical assumptions that can only be imperfectly measured or controlled econometrically when using field data. Despite these advantages, the range of organizational hypotheses studied in experiments is small, although it is growing rapidly.

      What makes an experiment organizational? The working definition we use to define the scope of this chapter is the following.

      Definition In an organizational experiment, two or more subjects engage in a...

    • 7 Insider Econometrics Empirical Studies of How Management Matters
      (pp. 263-312)
      Casey Ichniowski and Kathryn Shaw

      Survey data and casual observation suggest that there are striking differences in management practices among firms and establishments that operate within the same industry. Human resource management (HRM) practices—such as types of compensation, teamwork, job design, or training activities—vary across firms. Decisions about the scope of the firm, such as the extent of outsourcing or vertical integration and about adopting new technologies, are among the many management policies that vary across firms.¹ Industries are not populated by homogeneous firms having a single set of optimal management practices. Why do some firms within the same industry look so different...


    • 8 Employment as an Economic and a Social Relationship
      (pp. 315-341)
      James N. Baron and David M. Kreps

      Because employment is simultaneously an economic and a social relationship, one cannot profitably study it as one or the other in isolation. To understand employment relationships requires taking into account both economic and social-psychological dimensions of their content and context and, especially, how economic and social forces interact. This is true of many economic exchanges, but particularly of employment: Fraught with the complexities of time, uncertainty, and ambiguity, employment contracts are often massively incomplete. “Market discipline” is likely to become less and less acute the longer an employment relationship endures. Although supply-equals-demand may be informative in the aggregate, at the...

    • 9 Authority in Organizations A Survey
      (pp. 342-372)
      Patrick Bolton and Mathias Dewatripont

      Much of the theory of the firm has been concerned with what determines the boundaries of firms. When does a firm reach its efficient size? When does a merger between two separate entities improve efficiency of production? Which core activities should a firm focus on, and which should it outsource? A central achievement of the property rights theory of the firm (Grossman-Hart-Moore) is that these questions can all be framed in terms of an allocation problem of control rights or property rights over productive assets. That is, all questions relating to the boundaries of the firm can be phrased in...

    • 10 Decisions in Organizations
      (pp. 373-431)
      Robert Gibbons, Niko Matouschek and John Roberts

      Organizations exist largely to get things done. Determining what should be done, by whom, how, when, and where (and then actually getting it done) requires decisions, and making good decisions depends on the decisionmaker’s having the relevant information. However, as emphasized by Hayek (1945), the relevant information is typically dispersed (and may need to be developed). Thus, communication is necessary if decisionmakers are to become informed. If those communicating the information recognize how what they transmit will affect decisions, then they may be led to communicate strategically, withholding information or misrepresenting it. Then the decisionmaker will need to take account...

    • 11 Leadership and Corporate Culture
      (pp. 432-478)
      Benjamin E. Hermalin

      Much of the economics of organization deals with the formal rights and rules that govern organizations, both in normative and positive analyses. Who should have legal claim to what resources? Who should have authority over whom or what? What contracts should be utilized? But importantly, the operation of organizations is also determined by informal means. Two such means are leadership, a concept distinct from authority, and corporate culture, a broad concept covering the informal rules and expectations that affect operations. This chapter surveys the literature on these informal aspects of organization.¹

      The word “leadership” has many meanings and connotations. Some...

    • 12 Personnel Economics
      (pp. 479-519)
      Edward P. Lazear and Paul Oyer

      Personnel economics is the application of economic and mathematical approaches to traditional topics in the study of human resource management. This includes such topics as compensation, turnover, and incentives that are inherently economic, as well as those that do not at first appear to be economic topics (e.g., norms, teamwork, worker empowerment, and peer relationships). Using the tools from advances in game theory, information economics, econometrics, and other areas of economics, personnel economics has come a long way over the past few decades. It now produces a large share of the labor economics literature, has earned its own code in...

    • 13 Theory and Evidence in Internal Labor Markets
      (pp. 520-572)
      Michael Waldman

      During the past 30 years economics has made great progress in moving beyond treating the firm as a “black box” and understanding various aspects of its internal operation. One area, in particular, where substantial progress has been made is that of internal labor markets.¹ In this chapter I do not broadly survey the now-extensive literature on this topic (for broad surveys, see Gibbons 1998; Gibbons and Waldman 1999a; Lazear 1999; Lazear and Oyer, this volume) but rather focus on connections between theory and evidence in this literature. In particular, pursuing a theme first explored in Gibbons and Waldman (1999a), I...


    • 14 Technological Innovation and Organizations
      (pp. 575-603)
      Pierre Azoulay and Josh Lerner

      In a handbook that takes a broad view of organizational structure, it might be wondered whether a chapter devoted to the relationship between technological innovation and organization is appropriate. After all, is not innovation just one relatively modest facet of economic activity?

      There are two responses to this question. First, since the 1950s, economists have understood that technological innovation is critical to economic growth. Our lives are more comfortable and longer than those of our great-grandparents on many dimensions. At the heart of these changes has been the progress of technology. Innumerable studies have documented the strong connection between technological...

    • 15 Hierarchies and the Division of Labor
      (pp. 604-654)
      Luis Garicano and Timothy Van Zandt

      Knight (1921) saw the function of entrepreneurs (and others “of higher skill”) as making informed decisions in a world of uncertainty. Indeed, this would describe also the role of middle- and low-level managers, their assistants, and the technicians who collectively manage a large organization through decentralized decision processes.

      This chapter reviews some research in economics on such managerial decision processes. Such research is not a mere technological exercise, akin to studying production on an assembly line. Rather, organizational processes are integral to the external interaction between an organization and other actors and to the internal functioning of the organization. Externally,...

    • 16 Internal Capital Markets
      (pp. 655-679)
      Robert Gertner and David Scharfstein

      Resource allocation is at the core of economics. Economists mostly concern themselves with resource allocation across organizational boundaries mediated through contracts or markets. Yet a great deal of resource allocation occurs within organizations. Businesses allocate capital and other scarce resources across and within business units, including production capacity, R&D capabilities, physical inputs, and human capital.

      The most extensive research on internal resource allocation is by financial economists. These studies largely focus on the differences between internal and external capital allocation. Indeed, the insight that the key feature of conglomerates is the replacement of external capital markets with internal capital allocation...

    • 17 What Do Managers Do? Exploring Persistent Performance Differences among Seemingly Similar Enterprises
      (pp. 680-731)
      Robert Gibbons and Rebecca Henderson

      Decades of research using a wide variety of detailed plant- and firm-level data has provided strong evidence of persistent performance differences among seemingly similar enterprises (hereafter, PPDs among SSEs). Bartelsman and Doms (2000) reviewed the sizeable initial literature on this issue, and a recent review by Syverson (2011) highlighting much new research has only strengthened the result.

      As one striking example, Syverson (2004a) finds that “within 4-digit SIC [Standard Industrial Classification] industries in the U.S. manufacturing sector, the average difference in logged total factor productivity (TFP) between an industry’s 90th and 10th percentile plants is 0.651 . . . [meaning...

    • 18 Corporate Governance A Critical Assessment
      (pp. 732-763)
      Benjamin E. Hermalin

      People invest in organizations. They invest their human capital, and they invest their physical capital. In exchange, they expect some return, and all else equal, they would like the organizations in which they invest to maximize that return. A problem arises, however, when the people who invest in an organization are not the same people who control the organization. Lack of control makes the investors vulnerable to mismanagement of the organization, misallocation of its resources, or even misappropriation of their returns. In short, investors fear that their returns will not be maximized, because their desires are not necessarily aligned with...

    • 19 Incentives in Hierarchies
      (pp. 764-798)
      Dilip Mookherjee

      The twentieth century witnessed the emergence of large organizations in the private, public, and nonprofit sectors. Alfred Chandler’s (1962, 1977) classic studies Strategy and Structure and The Visible Hand document the historical transformation of American industrial enterprises from small or medium-sized owner-managed firms in the early nineteenth century into large business conglomerates controlled by a hierarchy of professional managers by the middle of the twentieth century. Likewise, government agencies managed by professional bureaucracies have grown in size and scope throughout the course of the twentieth century, accompanying the growth of the role of governments in taxation, regulation, and delivery of...

    • 20 Strategy and Organization
      (pp. 799-850)
      John Roberts and Garth Saloner

      A firm’s business strategy is a set of choices about what business it will be in, which products and services it will offer, which customers it will seek to serve, where it will operate, and which of the activities that are needed to realize these plans it will undertake itself rather than leave to others. A strategy sets direction and provides a standard against which later options can be evaluated. It is not a complete specification of all the decisions a firm must make, but it does fix enough of these choices to facilitate coordination of later decisions. It also...


    • 21 Vertical Integration and Market Structure
      (pp. 853-890)
      Timothy Bresnahan and Jonathan Levin

      Vertical integration occupies a central role in organizational economics. Williamson (2005) calls it the “paradigm” problem for explaining the distribution of firms and markets in modern economies. In this chapter, we review research on vertical integration decisions and their consequences, and offer some perspective on the current state of knowledge.¹

      Our discussion bridges two very different literatures. Research in organizational economics generally treats vertical integration as an efficient response to contracting frictions. This approach is often associated with Coase (1937) and Williamson (1971). Research in industrial organization has taken a complementary approach, emphasizing patterns of integration at the market or...

    • 22 Ownership and Organizational Form
      (pp. 891-917)
      Henry Hansmann

      In contemporary market economies, productive enterprise is undertaken predominantly by large numbers of independent firms. Although in theory these firms could be organized in myriad ways, in practice they typically adopt one or another of a small number of standard forms. In this chapter we examine the basic elements of those forms and analyze the economic forces that induce their adoption.

      Section 2 begins by exploring the basic legal nature and economic role of the firm. We focus on the firm as a contracting entity, and on the relationship between two different boundaries of the firm: the control boundary and...

    • 23 Contracts between Legal Persons
      (pp. 918-957)
      Lewis A. Kornhauser and W. Bentley MacLeod

      Contract law and the economics of contract have, for the most part, developed independently of each other. While contract law has existed for centuries, if not millennia, the economic analysis of contract is both very recent and largely divorced from the content and structure of contract law.¹ Current reviews of contract theory, such as Laffont and Martimort (2002) and Bolton and Dewatripont (2005), do not discuss either the substantive law of contract or the role that courts play in enforcement. In this chapter, we begin to bridge this gap.

      We briefly review the notion of a contract from the perspective...

    • 24 Inter-Firm Contracts Evidence
      (pp. 958-1013)
      Francine Lafontaine and Margaret E. Slade

      Economics is sometimes described as the study of markets. Many market transactions, however, do not take place in arm’s-length spot markets but instead are governed by long- or short-term contracts. Because those contracts restrict the actions of one or both parties, there must be offsetting benefits. Otherwise, parties would not voluntarily enter into agreements that limit their flexibility. In this chapter, we review empirical analyses of interfirm contracts, paying particular attention to the reasons for entering into contractual relationships and the associated costs and benefits. We consider not only studies of the incidence of such contracts—when different types of...

    • 25 Relational Incentive Contracts
      (pp. 1014-1065)
      James M. Malcomson

      This chapter is about relational contracts, agreements for which the ongoing relationship between the parties plays an essential role in determining what happens. Its concern is with relational incentive contracts, those that involve incentives for taking actions, and not, for example, those involving only risk sharing, such as the relational contracts studied by Thomas and Worrall (1988) and surveyed in Malcomson (1999: 2300–2311). It focuses on supply relationships between firms, not purely financial contracts, sovereign debt (discussed in Obstfeld and Rogoff 1996: 349–428), or employment (surveyed in Malcomson 1999: 2337–2364). The same underlying principles apply to all...

    • 26 Hybrid Modes of Organization Alliances, Joint Ventures, Networks, and Other Strange Animals
      (pp. 1066-1106)
      Claude Ménard

      The central message expressed throughout this chapter is that there is a whole class of economic organizations that contribute substantially to what Coase (1992: 713) called “the institutional structure of production.” These arrangements fall neither under pure market relationships nor within “firm boundaries.” They multiply because they are viewed as efficient in dealing with knowledge-based activities, solving hold-up problems, and reducing contractual hazards. They have properties of their own that deserve theoretical attention and empirical investigation.

      Indeed, although the significance of these arrangements, hereafter identified as “hybrids,” remains difficult to quantify, they play a major role in developed market economies....


    • 27 Corruption
      (pp. 1109-1147)
      Abhijit Banerjee, Rema Hanna and Sendhil Mullainathan

      Corruption is rampant in many poor countries. As such, anticorruption policies continue to be a central component of development strategies. For example, since 1996, the World Bank alone has supported more than 600 anticorruption programs.

      Unfortunately, this is one area where research has lagged policy. Research on corruption faces two important obstacles—one empirical and one theoretical. On the empirical side, the primary challenge is measurement. Corruption, by its very nature, is illicit and secretive. How does one study something that is defined in part by the fact that individuals go to great lengths to hide it? How does one...

    • 28 Delegation, Control, and the Study of Public Bureaucracy
      (pp. 1148-1182)
      Terry M. Moe

      For most of the past century, the study of public bureaucracy was a theoretical backwater in political science. Public administration, its home field until recently, was heavily focused on good management and the nuts and bolts of government operation, and these concerns tended to drive out theoretical thinking. Moreover, unlike the more advanced fields of political science—legislatures, elections, public opinion—bureaucracy did not provide scholars with raw materials that were readily quantified. Legislators vote, for instance, and bureaucrats do not. This single fact had much to do with putting the study of legislatures on the fast track and that...

    (pp. 1183-1202)
    (pp. 1203-1233)