The National Grange, also known as The Grange and officially named The National Grange of the Order of Patrons of Husbandry,
is a social organization in the United States that encourages families
to band together to promote the economic and political well-being of the
community and agriculture. The Grange, founded after the Civil War in 1867, is the oldest American agricultural advocacy group with a national scope. The Grange actively lobbied state legislatures and Congress for political goals, such as the Granger Laws to lower rates charged by railroads, and rural free mail delivery by the Post Office.
In 2005, the Grange had a membership of 160,000, with
organizations in 2,100 communities in 36 states. It is headquartered in
Washington, D.C., in a building built by the organization in 1960. Many
rural communities in the United States still have a Grange Hall and
local Granges still serve as a center of rural life for many farming
communities.
History
The commissioner of the Department of Agriculture commissioned Oliver Kelley, after a personal interview with President Andrew Johnson, to go to the Southern states and to collect data to improve Southern
agricultural conditions. In the South, poor farmers bore the brunt of
the Civil War and were suspicious of Northerners like Kelley. Kelley
found he was able to overcome these sectional differences as a Mason.
With Southern Masons as guides, he toured the war-torn countryside in
the South and was appalled by the outdated farming practices. In the
western states, Kelley deplored the lack of "progressive agriculture",
with illiterate "ignorant" farmers who were "using a system of farming
[that] was the same as that handed down by generations gone by". He saw the need for an organization that would bring people together
from across the country in a spirit of mutual cooperation. After many
letters and consultations with the other founders, the Grange was born. The first Grange, Grange #1, was founded in 1868 in Fredonia, New York. Seven men and one woman co-founded the Grange: Oliver Hudson Kelley, William Saunders, Francis M. McDowell, John Trimble, Aaron B. Grosh, John R. Thompson, William M. Ireland, and Caroline Hall. In 1873 the organization was united under a National Grange in Washington, D.C.
Paid agents organized local Granges and membership in the Grange
increased dramatically from 1873 (200,000) to 1875 (858,050). Many of
the state and local granges adopted non-partisan political resolutions,
especially regarding the regulation of railroad transportation costs.
The organization was unusual at this time, because women and any teen old enough to draw a plow (aged 14 to 16)
were encouraged to participate. The importance of women was reinforced
by requiring that four of the elected positions could be held only by
women.
1967 U.S. postage stamp honoring the National Grange
Rapid growth infused the national organization with money from dues, and many local granges established consumers' co-operatives, initially supplied by the wholesaler Aaron Montgomery Ward.
Poor fiscal management, combined with organizational difficulties
resulting from rapid growth, led to a massive decline in membership. By
the turn of the 20th century, the Grange rebounded and membership
stabilized.
Grange
membership has declined considerably as the percentage of American
farmers has fallen from a third of the population in the early 20th
century to less than two percent today. Between 1992 and 2007, the
number of Grange members fell by 40%, largely due to the National Grange
no longer offering insurance for its members. Washington has the largest membership of any state, at approximately 13,000.
In 2022, the National Grange reported a net gain in membership for the first time in almost seven decades.
As of 2024, the Grange continues to press for the causes of farmers, including issues of free trade and farm policy. In its 2006 Journal of Proceedings,
the organization's report on its annual convention, the organization
lays out its mission and how it works towards achieving it through
fellowship, service, and legislation:
The Grange provides opportunities
for individuals and families to develop to their highest potential in
order to build stronger communities and states, as well as a stronger
nation.
In February 2024, the National Grange revised their Mission Statement:
Strengthening individuals,
families, and communities through service, education, nonpartisan
grassroots advocacy, and agricultural awareness.
As a non-partisan organization, the Grange supports only policies,
never political parties or candidates. Although the Grange was founded
to serve the interests of farmers, because of the shrinking farm
population the Grange has begun to broaden its range to include a wide
variety of issues, and anyone is welcome to join the Grange.
The Junior Grange is open to children 5–14. Regular Grange
membership is open to anyone age 14 or older. The Grange Youth, a group
within the Grange, consists of members 13 1/2 to 30.
In 2013, the Grange signed on to a letter to Congress calling for the doubling of legal immigration and legalization for undocumented immigrants
currently in the United States. However, this position has been
somewhat revised, and the Grange now emphasizes an expansion in the H-2A visa
program to increase legal immigration and address the crisis-level
labor shortage in agriculture. They support the enforcement of
immigration law but urge discretion with regard to the impact on labor
availability.
Rituals and ceremonies
Grange in session, 1873
When the Grange first began in 1867, it borrowed some of its rituals and symbols from Freemasonry, including oaths, secret meetings, and special passwords necessary to keep railroad spies out of their meetings. It also copied ideas from Greek, Roman and Biblical mythology. Small,
ceremonial farm tools are often displayed at Grange meetings. Elected
officers are in charge of opening and closing each meeting. There are
seven degrees of Grange membership; the ceremony of each degree relates
to the seasons and various symbols and principles.
During the last few decades, the Grange has moved toward public
meetings and no longer meets in secret. Though the secret meetings do
not occur, the Grange still acknowledges its rich history and practices
some traditions.
Organization
The Grange is a hierarchical organization ranging from local
communities to the National Grange organization. At the local level are
community Granges, otherwise known as subordinate Granges. All members are affiliated with at least one subordinate. In most
states, multiple subordinate Granges are grouped together to form Pomona Granges.
Typically, Pomona Granges are made up of all the subordinates in a
county. Next in the order come State Granges, which is where the Grange
begins to be especially active in the political process. State Masters
(Presidents) are responsible for supervising the administration of
Subordinate and Pomona Granges. Together, thirty-five State Granges, as
well as Potomac Grange #1 in Washington, D.C., form the National Grange.
The National Grange represents the interests of most Grangers in
lobbying activities similar to the state, but on a much larger scale. In
addition, the National Grange oversees the Grange ritual. The Grange is
a grassroots organization; virtually all policy originates at the subordinate level.
The motto of the Grange is In necessariis unitas, in dubiis libertas, in omnibus caritas
("In essentials, unity; in non-essentials, liberty; in all things,
charity"). Indeed, the word "grange" comes from a Latin word for grain,
and is related to a "granary" or, generically, a farm.
William M. Ireland (???–1891), Founder of the National Grange. First Treasurer of the National Grange
Oliver Hudson Kelley
(1826–1913). Agriculturalist, organizer. Primary founder of the Order
of Patrons of Husbandry. First Secretary of the National Grange
Evander M. Law (1836–1920). Confederate general and organizer of the Alabama Grange
David Lubin
(1849–1919), California. Founder of the California Fruit Growers Union
and U.S. delegate to the International Institute of Agriculture
William Saunders
(1822–1900). Botanist, landscaper, designer of Soldiers Cemetery in
Gettysburg, PA. Founder of the National Grange. First Master/President
of the National Grange
The history of the cooperative movement concerns the origins and history of cooperatives across the world. Although cooperative arrangements, such as mutual insurance,
and principles of cooperation existed long before, the cooperative
movement began with the application of cooperative principles to
business organization.
The cooperative spirit spread in Greece earlier than in other
European countries. During the 18th century, a particular form of
cooperative organization was developed in certain areas under Ottoman sovereignty. It was associated with specific agricultural or craft products destined to international markets. Derived from the Byzantine guilds, it was favored by the Ottoman administration because it was enabling better control of the production and tax collection. The Common Company (Syntrofia) of Ambelakia (1780 to 1812), established in Thessaly
and providing Europe with high quality red cotton yarns, is typical of
this system. Its development was related with a dyeing technique using
the roots of the wild madder (ριζάρι, Rubia tinctorum)
and providing an indelible and shiny color. 22 villages possessing 24
factories participated to the Syntrofia, which had 6000 individual
members: financiers and landowners providing for capital and land,
technicians providing know-how, workers providing labor. It operated
several branch stores abroad (Amsterdam, Dresden, Hamburg, Leipzig,
Odessa, London, St. Petersburg...). In 1810, its capital amounted to 20 000 000 gold francs, deposited in
the Bank of Vienna. Other well-known cooperatives established in Greece
during the Ottoman period, are the Shipping Guilds of the islands Hydra, Spetses and Psara; the Community of Mantemi, exploiting the mines of Chalkidhiki (Macedonia); and the Community of “Mastic Villages” (Μαστιχοχώρια) de Chios (North Aegean), whose activities were based on the mastic - a resin extracted from the mastic trees, growing only on this island and used for cosmetic, culinary and medicinal purposes.
In the rest of Europe, primarily in Britain and France, the cooperative movement began mainily in the 19th century. The Industrial Revolution
and the increasing mechanisation of the economy transformed society and
threatened the livelihoods of many workers. The concurrent labour and social movements and the issues they attempted to address describe the climate at the time.
The first documented consumer cooperative was founded in 1769, in a barely furnished cottage in Fenwick, East Ayrshire,
when local weavers manhandled a sack of oatmeal into John Walker's
whitewashed front room and began selling the contents at a discount,
forming the Fenwick Weavers' Society.
In the decades that followed, several cooperatives or cooperative
societies formed including Lennoxtown Friendly Victualling Society,
founded in 1812.
By 1830, there were several hundred co-operatives. Some were initially successful, but most cooperatives founded in the early 19th century had failed by 1840. However, Lockhurst Lane Industrial Co-operative Society (founded in 1832 and now Heart of England Co-operative Society), and Galashiels and Hawick Co-operative Societies (1839 or earlier, merged with The Co-operative Group) still trade today.
It was not until 1844 when the Rochdale Society of Equitable Pioneers established the "Rochdale Principles"
on which they ran their cooperative, that the basis for development and
growth of the modern cooperative movement was established.
Robert Owen (1771–1858) is considered as the father of the
cooperative movement. A Welshman who made his fortune in the cotton
trade, Owen believed in putting his workers in a good environment with
access to education for themselves and their children. These ideas were
put into effect successfully in the cotton mills of New Lanark, Scotland.
It was here that the first co-operative store was opened. Spurred on by
the success of this, he had the idea of forming "villages of
co-operation" where workers would drag themselves out of poverty by
growing their own food, making their own clothes and ultimately becoming
self-governing. He tried to form such communities in Orbiston in Scotland and in New Harmony, Indiana in the United States of America, but both communities failed.
Although Owen inspired the co-operative movement, others – such as
Dr. William King (1786–1865) – took his ideas and made them more
workable and practical. King believed in starting small, and realized
that the working classes
would need to set up co-operatives for themselves, so he saw his role
as one of instruction. He founded a monthly periodical called The Co-operator, the first edition of which appeared on 1 May 1828. This gave a mixture
of co-operative philosophy and practical advice about running a shop
using cooperative principles. King advised people not to cut themselves
off from society,
but rather to form a society within a society, and to start with a shop
because, "We must go to a shop every day to buy food and necessaries –
why then should we not go to our own shop?" He proposed sensible rules,
such as having a weekly account audit, having 3 trustees, and not having
meetings in pubs (to avoid the temptation of drinking profits).
The Rochdale Society of Equitable Pioneers was a group of 10 weavers and 20 others in Rochdale, England, that was formed in 1844. As the mechanization of the Industrial Revolution was forcing more and
more skilled workers into poverty, these tradesmen decided to band
together to open their own store selling food items they could not
otherwise afford. With lessons from prior failed attempts at
co-operation in mind, they designed the now famous Rochdale Principles, and over a period of four months they struggled to pool one pound sterling
per person for a total of 28 pounds of capital. On December 21, 1844,
they opened their store with a very meagre selection of butter, sugar,
flour, oatmeal and a few candles. Within three months, they expanded
their selection to include tea and tobacco, and they were soon known for
providing high quality, unadulterated goods.
The Co-operative Group formed gradually over 140 years from the
merger of many independent retail societies, and their wholesale
societies and federations. In 1863, twenty years after the Rochdale Pioneers opened their co-operative, the North of England Co-operative Society was launched by 300 individual co-ops across Yorkshire and Lancashire.
By 1872, it had become known as the Co-operative Wholesale Society
(CWS). Through the 20th century, smaller societies merged with CWS, such
as the Scottish Co-operative Wholesale Society (1973) and the South Suburban Co-operative Society (1984).
By the 1990s, CWS's share of the market had declined considerably and
many came to doubt the viability of co-operative model. CWS sold its
factories to Andrew Regan in 1994. Regan returned in 1997 with a £1.2 billion bid for CWS. There were allegations of "carpet-bagging"
– new members who joined simply to make money from the sale – and more
seriously fraud and commercial leaks. After a lengthy battle, Regan's
bid was seen off and two senior CWS executives were dismissed and
imprisoned for fraud. Regan was cleared of charges. The episode
recharged CWS and its membership base. Tony Blair's Co-operative Commission, chaired by John Monks,
made major recommendations for the co-operative movement, including the
organisation and marketing of the retail societies. It was in this
climate that, in 2000, CWS merged with the UK's second largest society, Co-operative Retail Services.
Its headquarters complex is situated on the north side of Manchester city centre adjacent to the Manchester Victoria
railway station. The complex is made up of many different buildings
with two notable tower blocks of New Century House and the solar
panel-clad CIS tower.
Other independent societies are part owners of the Group.
Representatives of the societies that part own the Group are elected to
the Group's national board. The Group manages The Co-operative brand and the Co-operative Retail Trading Group (CRTG), which sources and promotes goods for food stores. There is a similar purchasing group (CTTG) for co-operative travel agents.
U.S. Co-operatives
The United States first known Co-op was the mutual fire insurance company founded in 1752 by Benjamin Franklin. The first dairy co-op was founded in 1810 with small locals found
nationwide by 1866. The first known consumer co-op in 1845 was Boston's
Workingman's Protective Union. The country's first organization to
promote cooperative values and the Rochdale Principles was the Order of the Patrons of Husbandry, known as the Grange
that started after the Civil War. The co-operative movement grew during
the 1890s in response to the expansion of large corporate monopolies.
The country's first credit unions were in Massachusetts while The
Cooperative League of the United States of America, known today as the National Cooperative Business Association was organized in 1916 to promote cooperatives. In the late 1960s the Co-op movement entered a new phase with Food cooperatives and Food Conspiracies as an alternative to corporate agriculture that linked organic farmers to urban consumers.
The co-operative model has a long history in the U.S., including a factory in the 1790s, the Knights of Labor, and the Grange. In Colorado, the Meadowlark cooperative administered the only private
free land program in the United States, providing many services to its
members who buy and sell together. In New York City, several food
co-operatives were founded around 2010, adding to others, some existing
since the 1970s. The U.S. has some diverse worker co-operatives, such as a home care agency, an organic bread factory co-op and an engineering firm. Some have already incorporated environmental and/or Fair Trade criteria
into their products, such as the aforementioned bread-maker, Organic Valley, and Equal Exchange.
Credit unions were established in the U.S. by 1908. Their member-owned, co-operative structure created stable governance
structure, so that they were only slightly affected by the 2008 mortgage
securities crisis.
Electrical co-operatives became an important economic strategy
for U.S. rural areas beginning in the 1930s, and continue to operate
successfully through events such as Hurricane Sandy in 2012.However, the majority in the U.S. demonstrate that co-operative values
do not necessarily lead to a progressive social and environmental
consciousness, as many remain focuses on fossil fuel and nuclear fuels. Nevertheless, new generation renewable power co-operatives have begun to be organized.
Agricultural co-operatives in the U.S. have had some mainstream success, including Welch's, Ocean Spray, and Land O'Lakes.
In the United States, a co-operative association was founded by
1920. Currently there are over 29,000 co-operatives employing 2 million
people with over $652 billion in annual revenue. To address the need for an organization oriented to newer and smaller co-ops, the United States Federation of Worker Cooperatives was founded after 2000.
An alternative method of employee-ownership, the Employee Stock
Ownership Plan (ESOP), was developed in the U.S. by Louis Kelso and
advocated by Senator Russell Long to be incentivized in the ERISA law of
1974. For example, a large Southeastern US supermarket chain a California manufacturer, and a furniture-maker with earnings of more than $2 billion, are employee-owned. Employee-owned trusts have also been developed more
or less independently, for example at an established iron pipe company
Alice Acland, the editor of the "Women's Corner" in the Co-operative News publication, and Mary Lawrenson,
a teacher, recognized the need for a separate women's organization
within the Cooperative Movement and began organizing a "Woman's League
for the Spread of Co-operation" in 1883. This League formally met for
the first time during the 1883 Co-operative Congress in Edinburgh in a
group of 50 women and established Acland as its organizing secretary. By
1884 it had six different branches with 195 members, and the League was
renamed the Women's Cooperative Guild.
The Guild organized around working women's issues and expanding
the Cooperative Movement. It continued to publish articles advocating
for women's involvement in the Cooperative Movement in the "Women's
Corner," and later through its own publications such as "The importance
of women for the cooperative movement." The Guild also opened the
Sunderland cooperative store in 1902, which catered to poor
working-class women. It engaged in many political campaigns concerning
women's health, women's suffrage and pacifism. Until recently the organisation participated in social justice activism, but has now closed.
In Russia the village co-operative (obshchina or mir), operated from pre-serfdom times until the 20th century.
Raiffeisen and Schultz-Delitsch developed an independently
formulated co-operative model in Germany, the credit union. The model
also moved abroad, reaching the United States by the 1880s and the
Knights of Labour's projects. Leland Stanford, the railroad magnate and Robber Baron, became a Senator and advocated for co-operatives. By 1920 a national association had formed in the U.S. This organization
began to develop international programs, and by the 1970s, a World
Council formed.
Co-operatives in the U.S. have a long history, including an early
factory in the 1790s. By the 1860s Brigham Young had started applying
co-operative ideas in Utah, and by the 1880s, the Knights of Labor and the Grange both promoted member-owned organizations. Energy co-operatives were founded in the U.S. during the Depression and the New Deal. Diverse kinds of co-operatives were founded and have continued to
perform successfully in different areas: in agriculture, wholesale
purchasing, telephones, and in consumer-food buying.
James Warbasse, an American doctor, became the first president of
the U.S. National Co-operative Business Association. He wrote
extensively on co-operative history and philosophy. Benjamin Ward began an important effort in co-operative economic theory
in the 1950s, with Jaroslav Vanek developing a general theory. David Ellerman began a line of theoretical thinking beginning with
legal principles, developing especially the labor theory of property,
and later reaching a treatment which evaluates the role of capital in
labor managed firms using the conventional economic production formula Q
= f(K, L). At one point in the 1990s he worked at the World Bank with
Nobel laureate Joseph Stiglitz.
Modern day
Co-operative enterprises were formed successfully following Rochdale, and an international association was formed in 1895. Co-operative enterprises are now widespread, with one of the largest and most successful examples being the industrial Mondragón Cooperative Corporation in the Basque country of Spain.
Mondragon Co-op was founded under the oppressive conditions of Fascist
Franco Spain after community-based democracy-building activities of a
priest, Jose Maria Arizmendiarrieta.
They have become an extremely diverse network of co-operative
enterprises, a huge enterprise in Spain, and a multinational concern. Co-operatives were also successful in Yugoslavia under Tito where Workers' Councils gained a significant role in management.
In many European countries, cooperative institutions have a predominant market share in the retail banking and insurance businesses. There are also concrete proposals for the cooperative management of the common goods, such as the one by Initiative 136 in Greece.
An annual general meeting of a retail co-operative in England, 2005.
In the UK, co-operatives formed the Co-operative Party
in the early 20th century to represent members of co-ops in Parliament.
The Co-operative Party now has a permanent electoral pact with the Labour Party, and some Labour MPs are Co-operative Party members. UK co-operatives retain a significant market share in food retail, insurance, banking, funeral services, and the travel industry in many parts of the country.
Denmark has had a strong cooperative movement, especially in the farming and industrial sectors. Co-housing is also common in Denmark in which residents share a common eating and gathering space. In some instances, the living spaces are financed by the Danish Housing
Association, but other times residents collectively own the land and
property.
In Germany, the rebuilding of the country after World War II
created a legislative opportunity in which politician Hans Boeckler
significantly lobbied for the co-determination
("Mitbestimmung") policies which were established, requiring large
companies to include a Workers' Council in the Board of Directors. These policies have had some influence on European Union policies.
Emilia Romagna, Italy had two separate and strong co-operative
traditions that resisted Cold War interference by US agencies and have
worked effectively in conjunction with each other.
Co-operative banks have become very successful throughout Europe,
and were able to respond more effectively than most corporate banks
during the 2008 mortgage-securities crisis.
Renewable Energy co-operatives in Europe became important in the
early development of windpower in Denmark beginning in the 1970s. Germany followed in the early 1990s, first on a larger scale with wind
co-ops, then with a citizen's movement which challenged the reliance on
nuclear power, organized, challenged the energy monopolists there, and
successfully created a successful co-op social enterprise by 1999. A citizen's group began operating wind turbines and involving broad
community ownership in the U.K. by 1995. Deregulation of the electricity
markets allowed energy co-operative social entrepreneurs to begin to
create alternatives to the monopolies in various countries. In France,
where an enormous percentage of the power is generated by nuclear
sources, this occurred after 2000. In Spain, wind power was developed by corporate-led efforts, and it
took longer for a renewable energy-focused social enterprise to get
established. Similar renewable energy co-ops around Europe have organized in a network.
Asian societies have adapted the co-operative model, including some of the most successful in the world.Nevertheless, the crises generated by traditional inequalities and the
shareholder model continues to require civil society and entrepreneurial
responses, such as the Citizens Coalition for Economic Justice in South
Korea, the Seikatsu Club Consumers' Co-operative Union in Japan, and the Self-Employed Women's Association in India. Other noteworthy efforts include Sophon Suphapong's efforts as governor
in Thailand with agricultural co-ops and Antonio Yapsutco Fortich's
contributions in the Philippines helping formulate a co-operative
strategy with sugar workers.
The International Labor Organization, originally established in 1919, has a Co-operative Division.
Co-operatives were brought to Latin America and developed there by 1902. Substantial independent efforts to develop employee-owned enterprises
or co-operatives have occurred as responses to crises, such as 2001 crisis in Argentina. In Brazil, the World Social Forum process lead to the articulation of Solidarity Economics, a modern, activist formulation of co-operativism.
The Fair Trade certification movement established first in the
Netherlands in 1988 with an international headquarters in Bonn nine
years later requires member farmers to have established a co-operative.
In 2016, UNESCO inscribed "Idea and practice of organizing shared interests in cooperatives" on the Representative List of the Intangible Cultural Heritage of Humanity.
In economics, a transaction cost is a cost incurred when making an economic trade when participating in a market.
The idea that transactions form the basis of economic thinking was introduced by the institutional economistJohn R. Commons in 1931. Oliver E. Williamson's Transaction Cost Economics article, published in 2008, popularized the concept of transaction costs. Douglass C. North argues that institutions, understood as the set of rules in a society, are key in the determination of transaction costs. In this sense, institutions that facilitate low transaction costs can boost economic growth.
Alongside production costs, transaction costs are one of the most significant factors in business operation and management.
Definition
Williamson
defines transaction costs as a cost innate in running an economic
system of companies, comprising the total costs of making a transaction,
including the cost of planning, deciding, changing plans, resolving
disputes, and after-sales. According to Williamson, the determinants of transaction costs are frequency, specificity, uncertainty, limited rationality, and opportunistic behavior.
Douglass North states that there are four factors that comprise
transaction costs – "measurement", "enforcement", "ideological attitudes
and perceptions", and "the size of the market". Measurement refers to the calculation of the value of all aspects of the good or service involved in the transaction. Enforcement
can be defined as the need for an unbiased third party to ensure that
neither party involved in the transaction reneges on their part of the
deal. These first two factors appear in the concept of ideological attitudes and perceptions, North's third aspect of transaction costs. Ideological attitudes and perceptions encapsulate each individual's set
of values, which influences their interpretation of the world. The final aspect of transaction costs, according to North, is market size, which affects the partiality or impartiality of transactions.
Dahlman categorized the content of transaction activities into three broad categories:
Search and information costs are costs such as in determining that the required good is available on the market, which has the lowest price, etc.
Bargaining and decision costs are the costs required to come to an acceptable agreement with the other party to the transaction, drawing up an appropriate contract and so on. In game theory this is analyzed for instance in the game of chicken. On asset markets and in organizational economics, the transaction cost is some function of the distance between the supply and demand.
Policing and enforcement costs are the costs of making sure
the other party sticks to the terms of the contract, and taking
appropriate action, often through the legal system, if this turns out not to be the case.
Steven N. S. Cheung defines transaction costs as any costs that are not conceivable in a "Robinson Crusoe economy"—in other words, any costs that arise due to the existence of institutions. For Cheung, term "transaction costs" are better described as "institutional costs". Many economists, however, restrict this definition to exclude costs internal to an organization.
History
The
pool shows institutions and market as a possible form of organization
to coordinate economic transactions. When the external transaction costs
are higher than the internal transaction costs, the company will grow.
If the internal transaction costs are higher than the external
transaction costs the company will be downsized by outsourcing, for
example.
These individual actions are really
trans-actions instead of either individual behavior or the "exchange"
of commodities. It is this shift from commodities and individuals to
transactions and working rules of collective action that marks the
transition from the classical and hedonic schools to the institutional
schools of economic thinking. The shift is a change in the ultimate unit
of economic investigation. The classic and hedonic economists, with
their communistic and anarchistic offshoots, founded their theories on
the relation of man to nature, but institutionalism is a relation of man
to man. The smallest unit of the classic economists was a commodity
produced by labor. The smallest unit of the hedonic economists was the
same or similar commodity enjoyed by ultimate consumers. One was the
objective side, the other the subjective side, of the same relation
between the individual and the forces of nature. The outcome, in either
case, was the materialistic metaphor of an automatic equilibrium,
analogous to the waves of the ocean, but personified as "seeking their
level". But the smallest unit of the institutional economists is a unit
of activity – a transaction, with its participants. Transactions
intervene between the labor of the classic economists and the pleasures
of the hedonic economists, simply because it is society that controls
access to the forces of nature, and transactions are, not the "exchange
of commodities", but the alienation and acquisition, between
individuals, of the rights of property and liberty created by society,
which must therefore be negotiated between the parties concerned before
labor can produce, or consumers can consume, or commodities be
physically exchanged".
— John R. Commons, Institutional Economics, American Economic Review, Vol.21, pp.648-657, 1931
The term "transaction cost" is frequently and mistakenly thought to have been coined by Ronald Coase, who used it to develop a theoretical framework for predicting when certain economic tasks would be performed by firms, and when they would be performed on the market. While he did not coin the specific term, Coase indeed discussed "costs of using the price mechanism" in his 1937 paper The Nature of the Firm,
where he first discusses the concept of transaction costs, marking the
first time that the concept of transaction costs was introduced into the
study of enterprises and market organizations. The term "Transaction
Costs" itself can be traced back to the monetary economics literature of
the 1950s, and does not appear to have been consciously 'coined' by any
particular individual.
Transaction cost as a formal theory started in the late 1960s and early 1970s. And refers to the "Costs of Market Transactions" in his seminal work, The Problem of Social Cost (1960).
Arguably, transaction cost reasoning became most widely known through Oliver E. Williamson's Transaction Cost Economics.
Today, transaction cost economics is used to explain a number of
different behaviours. Often this involves considering as "transactions"
not only the obvious cases of buying and selling, but also day-to-day emotional interactions and informal gift exchanges. Williamson was one of the most cited social scientists at the turn of the century, and was later awarded the 2009 Nobel Memorial Prize in Economics.
Technologies associated with the Fourth Industrial Revolution such as distributed ledger technology and blockchains may reduce transaction costs when compared to traditional forms of contracting.
Examples
A supplier may bid in a very competitive environment with a customer to build a widget.
To make the widget, the supplier needs to build specialized machinery
that cannot be used to make other products. Once the contract is awarded
to the supplier, the relationship between customer and supplier changes
from a competitive environment to a monopoly/monopsony relationship, known as a bilateral monopoly.
This means that the customer has greater leverage over the supplier. To
avoid these potential costs, "hostages" may be swapped, which may
involve partial ownership in the widget factory and revenue sharing.
Car companies and their suppliers often fit into this category,
with the car companies forcing price cuts on their suppliers. Defense
suppliers and the military appear to have the opposite problem, with
cost overruns occurring quite often.
An example of measurement, one of North's four factors of
transaction costs, occurs when roving bandits calculate the success of
their banditry based on how much money they can take from their
citizens. Enforcement, the second of North's factors of transaction costs, may
take the form of a mediator in dealings with the Sicilian mafia when it
is not certain that both parties will maintain their end of the deal.
Differences from neoclassical microeconomics
Williamson argues in The Mechanisms of Governance (1996) that Transaction Cost Economics (TCE) differs from neoclassical microeconomics in the following points:
Item
Neoclassical microeconomics
Transaction cost economics
Behavioural assumptions
Assumes hyperrationality and ignores most of the hazards related to opportunism
Argues that there is no optimal solution and that all alternatives are flawed, thus bounding "optimal" efficiency to the solution with no superior alternative and whose implementation produces net gains
Imperfect Markets
Downplays the importance of imperfect markets
Robert Almgren and Neil Chriss, and later Robert Almgren and Tianhui Li,
showed that the effects of transaction costs lead portfolio managers
and options traders to deviate from neoclassically optimal portfolios
extending the original analysis to derivative markets.
The transaction costs frameworks reject the notion of instrumental rationality
and its implications for predicting behavior. Whereas instrumental
rationality assumes that an actor's understanding of the world is the
same as the objective reality of the world, scholars who focus on
transaction costs note that actors lack perfect information about the
world (due to bounded rationality).
Game theory
In game theory, transaction costs have been studied by Anderlini and Felli (2006). They consider a model with two parties who together can generate a
surplus. Both parties are needed to create the surplus. Yet, before the
parties can negotiate about dividing the surplus, each party must incur
transaction costs. Anderlini and Felli find that transaction costs cause
a severe problem when there is a mismatch between the parties' bargaining powers
and the magnitude of the transaction costs. In particular, if a party
has large transaction costs but in future negotiations it can seize only
a small fraction of the surplus (i.e., its bargaining power is small),
then this party will not incur the transaction costs and hence the total
surplus will be lost. It has been shown that the presence of
transaction costs as modelled by Anderlini and Felli can overturn
central insights of the Grossman-Hart-Moore theory of the firm.
Evaluative mechanisms
Oliver E. Williamson's theory of evaluative mechanisms assess economic entitles based on
eight variables: bounded rationality, atmosphere, small numbers,
information asymmetric, frequency of exchange, asset specificity,
uncertainty, and threat of opportunism.
Bounded Rationality: refers to the physical and mental,
intellectual, emotional and other restrictions imposed by people
participating in the transaction in order to maximize their interests.
Atmosphere: The reason for increasing the difficulty of the
transaction here is mostly because both parties to the transaction
remain suspicious of the transaction, and the two sides are hostile to
each other. Such a relationship cannot achieve a harmonious atmosphere,
let alone a harmonious transaction relationship. This will cause both
parties to increase security measures and increase expenditure during
the transaction process.
Small Numbers: Because the number of the two parties is not equal,
the number of available transaction objects is reduced, and the market
will be dominated by a few people, which leads to higher market
expenditures. The main reason here is that some deals are too
proprietary.
Information Asymmetric: The pioneers in the market will control the
direction of the market, and will know the information that is more
beneficial to their own development earlier, and often these information
will make opportunists and uncertain environments finalized, which will
form a unique information gap. so as to form a transaction and obtain a
profit
Frequency of exchange: Frequency of exchange refers to buyer
activity in the market or the frequency of transactions between the
parties occurs. The higher the frequency of transactions, the higher the
relative administrative and bargaining costs.
Asset specificity: Asset specificity consist of site, physical
asset, and human asset specificity. The asset specific investment is a
specialized investment, which does not have market liquidity. Once the
contract is terminated, the asset specific investment cannot to be
redeployed. Therefore, a change or termination of this transaction will
result in significant loss.
Uncertainty: Uncertainty refers to the risks that may occur in a
market exchange. The increase of environmental uncertainty will be
accompanied by the increase of transaction cost, such as information
acquisition cost, supervision cost and bargaining cost.
Threat of opportunism: Threat of opportunism is attributed to human
nature. Opportunistic behavior of vendors can lead to higher transaction
coordination costs or even termination of contracts. A company can use
governance mechanism to reducing the threat of opportunism.
The theory of the firm consists of a number of economic theories that explain and predict the nature of the firm, company, or corporation, including its existence, behaviour, structure, and relationship to the market. Firms are key drivers in economics, providing goods and services in
return for monetary payments and rewards. Organisational structure,
incentives, employee productivity, and information all influence the
successful operation of a firm in the economy and within itself. As such major economic theories such as transaction cost theory, managerial economics and behavioural theory of the firm will allow for an in-depth analysis on various firm and management types.
Overview
In simplified terms, the theory of the firm aims to answer these questions:
Existence. Why do firms emerge? Why are not all transactions in the economy mediated over the market?
Boundaries. Why is the boundary between firms and the market located
exactly there in relation to size and output variety? Which
transactions are performed internally and which are negotiated on the
market?
Organization. Why are firms structured in such a specific way, for
example as to hierarchy or decentralization? What is the interplay of
formal and informal relationships?
Heterogeneity of firm actions/performances. What drives different actions and performances of firms?
Evidence. What tests are there for the respective theories of the firm?
Firms exist as an alternative system to the market-price mechanism
when it is more efficient to produce in a non-market environment. For
example, in a labourmarket, it might be very difficult or costly for firms or organizations to engage in production when they have to hire and fire their workers depending on demand/supply conditions. It might also be costly for employees
to shift companies every day looking for better alternatives.
Similarly, it may be costly for companies to find new suppliers daily.
Thus, firms engage in a long-term contract with their employees or a
long-term contract with suppliers to minimize the cost or maximize the value of property rights.
Background
The
First World War period saw a change of emphasis in economic theory away
from industry-level analysis which mainly included analyzing markets to analysis at the level of the firm, as it became increasingly clear that perfect competition
was no longer an adequate model of how firms behaved. Economic theory
until then had focused on trying to understand markets alone and there
had been little study on understanding why firms or organisations exist.
Markets
are guided by prices and quality as illustrated by vegetable markets
where a buyer is free to switch sellers in an exchange. The need for a
revised theory of the firm was emphasized by empirical studies by Adolf Berle and Gardiner Means, who made it clear that ownership of a typical American corporation is spread over a wide number of shareholders, leaving control in the hands of managers who own very little equity themselves. R. L. Hall and Charles J. Hitch found that executives made decisions by rule of thumb rather than in the marginalist way.
The
model shows institutions and market as a possible form of organization
to coordinate economic transactions. When the external transaction costs
are higher than the internal transaction costs, the company will grow.
If the external transaction costs are lower than the internal
transaction costs the company will be downsized by outsourcing, for
example.
According to Ronald Coase's essay "The Nature of the Firm", people begin to organise their production in firms when the transaction cost of coordinating production through the market exchange, given imperfect information, is greater than within the firm.
Ronald Coase set out his transaction cost theory of the firm in 1937, making it one of the first (neo-classical) attempts to define the firm theoretically in relation to the market. One aspect of its 'neoclassicism' lies in presenting an explanation of the firm consistent with constant returns to scale, rather than relying on increasing returns to scale. Another is in defining a firm in a manner which is both realistic and
compatible with the idea of substitution at the margin, so instruments
of conventional economic analysis apply. He notes that a firm's
interactions with the market may not be under its control (for instance
because of sales taxes), but its internal allocation of resources are:
“Within a firm, … market transactions are eliminated and in place of the
complicated market structure with exchange transactions is substituted
the entrepreneur … who directs production.” He asks why alternative methods of production (such as the price mechanism and economic planning),
could not either achieve all production, so that either firms use
internal prices for all their production, or one big firm runs the
entire economy.
Coase begins from the standpoint that markets could in theory
carry out all production and that what needs to be explained is the
existence of the firm, with its "distinguishing mark … [of] the
supersession of the price mechanism." Coase identifies some reasons why
firms might arise, and dismisses each as unimportant:
if some people prefer to work under the direction and are prepared to pay for the privilege (but this is unlikely);
if some people prefer to direct others and are prepared to pay for this (but generally people are paid more to direct others);
if purchasers prefer goods produced by firms.
Instead, for Coase the main reason to establish a firm is to avoid
some of the transaction costs of using the price mechanism. These
include discovering relevant prices (which can be reduced but not
eliminated by purchasing this information through specialists), as well
as the costs of negotiating and writing enforceable contracts for each
transaction (which can be large if there is uncertainty). Moreover,
contracts in an uncertain world will necessarily be incomplete and have
to be frequently re-negotiated. The costs of haggling about the division
of surplus, particularly if there is asymmetric information and asset specificity, may be considerable.
If a firm operated internally under the market system, many
contracts would be required (for instance, even for procuring a pen or
delivering a presentation). In contrast, a real firm has very few
(though much more complex) contracts, such as defining a manager's power
of direction over employees, in exchange for which the employee is
paid. These kinds of contracts are drawn up in situations of
uncertainty, in particular for relationships that last over long periods
of time. Such a situation runs counter to neo-classical economic
theory. The neo-classical market is instantaneous, forbidding the
development of extended agent-principal (employee-manager)
relationships, planning, and of trust.
Coase concludes that “a firm is likely therefore to emerge in those
cases where a very short-term contract would be unsatisfactory”, and
that “it seems improbable that a firm would emerge without the existence
of uncertainty”.
He notes that government measures relating to the market (sales taxes, rationing, price controls)
tend to increase the size of firms, since firms internally would not be
subject to such transaction costs. Thus, Coase defines the firm as
"the system of relationships which comes into existence when the
direction of resources is dependent on the entrepreneur." We can
therefore think of a firm as getting larger or smaller based on whether
the entrepreneur organises more or fewer transactions.
The question then arises of what determines the size of the firm;
why does the entrepreneur organise the transactions he does, why no
more or less? Since the reason for the firm's being is to have lower
costs than the market, the upper limit on the firm's size is set by
costs rising to the point where internalising an additional transaction
equals the cost of making that transaction in the market. (At the lower
limit, the firm's costs exceed the market's costs, and it does not come
into existence.) In practice, diminishing returns to management
contribute most to raising the costs of organising a large firm,
particularly in large firms with many different plants and differing
internal transactions (such as a conglomerate), or if the relevant prices change frequently.
Coase concludes by saying that the size of the firm is dependent
on the costs of using the price mechanism, and on the costs of
organisation of other entrepreneurs. These two factors together
determine how many products a firm produces and how much of each.
Reconsiderations of transaction cost theory
According to Louis Putterman,
most economists accept distinction between intra-firm and interfirm
transaction but also that the two shade into each other; the extent of a
firm is not simply defined by its capital stock. George Barclay Richardson
for example, notes that a rigid distinction fails because of the
existence of intermediate forms between firm and market such as
inter-firm co-operation.
Klein (1983) asserts that “Economists now recognise that such a
sharp distinction does not exist and that it is useful to consider also
transactions occurring within the firm as representing market
(contractual) relationships.” The costs involved in such transactions
that are within a firm or even between the firms are the transaction costs.
Ultimately, whether the firm constitutes a domain of bureaucratic
direction that is shielded from market forces or simply “a legal
fiction”, “a nexus for a set of contracting relationships among
individuals” (as Jensen and Meckling put it) is “a function of the completeness of markets and the ability of market forces to penetrate intra-firm relationships”.
Managerial and behavioural theories
It
was only in the 1960s that the neo-classical theory of the firm was
seriously challenged by alternatives such as managerial and behavioral
theories. Managerial theories of the firm, as developed by William Baumol (1959 and 1962), Robin Marris (1964) and Oliver E. Williamson (1966), suggest that managers would seek to maximise their own utility
and consider the implications of this for firm behavior in contrast to
the profit-maximising case. (Baumol suggested that managers’ interests
are best served by maximising sales after achieving a minimum level of
profit which satisfies shareholders.) More recently this has developed
into ‘principal–agent’ analysis (e.g., Spence and Zeckhauser and Ross (1973) on problems of contracting with asymmetric information) which models a
widely applicable case where a principal (a shareholder or firm for
example) cannot costlessly infer how an agent (a manager or supplier,
say) is behaving. This may arise either because the agent has greater
expertise or knowledge than the principal, or because the principal
cannot directly observe the agent's actions; it is asymmetric
information that leads to a problem of moral hazard.
This means that to an extent managers can pursue their own interests.
Traditional managerial models typically assume that managers, instead of
maximising profit, maximise a simple objective utility function (this
may include salary, perks, security, power, prestige) subject to an arbitrarily given profit constraint (profit satisficing).
The behavioural approach, as developed in particular by Richard Cyert and James G. March of the Carnegie School places emphasis on explaining how decisions are taken within the firm, and goes well beyond neoclassical economics. Much of this depended on Herbert A. Simon's
work in the 1950s concerning behaviour in situations of uncertainty,
which argued that “people possess limited cognitive ability and so can
exercise only ‘bounded rationality’ when making decisions in complex, uncertain situations”. Thus individuals and groups tend to "satisfice"—that
is, to attempt to attain realistic goals, rather than maximize a
utility or profit function. Cyert and March argued that the firm cannot
be regarded as a monolith, because different individuals and groups
within it have their own aspirations and conflicting interests, and that
firm behaviour is the weighted outcome of these conflicts.
Organisational mechanisms (such as "satisficing" and sequential
decision-taking) exist to maintain conflict at levels that are not
unacceptably detrimental. Compared to ideal state of productive
efficiency, there is organisational slack (Leibenstein's X-inefficiency).
Team production
Armen Alchian and Harold Demsetz's analysis of team production extends and clarifies earlier work by Coase. Thus according to them the firm emerges because extra output is
provided by team production, but the success of this depends on being
able to manage the team so that metering problems (it is costly to
measure the marginal outputs of the co-operating inputs for reward
purposes) and attendant shirking (the moral hazard problem) can be
overcome, by estimating marginal productivity
by observing or specifying input behaviour. Such monitoring as is
therefore necessary, however, can only be encouraged effectively if the
monitor is the recipient of the activity's residual income (otherwise
the monitor herself would have to be monitored, ad infinitum). For
Alchian and Demsetz, the firm, therefore, is an entity that brings
together a team that is more productive working together than at arm's
length through the market, because of informational problems associated
with monitoring of effort. In effect, therefore, this is a
"principal-agent" theory, since it is asymmetric information within the
firm which Alchian and Demsetz emphasise must be overcome. In Barzel
(1982)’s theory of the firm, drawing on Jensen and Meckling (1976), the
firm emerges as a means of centralising monitoring and thereby avoiding
costly redundancy in that function (since in a firm the responsibility
for monitoring can be centralised in a way that it cannot if production
is organised as a group of workers each acting as a firm).
The weakness in Alchian and Demsetz's argument, according to
Williamson, is that their concept of team production has quite a narrow
range of applications, as it assumes outputs cannot be related to
individual inputs. In practice, this may have limited applicability
(small work group activities, the largest perhaps a symphony orchestra),
since most outputs within a firm (such as manufacturing and secretarial
work) are separable so that individual inputs can be rewarded on the
basis of outputs. Hence team production cannot offer the explanation of
why firms (in particular, large multi-plant and multi-product firms)
exist.
Asset specificity
For Oliver E. Williamson,
the existence of firms derives from ‘asset specificity’ in production,
where assets are specific to each other such that their value is much
less in a second-best use. This causes problems if the assets are owned by different firms (such
as purchaser and supplier), because it will lead to protracted bargaining concerning the gains from trade, because both agents are likely to become locked into a position where they are no longer competing
with a (possibly large) number of agents in the entire market, and the
incentives are no longer there to represent their positions honestly:
large-numbers bargaining is transformed into small-number bargaining.
If the transaction is a recurring or lengthy one, re-negotiation
may be necessary as a continual power struggle takes place concerning
the gains from trade, further increasing the transaction costs.
Moreover, there are likely to be situations where a purchaser may
require a particular, firm-specific investment of a supplier which would
be profitable for both; but after the investment has been made it
becomes a sunk cost and the purchaser can attempt to re-negotiate the
contract such that the supplier may make a loss on the investment (this
is the hold-up problem,
which occurs when either party asymmetrically incurs substantial costs
or benefits before being paid for or paying for them). In this kind of
situation, the most efficient way to overcome the continual conflict of
interest between the two agents (or coalitions of agents) may be the
removal of one of them from the equation by takeover or merger.
Asset specificity can also apply to some extent to both physical and
human capital so that the hold-up problem can also occur with labour
(e.g. labour can threaten a strike, because of the lack of good
alternative human capital; but equally the firm can threaten to fire).
Probably the best constraint on such opportunism is reputation (rather than the law, because of the difficulty of negotiation, composition, and enforcement of contracts). If a reputation for opportunism significantly damages an agent's dealings in the future, this alters the incentives to be opportunistic.
Williamson sees the limit on the size of the firm as being given partly by costs of delegation (as a firm's size increases its hierarchical bureaucracy
does too), and the large firm's increasing inability to replicate the
high-powered incentives of the residual income of an owner-entrepreneur.
This is partly because it is in the nature of a large firm that its
existence is more secure and less dependent on the actions of any one
individual (increasing the incentives to shirk), and because
intervention rights from the central characteristic of a firm tend to be
accompanied by some form of income insurance to compensate for the
lesser responsibility, thereby diluting incentives. Milgrom and Roberts
(1990) explain the increased cost of management as due to the incentives
of employees to provide false information beneficial to themselves,
resulting in costs to managers of filtering information, and often the
making of decisions without full information. This grows worse with firm size and more layers in the hierarchy.
Empirical analyses of transaction costs have attempted to measure and
operationalize transaction costs.Research that attempts to measure transaction costs is the most
critical limit to efforts to potential falsification and validation of
transaction cost economics.
Boundaries of the firm
Boundaries
of the firm explores the restrictions on size and output variety of
firms, and how and why these restrictions affect production and
enterprise success. There are two boundaries, horizontal, and vertical.
As part of their corporate strategy, firms must choose between being
horizontally broad, vertically deep, or both. Firms with horizontal
breadth have numerous product lines or types, whereas firms with
vertical depth are integrated into various stages of the value chain.
Generally, a firm's capabilities are specific to a particular scope
direction, for example, marketing skills lead to horizontal breadth, and
production expertise lead to vertical depth.
A firm is horizontally broad when it utilises excess indivisible
resources to expand into various products, and obtain scope economies.
Horizontally broad firms leverage capabilities such as marketing skills,
product knowledge, customer service, and reputation for their
expansions. Scope economies, or economies of scope, describe the aspect of production wherein cost savings result from the scope of an enterprise, as opposed to its scale (see economies of scale).
Meaning, there are economies of scope where it is less expensive for
firms to combine two or more product lines into one, than it is to
produce each product separately. Scope economies, wherein resources are synergistically used, has been found to improve firm performance. However, coordination, adjustment and execution costs related to producing products synergistically are limiting factors.
A firm is vertically deep if it possesses stronger capabilities
than external producers, and thus can produce and distribute its goods
or services more efficiently internally - either upstream or downstream
on the manufacturing chain. Vertically deep firms leverage capabilities such as production and
process expertise, including technology selection, asset utilisation,
and supply chain management. Vertical depth often improves a firm's
governance of activities, and contributes to a beneficial exploitation
of internal capabilities, but is limited by the costs of hierarchical
management, such as monitoring and coordination.
The concept of boundaries can be linked to Coase's understanding of The Nature of the Firm,
as it recognises that transaction costs are a significant factor in a
firm's decision to outsource, or internally produce, but also considers
other influences specific to firms, such as their relevant capabilities,
and governance decisions.
Importance of boundaries
A
study of firms in France illustrated how distortions to the number of
employees and size of a firm directly impacts levels of productivity,
wage and welfare within the organisation. Firms with at least 50 workers
are subject to a number of additional regulations, which leads some
firms to stay below the 50-worker threshold. The distortion acts like an
additional tax on hiring workers, thereby preventing the reallocation
from less productive to more productive firms, and reducing overall
welfare.
Economic theory of outsourcing
In economic theory, the pros and cons of outsourcing have been discussed since Ronald Coase (1937) asked the famous question: Why is not all production carried on by one big firm? An informal answer has been provided by Oliver Williamson (1979), who has emphasized the importance of different transaction costs within and between firms. The boundaries of the firm (i.e., the distinction between transactions
taking place within a firm and transactions between different firms)
have been formally studied by Oliver Hart (1995) and his coauthors. According to the property rights approach to the theory of the firm based on incomplete contracting,
the ownership structure (i.e., integration or non-integration)
determines how the returns to non-contractible investments will be
divided in future negotiations. Hence, whether or not outsourcing an
activity to a different firm is optimal depends on the relative
importance of the investments that the trading partners have to make.
For instance, if only one party has to make an important
non-contractible investment decision, then this party should be owner. However, the conclusions of the incomplete contracting theory crucially rely on the specification of the negotiations protocol and on whether or not there is asymmetric information.
Firm as a Sociotechnical System
The
concept of viewing firms as sociotechnical systems finds its roots in
the studies conducted by researchers at The Tavistock Institute of Human
Relations, particularly the seminal works of Trist and Bamforth and Emery and Trist. These pioneering scholars observed, through extensive field
observations employing a systemic perspective, that firms could be
comprehended as structured sociotechnical systems. These systems were
recognized as being open to the environment, possessing the capacity for
self-regulation to achieve their objectives, and adapting by creating
alternative pathways when necessary.
Sociotechnical Approach
The
sociotechnical approach delineates firms not merely as economic
entities but as systems that amalgamate social and technical facets. It
delves into the interplay between the human and technological elements
within organizations, emphasizing the interconnectedness and
interdependence between the social structure—comprising people,
relationships, and interactions—and the technical system—encompassing
tools, processes, and resources. This approach acknowledges that the effectiveness and functionality of a
firm arise not solely from its technical prowess but also from the way
its social system interacts and interfaces with the technical framework.
The dynamic between these systems, as articulated by Trist, Bamforth,
Emery, and Trist, illustrates the need for an integrated understanding
of human behavior, organizational culture, and technological systems
within the framework of a firm.
Evolutionary and Complexity Theory-Based Approaches.
Evolutionary
approaches to understanding firms arose as a parallel branch to
classical theories, stemming from the pioneering work of Joseph A.
Schumpeter. Schumpeter diverged from the abstract concept of the firm, introducing the notion
that each firm possesses a distinct structural identity. He unified the
creation and management of a firm into a single economic theory,
emphasizing the dynamic nature of firms as evolving entities that learn
and innovate within their fundamental routines. He also differentiated
between firm development and growth, previously considered interlinked
concepts.
Symbiotic Perspective
This structural description paved the way for Terra and Passador to propose a dynamic perspective on firms that goes beyond
profit-centric views. The authors utilize sociotechnical concepts,
describing firms where the social system meets the self-regulation and
self-preservation requirements proposed by Luhmann, imparting an autoreferential dynamic to this subsystem, while technical
structures exhibit a goal-oriented dynamic. These two systems
symbiotically form the firm's supersystem, also manifesting an
autoreferential dynamic, where social systems act as the mind animating
the organization's physical body.
From this standpoint, firms represent a system traversed by a
continuous flow of information and resources, enclosed within
themselves, ensuring their unity. Therefore, they lack inputs or outputs
in the same sense as in finalistic views of firms. Due to their
structural determinism, once the system emerges, its development
inherently involves a history of recurrent interactions within the
environment that both emerges with it and contains it. Both the system's
structure and the environment spontaneously change congruently and
complementarily as the firm strives to maintain its organization and
operational coherence. Its ultimate product refers not to its outputs
per se but to its own organization and realization of identity and
autonomy.
As an organization is a self-referential entity, enclosed within
operational closure, its function focuses on its own constitution. In
this context, the exchanges it conducts with its supra-systems merely
represent disturbances and residues allowing it to capture from the
environment the necessary order for its survival and sustenance of its
identity. This contrasts with finalistic conceptions of firms, where the
scope is to meet external demands. Under this perspective, the firm's
purpose is to ensure its own existence.
Boundaries
Under
the perspective of the firm as a symbiotic entity, boundaries are
defined through its operational closure. These boundaries encompass not
only hierarchical relationships among agents but also various classes of
relations linking social agents to a particular technical and social
system. This occurs through the values and bonds of trust established by
agents, ensuring the self-production of the organization's values and
their relative stability over time.
Viable Contour
The
viability of the firm, as a self-referential entity enclosed within
operational closure, is linked to the rate of regeneration of its
sociotechnical systems and the flow of resources and information
traversing it. If the rate of disintegration exceeds the pace at which
the firm can repair itself, the structure of this network of
interactions unravels. This makes disintegration a powerful constraint
on the maximum size for a viable contour structure. The flow of
resources and information also places the firm in a situation of
constant threat since such structures rely on relationships with the
environment to sustain their dynamics. This underscores the necessity
for an adjustment field that compensates for environmental
disturbances—a crucial factor in preventing the system from reaching
thermodynamic equilibrium, which ultimately signifies the demise of the
structure.
Social Attractors
Experiments
conducted by Terra and Passador underscored the significant role of
attraction basins governing firm dynamics. In this context, technical
systems emerged as the central element of organizational dynamics,
around which social attractors orbit. These social attractors create
secondary attraction basins and are surrounded by their own social
"satellites" in a structure analogous to a planetary system. Here, the
star can be understood as the technical system, the planets as leaders,
and other agents as satellites or free bodies not confined to a single
social attraction basin but related to the technical system.
Although the experiments highlighted technical systems as primary
attractors, the authors' model also demonstrates a recursion in this
system, where agents contribute to what attracts them in the technical
system, just as the technical system shapes social structures by
attracting agents. Hence, an intimate and symbiotic relationship exists
between the social and technical systems, wherein the former shapes the
latter. This grants leaders a crucial role in the growth and
regeneration of structures since their control capacity directly impacts
the organization's viable boundary.
The model also reveals that relocating or including an agent or
subsystem in an organization can affect its dynamics by altering the
attraction basins governing it. This may lead to undesired qualitative
leaps or even rupture of the organization's self-referential network,
potentially resulting in the collapse of one of its subsystems.
Simultaneously, such restructuring in relationships and social
attraction basins can also promote innovation, akin to DNA mutations,
creating new dynamics and altering the variety and redundancy within
organizations.
Essential conditions for a firm's emergence
Regarding
the essential conditions for a firm's emergence and sustenance, Terra
and Passador identified four crucial elements: (1) the ability to
integrate external agents into its formal network of relations; (2)
being pervaded by a resource flow sustaining its self-referential
network; (3) offering advantages for agents to associate with it; and
(4) the capability to regenerate its formal network of relations when an
agent is lost, especially at the supervisory level.
While regeneration of the formal network of relations appeared
possible without specialized structures, organizations lacking such
systems tend to be structurally unstable. Establishing routines
specialized in replacing and reconstituting the social network enhances
stability and significantly extends the organization's lifespan. This
suggests that mechanisms specialized in reconstructing the
organization's social network topology, even in simplified forms, are
vital to ensure the longevity of such structures.
Relationships with the environment and sustainability
The
theory of Symbiotic Dynamics is based on the intimate association
between organizations and the systems that surround them, in such a way
that the survival of these is correlated. Thus, it is important for the
organization's survival that the deterioration and transformation of
supersystems, such as markets, society, and the environment, occur at a
pace that allows them to regenerate to maintain their identity and
organization, or that enables the firm itself to adapt to the new
realities imposed by qualitative leaps that may occur in the dynamics of
supersystems. If this need is neglected, it can lead the environment to
deteriorate at a rate greater than the compensatory fields of
organizations can support, leading them to disintegrate.
In this context, organizations need to be guided by a hybrid
logic, blending proactivity and reactivity, where organizations
recognize their impact on the environment as a whole and act in an
organized manner to reduce their degeneration, while adapting to the
demands that may arise from these interactions. In the context at hand,
organizations need to include in their decisions all the other systems
with which they are coupled, making it possible to envision the
construction of complex socio-economic systems where they integrate in a
stable and sustainable manner.
Other models
Efficiency wage
models like that of Shapiro and Stiglitz (1984) suggest wage rents as
an addition to monitoring, since this gives employees an incentive not
to shirk, given a certain probability of detection and the consequence
of being fired. Williamson, Wachter and Harris (1975) suggest promotion incentives
within the firm as an alternative to morale-damaging monitoring, where
promotion is based on objectively measurable performance. (The difference between these two approaches may be that the former is applicable to a blue-collar environment, the latter to a white-collar
one). Leibenstein (1966) sees a firm's norms or conventions, dependent
on its history of management initiatives, labour relations and other
factors, as determining the firm's "culture" of effort, thus affecting
the firm's productivity and hence size.
George Akerlof (1982) develops a gift exchange model of reciprocity,
in which employers offer wages unrelated to variations in output and
above the market level, and workers have developed a concern for each
other's welfare, such that all put in effort above the minimum required,
but the more able workers are not rewarded for their extra
productivity; again, size here depends not on rationality or efficiency
but on social factors. In sum, the limit to the firm's size is given where costs rise to the
point where the market can undertake some transactions more efficiently
than the firm.
In modern contract theory, the “theory of the firm” is often identified with the “property rights approach” that was developed by Sanford J. Grossman, Oliver D. Hart, and John H. Moore. The property rights approach to the theory of the firm is also known as
the “Grossman–Hart–Moore theory”. In their seminal work, Grossman and
Hart (1986), Hart and Moore (1990) and Hart (1995) developed the incomplete contracting paradigm. They argue that if contracts cannot specify what is to be done given
every possible contingency, then property rights (and hence firm
boundaries) matter. Specifically, consider a seller of an intermediate
good and a buyer. Should the seller own the physical assets that are
necessary to produce the good (non-integration) or should the buyer be
the owner (integration)? After relationship-specific investments have
been made, the seller and the buyer bargain. When they are symmetrically
informed, they will always agree to collaborate. Yet, the division of
the ex post surplus depends on the parties’ disagreement payoffs (the
payoffs they would get if no ex post agreement were reached), which in
turn depend on the ownership structure. Thus, the ownership structure
has an influence on the incentives to invest. A central insight of the
theory is that the party with the more important investment decision
should be the owner. Another prominent conclusion is that joint asset
ownership is suboptimal if investments are in human capital.
The Grossman–Hart–Moore model has been successfully applied in many contexts, e.g. with regard to privatization. Chiu (1998) and DeMeza and Lockwood (1998) have extended the model by
considering different bargaining games that the parties may play ex post
(which can explain ownership by the less important investor). Oliver Williamson (2002) has criticized the Grossman–Hart–Moore model
because it is focused on ex ante investment incentives, while it
neglects ex post inefficiencies. Schmitz (2006) has studied a variant of the Grossman–Hart–Moore model
in which a party may have or acquire private information about its
disagreement payoff, which can explain ex post inefficiencies and
ownership by the less important investor. Several variants of the Grossman–Hart–Moore model such as the one with private information can also explain joint ownership.
