Posts Tagged ‘new institutional economics’

The organization of business

January 13, 2013

During the early 1930s, Ronald Coase (Nobel Prize in Economic Sciences 1991), visited the United States to observe how large businesses actually worked. He investigated corporate structures with a skeptical prejudice, arguing against the prevailing rational choice approach within the economics profession that: ‘There is no reason to suppose that most human beings are engaged in maximizing anything unless it be unhappiness, and even this with incomplete success.’

“If we qualify this claim by noting a certain consistent success in increasing the unhappiness of others, we have the definition of the workplace that will ring true for many people,” Trevor Butterworth, ‘How to Fail in Business’, Book review of ‘The Org. by Ray Fisman and Tim Sullivan, The Wall Street Journal, January 12, 2013

The question asked by Ronald Coase as the basis for his inquiry was: ‘Why, in the great game of economic activity do firms exist? Why isn’t everyone directly involved in the market? After spending time examining at close quarters corporations such as General Electric and Ford, his answer was that many of the transaction costs of business are lower when conducted within the command structure of the firm than when conducted through the market. The size and structure of businesses, in the absence of government intervention, are determined, at the margin, by the transaction costs of internal versus market organization. This insight led to Coase’s famous 1937 essay on ‘The nature of the firm’, one of two papers central to his 1991 Nobel Prize.

Of course, those who build businesses are both successful and unsuccessful in assessing the balance of such transaction costs. Companies succeed or fail in part upon the effectiveness of their judgment. For example, Apple has discovered and implemented a successful balance of empowering a smart workforce through decentralization while guiding it through enlightened control. Apple is a star in the business firmament, not least because of this achievement. British Petroleum, during the 1960s was run on the style of a Soviet republic and lost billions of dollars. During the 1990s, a new leadership decentralized the organization and turned it into the darling of Wall Street. Then decentralization went too far, and the 2005 explosion at the company’s Texas City Refinery,put the corporation right back on the rocks.

So corporate bureaucracies play a crucial role in those islands of conscious power dotted across the ocean of the market. At their best they promote efficiency and avoid disasters. At their worst, they throttle enterprise. Bureaucracies always serve as brakes on enterprise. Sometimes those brakes are necessary, sometimes they are not. Great leadership makes the correct judgment on where the boundaries lie. Ronald Coase – now 102 years of age – provided an insight some 75 years ago that by now should be firmly embedded in the thinking of all leaders of corporate enterprise across the globe. A Nobel Prize truly well-earned.


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