Why Do Different Theories of the Firm Exist - Essay Example

Why do different theories of the firm exist "To be accepted as a paradigm, a theory must seem better than its competitors but it need not, and in fact never does, explain all the facts with which it can be confronted." (Kuhn, 1996:17) Introduction Theory of the firm is an analysis of the behavior of the companies, its structure that checks inputs, ways of production, output and prices. Organizations are not valuable without any theory of firm. For example, if we take science as our source of interest and we start learning about sciences. Then we will come to know that science has also two fields. One is Theoretical side and other is practical side. If we study only theories of sciences and don't get involved in practical side then we will learn nothing about science. Theories are useless without practical experiments. In the same way different theories of firms exist to make firms progressive. As these theories helps us to analyze the behavior of the companies. Also give options to increase productions. There are many theories exist and it is not easy to find better on another, as every theory has its unique value. It is also not easy to adopt all the theories but it is necessary to learn about all the theories. As it helps in making a firm progressive. Theory of the Firm: Organizational analysis is relatively new among the sciences as a field of study, coming out of the latter years of the 19th century as industrialization became more technological (Pheby, 2000). Originators of organizational management, among them Taylor, Weber and Mayo, believed there was one best way to manage an organization, and all recommended single, universal solutions to management problems, though they did not agree on what the solutions should be (Buchanan, 1997). Organizations were considered to be the setting in which work was carried out, and were not considered to have self-interest of their own. It was in the 1920's when Mary Follett wrote about the "law of the situation", that the notion of organizations taking direction from outside themselves began to take root. In her way of thinking, it is the situation that an organization exists in that dictates the orders of what needs to be done (Buchanan, 1997). Further development of these concepts by thinkers such as Woodward, Thompson and Perrow over the next few decades, lead the way for supporters of the contingency approach. That an organizations' structure and management was effected by, and actually contingent upon, factors other than the whim of the owner, and that there clearly was no one best way to be a successful organization, contributed to the development of this new field of study (Buchanan, 1997). The novel concept that organizations interact with their environment and with each other, as social units within and without, sparked interest in the field that has become known as organizational sociology, and led to a broadening and a deepening of theory in the field (Pheby, 2000).. Resource Dependency Theory The key concept of the resource dependency perspective is that organizations are not self-sufficient. Instead, an organization's activities and outcomes are accounted for by the context in which the organization is embedded (Pfeffer & Salancik, 1970.) Dependence is determined by three factors (Pfeffer & Salancik, 1978): the importance of the resource, the degree of discretion others have over allocation and use of the resource, and the concentration of the resource. Without it the organization cannot operate and will cease to exist. . This is in keeping with resource dependency theory as it predicts that organizations will seek to reduce their dependence by expanding into other domains, thereby decreasing their reliance on any single exchange partner (Davis & Powell, 1992). In order to coordinate the actions of the members of the network and the Foundation toward this goal, linkages have been used. These have especially taken the shape of interlocks among board members and shared social norms. Such linkages and interlocks, as described by Maylor, Harvey, and Blackmon, come into play when uncertainty is the greatest. The linkage represents a way of sharing power, which stabilizes and coordinates mutual interdependence. An overlapping board member increases the likelihood that the needs of the organization will be heard, and that efforts will be made to assist in its survival The discussion in resource dependency theory of linkages such as merger, trade associations, cartels, and joint ventures are dyadic in nature (Davis & Powell, 1992), i.e., they explain the relationship between two organizations. The examination of an organization using resource dependency theory is accomplished at the level of the organization, with the organization being the unit of analysis. Network Approach to Understanding Organizations The network approach builds on the concept of embeddedness, introduced in resource dependency theory, as essential in looking at organizational structure and management, and contends that the organization and the environment in which it is embedded are best understood as a system of social networks. Taking this a step further, Pheby states (2000:26): "To assert that an organization is not a network is to strip of it that quality in terms of which it is best defined: the pattern of recurring linkages among its parts." These networks range from the informal to the formal; they may be large or small, they may be subunits in organizations, they may be entire organizations, regions, industries, nations economies and even the organization of the world system (Healey, 2005)). There is divergence in the field of organizational research as to which are the more important social ties or which are more predictive of organizational success. Granovetter (1973) was a proponent of informal networks, also known as weak ties. He argued that people are more likely to find out about a job opening from a weak tie than a strong one, and that this is not only the case for professional and managerial employees, but that networks also facilitate job-searches among blue-collar groups. Formal networks, or strong ties, can also be used to explain certain relationships between individuals within an organization, and relationships between organizations. The formal network has become a new organizational form, providing quick access to resources and know-how (Benton & Craib, 1998). Collaboration is key to the formation of formal networks. Collaboration among the network scientists is essential to the organization's success. The environment consists of a field of relationships that binds the organization together. From a network perspective, this is called an "interorganizational field" (Silverman, 2005), and reinforces the concept asserted by Nohria (1992:5), "an organization's environment is properly seen as a network of other organizations." Having demonstrated the utility of the network approach for analyzing an organization, at this point we will look at the similarities and differences of the resource dependency and network theory perspectives. Comparison and Contrast of the Two Theories of firms Resource dependency theory is useful for examining organizations when the organization is the level of interest, and the unit of analysis. The network approach can also be used to analyze organizations at that level, but it can do more. It may be used to explain the relationships of individual workers, sub-units and units in an organization. It may also be used to explain the relationship between whole industries or fields of organizations. Resource dependency is about the relationship of a dyad, while the network approach focuses on multiple social networks. Network theory includes a concept that is basic to resource dependency theory: that organizations are embedded in context. Both perspectives allow for a shifting of boundaries between organizations, and between an organization and its environment. Both resource dependency and the network approach are deterministic and conform to the "system-structural view" described by Astley and de Vaus, D (1996). The shared goals of the organization impose a need for conformity and coherence that forces the organization into a structured, interlocking system that shapes and determines its behavior. Network arguments and methods are being incorporated into resource dependency perspectives by some sociologists (Scott, 2004), so that there is a melding underway. It has been suggested, by Scott and others (2000), that the perspectives should be treated as complementary. That each is necessary for a more comprehensive approach, and a more adequate understanding of organizations. Below some Theories of firms are describing. Every theory has different perspectives. 1. Transaction cost theory: This theory of firm was explained by Ronald Coase in 1937. This theory attempts to define a firm theoretically with respect to markets. Coase define 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 may apply. This theory says: 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." Ronald Coase 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 the supersession of the price mechanism." Coase defines some reasons why firms might arise, and dismisses each as unimportant: if some people prefer to work under 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 division of surplus, particularly if there is asymmetric information and asset specificity, may be considerable. If a firm operated internally under the market system, a large number of 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 which last 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, of 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 organizes more or fewer transactions. The question then arises of what determines the size of the firm; why does the entrepreneur organize 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 organizing 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 organization of other entrepreneurs. These two factors together determining how many products a firm produces and how much of each. 2. Managerial and Behavioral Theories: William Baumol, Robin Marris and Oliver E. Williamson offered a theories for the Firm, called Managerial Theories of the Firm. Oliver E. Williamson says that managers seek to maximize their own utility and consider the implications of this for firm behaviour in contrast to the profit-maximising case. 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 which 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. 3. Behavioral approach Richard Cyert and James G. March offerd this approach. They emphasis on how decisions are taken in the firm. Much of this depended on Herbert 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 maximise 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. 4. Team Production Alchian and Demsetz's offerd a theory related to Team Production, It is an extension in work of Coase. They say firm emerges because extra output is provided by team production, but that 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 which brings together a team which 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). Weakness: According to Williamson, is that their concept of team production has quite a narrow range of application, 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. 5. Williamson's Approach According to 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. Probably the best constraint on such opportunism is reputation (rather than the law, because of the difficulty of negotiating, writing 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 increase 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 centre 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. 6. Other Theories: Shapiro and Stiglitz says 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 of 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 suggests 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. Arguments about Theories: It has been hard to make progress on Coase's 1937 agenda because of the difficulty of formalizing haggling costs. An approach based on the idea of agreement costs, and can throw light on whether a transaction should be placed inside a firm (in-house production) or in the market place (outsourcing). To emphasize the obvious, the analysis is preliminary and rudimentary. How useful it will be in the development of a general Theory of the firm time will tell. Several theories exist in order to explain the existence of firms, We take as given the fact that they are sufficiently coherent to be of interest in order to understand why firms exist. We rather focus on empirical works that may help to choose between them. If many empirical studies exist, we argue that very few are shaped in order to rule out competing views developed by the transaction cost theory and the resource based view of the firm. These arguments raise the question of scientific methodology in empirical testing. For transaction cost economics to remain an empirical success story (with the assumption it is already a theoretical success story) and for resource based-view to be recognized as empirically relevant, it is time to shape empirical works in order to test one theory against the other one instead of simply corroborate propositions derived from only one theoretical framework. Without such effort, we can expect the coexistence of many theories giving different explanations of what is a firm and why they emerge. The question Coase raised long time ago is still at the top of agenda and will stay as long as data will not be collected with more attention. Conclusion As has been demonstrated, both resource dependency theory and the network perspective are useful for understanding the structure of organizations, but what is to be gained from using either Organizational literature tells us that such theories can be used to explain differences in power among organizations, to explain efforts to create new organizations or change existing ones, and to explain strategic behavior of organizations. It can be used to explain these things at different levels of analysis: from the micro level of the individual worker to the macro level of world systems ( De Vaus D, 1996; Davis & Powell, 1992; Kaluzny & Hurley, 1987). Understanding the way things work, i.e. knowledge about the design of things, makes it possible to improve on them. Likewise, understanding the way things work, i.e. the strategy behind decisions, makes it possible to learn from past mistakes and successes. Furthermore, understanding the way things work, i.e. the evolution of systems, makes it possible to predict future performance. Using resource dependency theory, applying network theory, or employing any of the other theories (e.g. contingency theory, institutionalism, transaction cost economics) to explain and understand health care organizations clarifies the situation. It also allows social scientists, the "puzzle-solvers" in this realm (Kuhn, 1996), to add to the body of knowledge in this new field of study; adding to the scope and precision with which the paradigm can be applied. Sharing these observations will allow others to view things through a clearer lens. Works cited Anne plunket, Stephane Saussier. 2003. 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