Summary Corporate Ownership and Governance
Module 1
ORGANIZATIONAL BOUNDARIES AND THEORIES OF ORGANIZATION
Why firms exist; 4 boundary conceptions:
1. Efficiency (legal-ownership view): transaction cost theory (TCT), agency theory. Deals with costs. Should
a transaction be governed by a market or organization in order to minimize governance costs? Transaction
costs=costs to using the market/price mechanism for exchange. it is sometimes cheaper to organize
exchange within a firm under the authority of managers than through the market. Organizations have
specific decision and property rights that enable the use of fiat, alignment of incentives, and monitoring of
managerial actions to efficiently govern transactions. But there are also costs of organizing exchange under
authority within the firm: governance costs. Sources of governance cost differences between organization
and market:
Transaction costs: In a context of bounded rationality (behavioral uncertainty) of economic agents
and exchange (environmental) uncertainty, the precise terms of transactions are costly to define,
monitor, and enforce, leading to incomplete contracts. Asset specificity and repeated (or
interdependent) transactions increase the potential for hold-up by opportunistic agents. In these
situations, hierarchical governance has advantages over market governance. Technological
uncertainty favors market governance over hierarchical governance to mitigate obsolescence and
preserve flexibility. The efficiency conception is most applicable in industries characterized by
intense price competition and stable structure, situations where efficiency is paramount and
equilibrium can emerge.
Measurement difficulties (agency theory): caused by information problems, costly to assign the
correct value to product attributes in a market exchange, leading to adverse selection and moral
hazard. Easier to supervise activities, align incentives, and gather information within organizations
-> bringing transactions inside the organization is likely to reduce costs associated with information
problems.
Knowledge differences: suggests that idiosyncratic knowledge creates coordination costs in market
exchanges, even when partners behave honestly. Individuals bring different knowledge, and so will
likely have different views on how to accomplish the task. Can lead to coordination costs, especially
when uncertainty is present. These costs can be reduced within organizations through authority
relations.
Maximize transactional efficiency: i.e. minimize the sum of transaction and governance costs.
Every stage of production should undergo assessment of the make-or-buy choice to minimize governance
costs -> organizational boundaries are managed through the accumulation of independent make-or-buy
decisions. Economies of scope can be more efficiently gained through market exchange when governance
costs created by indivisibility and nontradability of assets are low.
2. Power (sphere of influence of the organization): resource dependence theory (RDT). Deals with
autonomy. Control exchange relations in which the organization is involved. Reduce uncertainty and
exercise power to improve performance. Maximize strategic control over crucial external forces. Reduce
dependence and increase power to exert control over external forces. Vertical boundaries: internalize
sources of environmental uncertainty (forward/backward integration). Horizontal boundaries: expand
product/market scope to increase size and reach or reduce dependence on single market.
In ambiguous/dynamic environments, organizations not only use boundaries defensively, but also
offensively to tip emergent markets in their favor. Products in such environments are often knowledge
based, and therefore likely to have low variable costs relative to fixed ones, leading to increasing returns to
scale and tipping points. High knowledge content also means that the products are more challenging to
use, leading to high switching costs and again to tipping points. Finally, they often have network effects
,such that their attractiveness increases with more users. The existence of tipping points puts a premium on
quickly and aggressively taking control of a market before a competitor does.
The power conception implies that organizational actors may choose to influence other organizations not
only through ownership mechanisms that expand vertical and horizontal boundaries, but also through non-
ownership mechanisms such as board appointments, alliances, lobbying activities, and friendship ties with
competitors. These mechanisms extend the organization’s sphere of influence without extending its legal
boundaries. Relative to the efficiency conception, this expands strategic flexibility.
The power conception shifts the level of analysis from discrete transactions (efficiency) to the external
strategic relationships, and from a dyadic view to a network view. These relationships include not only
those within the industry value chain, but also those with other firms and institutions.
The power conception also applies to environments with well-identified and influential players (e.g.,
oligopolies and regulated environments). Here, external relationships with specific organizations can deeply
affect performance.
3. Competence (resource portfolio / configuration): resource-based view (RBV). Deals with growth. How
organizational members gather, exploit, and renew firm-specific, resource-based advantages, and what
resources the organization should possess. Its boundary is dynamically determined by matching
organizational resources with environmental opportunities for competitive advantage. Maximize the value
of the firm’s resource portfolio. Resources are assumed to be heterogeneous across organizations, and
when applied in attractive environments, VRIN resources can lead to competitive advantage. The
possession of particular resources can be tied to choices of both product/market domain and internal
organization.
In less dynamic environments, organizations often become configurations of deeply entwined
resources that display tight internal linkage due to complementarities among component
resources. Can lead to inertia. Organizational boundaries evolve along the predictable, path-
dependent trajectories that are guided by these stable, difficult-to-reverse resource configurations.
Vertical boundaries: internalizing activities that leverage current resource configurations, and
outsourcing those that are based on very different resources. Horizontal boundaries: expand to
nearby product/market domains that are both financially attractive and leverage the current
resource configuration.
In moderately dynamic environments, resources are often more loosely coupled. Knowledge
resources become important because they enable the innovative activities associated with
adaptation and are often fungible across product/market domains. Dynamic capabilities
(=organizational processes by which members manipulate resources to develop new value-creating
strategies) become crucial. Create value by building new resources inside the firm, accessing
resources from outside the firm, recombining existing resources in new ways, and eliminating no
longer valuable resources. Shape horizontal and vertical boundaries by using dynamic capabilities
to blend modular existing and new resources into fresh resource combinations. The boundary
trajectory is only partially predictable, as organizational members strive to take advantage of
unexpected environmental opportunities by combining path-breaking and path-dependent
resources. Therefore, boundary decisions reflect the coevolution of resources with environmental
opportunities.
In high-velocity environments, characterized by ambiguity, nonlinear turbulence, and fast pace,
dynamic capabilities move from routines to simple rules that enable organizational actors to
improvise with loosely coupled resources within shifting environments. Boundary trajectories
become increasingly path breaking as the underlying strategic logic shifts further from leveraging
existing resources to seizing opportunities using novel combinations of new and existing resources.
Extreme ambiguity can blur the distinction between horizontal and vertical boundaries.
The competence conception focuses on internal organizational boundaries, not just external ones. It
assumes that the advantages of internal organization are reduced information complexity and
,increased flexibility, not the fiat, incentive alignment, and monitoring of the efficiency conception. The
competence conception is also relevant across a wider range of environmental dynamism than
efficiency, and it raises the level of analysis from the transaction to the resource portfolio of the
organization. Efficiency and competence may sometimes be synergistic, especially in competitive
environments where both costs and innovation are germane; organizations can develop resources, but
then outsource their related activities when transaction costs are low and their strategic value is
limited. This frees resources for internalizing activities with high strategic value.
The competence and power conceptions have complementary environmental assumptions. The
competence view is germane in competitive environments, the power view is relevant in oligopolistic,
regulated, or ambiguous environments. Both conceptions recognize alliances as a nonownership
boundary mechanism, and both are strategic. When the two conceptions compete (e.g., high
dependence suggests internalization, competence dissimilarity suggests externalization), power will
likely dominate because the risks of dependence deal with survival, typically more crucial than resource
mismatches that limit competitive advantage. The two conceptions may be synergistic, particularly in
more dynamic environments where both innovation and interdependence are critical, when resources
are used to exercise influence, especially in shifting patterns of coopetition. Resources can be deployed
in complementary product/market domains to secure adoption of the focal organization’s industry
standard, or be used to discipline wayward buyers and suppliers by threatening to deploy resources
into their product/market domains.
4. Identity (the often unconscious mind-set by which organizational members understand “who we
are”): organizational identity, sense making, purpose. Deals with coherence. Organizations are
conceptualized as social contexts for sensemaking. Achieve coherence between the identity of the
organization and its activities. Organizational members actively perform collective sensemaking
through which they gain awareness of new information, share interpretations of prior actions, and
converge on the meaning of environmental changes and appropriate courses of action. Given bounded
rationality and environmental complexity, sensemaking tends to crystallize into cognitive frames that
reduce ambiguity and facilitate decision making. When shared among organizational leaders and widely
communicated, cognitive frames can be building blocks for the organization’s identity, providing
direction. Identity also grants members a sense of belongingness and place that provides emotional
coherence. By shaping how members perceive what is appropriate for the organization, identity guides
decisions regarding the value-chain activities to incorporate or product/market domains to enter.
Beyond vertical and horizontal boundaries, identity also determines a broad set of activities that go on
within the organization such that they are consonant with “who we are.” Identity can be a source of
competitive strength by distinguishing the organization from potential competitors, by inspiring
commitment and emotional attachment to the firm among employees and customers. Organizational
identity is particularly valuable for boundary decisions in environments characterized by ambiguity
(e.g., nascent markets), where other guides for behavior are unavailable.
Organizational identity can be imprinted when the organization is created, being shaped by founders’
beliefs or founding institutional conditions. It can also evolve over time, shaped by interactions among
members, and between members and the industry or institutional environments.
Although organizational identity can be a competitive strength that provides focus and distinctiveness,
it can become a competitive weakness; managers may ignore, reject, misinterpret, hide, or lose
information that threatens the organization’s self-concept. Therefore, an important boundary change
mechanism is hiring of new employees, especially senior executives, to create diversity and even
change in the cognitive frames (and emotional attachment to these frames) of organizational members.
May be effective only when organizational survival is at stake; otherwise, attempts to form an identity
are likely to be ignored or to create undesirable instability.
Identity often dominates efficiency considerations. A boundary that challenges organizational identity is
not likely to be considered and accepted by organizational members, even if there is evidence for
, increased governance efficiency. Sometimes, identity and efficiency may be coevolutionary.
Identity often dominates power considerations because of its grip on organizational members. Extreme
circumstances, however, can shake that grip.
The identity conception is also likely to dominate competence considerations, particularly in routine
circumstances. Sometimes they coevolve. E.g., Intel’s development of microprocessor resources and
the related reconfiguration of manufacturing resources led senior executives to rethink their identity as
a “memory company”.
The conceptions are related and can be complementary, coevolutionary with one another (especially
identity), and synergistic (especially competence).
Boundaries are the demarcation between an organization and its environment. Horizontal boundaries:
defined by the scope of product/markets addressed. Vertical boundaries: defined by the scope of
activities undertaken in the industry value chain.
TRANSACTION COST ECONOMICS AS A THEORY OF THE FIRM, MANAGEMENT, AND GOVERNANCE
Transaction Cost Economics (TCE)= how should a complex contractual relationship be structured and
governed to avoid waste and to create transaction value? Transactions are complex when they are
recurring, subject to uncertainty, and involve commitments that are difficult to reverse without significant
economic loss (specificity). Simple transactions are supported by the price system (customers know what
the price should be or can easily find out) and the system of institutions (ensures quality of product) ->
seller benefits from customer’s confidence to buy. Are easily reversable. Transaction costs can include the
costs of obtaining information, contracting, renegotiation, arbitration, and litigation. Economic efficiency is
