Organisation theory:
an interdisciplinary approach
P. Abell
MN3127
2013
Undergraduate study in
Economics, Management,
Finance and the Social Sciences
This subject guide is for a 300 course offered as part of the University of London
International Programmes in Economics, Management, Finance and the Social Sciences.
This is equivalent to Level 6 within the Framework for Higher Education Qualifications in
England, Wales and Northern Ireland (FHEQ).
For more information about the University of London International Programmes
undergraduate study in Economics, Management, Finance and the Social Sciences, see:
www.londoninternational.ac.uk
This guide was prepared for the University of London International Programmes by:
P. Abell, Emeritus Professor of Management, Managerial Economics and Strategy Group,
The London School of Economics and Political Science and Professor of Social Research
Methods, Copenhagen Business School.
This is one of a series of subject guides published by the University. We regret that due to
pressure of work the author is unable to enter into any correspondence relating to, or arising
from, the guide. If you have any comments on this subject guide, favourable or unfavourable,
please use the form at the back of this guide.
University of London International Programmes
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Published by: University of London
© University of London 2013
The University of London asserts copyright over all material in this subject guide except where
otherwise indicated. All rights reserved. No part of this work may be reproduced in any form,
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us know.
Contents
Contents
Introduction ............................................................................................................ 1
Aims and objectives ....................................................................................................... 1
Learning outcomes ........................................................................................................ 2
How to use this subject guide ........................................................................................ 2
Reading advice .............................................................................................................. 2
Online study resources ................................................................................................... 5
A note about the appendices ......................................................................................... 6
Syllabus......................................................................................................................... 6
Examination advice........................................................................................................ 8
Chapter 1: Getting started ................................................................................... 11
Aim of the chapter....................................................................................................... 11
Learning outcomes ...................................................................................................... 11
Essential reading ......................................................................................................... 11
Further reading............................................................................................................ 11
1.1 Introduction .......................................................................................................... 11
1.2 Division of labour, specialisation and productivity ................................................... 20
1.3 Coordination: markets and organisations ............................................................... 21
1.4 Coordination and information ................................................................................ 24
1.5 Organisational control and coordination ................................................................ 28
1.6 Hierarchy and the boundaries of the firm/organisation............................................ 29
A reminder of your learning outcomes.......................................................................... 31
Sample examination question ...................................................................................... 32
Chapter 2: Organisational control and coordination: information
and knowledge ..................................................................................................... 33
Aim of the chapter....................................................................................................... 33
Learning outcomes ...................................................................................................... 33
Essential reading ......................................................................................................... 33
2.1 Introduction .......................................................................................................... 33
2.2 The psychologists’ and sociologists’ approach ........................................................ 35
A reminder of your learning outcomes.......................................................................... 38
Sample examination questions ..................................................................................... 38
Chapter 3: Coordination and control: monitoring ................................................ 39
Aim of the chapter....................................................................................................... 39
Learning outcomes ...................................................................................................... 39
Essential reading ......................................................................................................... 39
Further reading............................................................................................................ 39
3.1 Introduction .......................................................................................................... 39
3.2 Taylorism and Fordism............................................................................................ 42
3.3 The de-skilling debate ............................................................................................ 45
3.4 Technology, coordination, control and monitoring ................................................... 46
A reminder of your learning outcomes.......................................................................... 49
Sample examination questions ..................................................................................... 49
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MN3127 Organisation theory: an interdisciplinary approach
Chapter 4: Coordination and control: incentives and motivation ........................ 51
Aim of the chapter....................................................................................................... 51
Learning outcomes ...................................................................................................... 51
Essential reading ......................................................................................................... 51
4.1 Introduction .......................................................................................................... 51
4.2 The contribution of sociologists and psychologists .................................................. 54
A reminder of your learning outcomes.......................................................................... 56
Sample examination questions ..................................................................................... 56
Chapter 5: Control and coordination: incentives, groups and teams ................... 57
Aim of the chapter....................................................................................................... 57
Learning outcomes ...................................................................................................... 57
Essential reading ......................................................................................................... 57
Further reading............................................................................................................ 57
5.1 Introduction .......................................................................................................... 57
5.2 The economists’ contribution ................................................................................. 58
5.3 The contribution of psychologists and sociologists .................................................. 60
A reminder of your learning outcomes.......................................................................... 65
Sample examination questions ..................................................................................... 65
Chapter 6: Coordination and control: power and authority................................. 67
Aim of the chapter....................................................................................................... 67
Learning outcomes ...................................................................................................... 67
Essential reading ......................................................................................................... 67
Further reading............................................................................................................ 67
6.1 Introduction .......................................................................................................... 67
6.2 Bargaining and power ........................................................................................... 68
6.3 Behavioural theory of the firm ................................................................................ 70
6.4 Sociologists’ and psychologists’ approaches to power and kindred concepts ........... 71
6.5 Contested conceptual matters................................................................................ 72
6.6 Influence, groups and individuals ........................................................................... 75
6.7 Gender and power................................................................................................. 75
6.8 Marxism and power ............................................................................................... 76
6.9 The role of power and allied concepts in organisation theory .................................. 77
A reminder of your learning outcomes.......................................................................... 78
Sample examination questions ..................................................................................... 78
Chapter 7: Coordination and control: culture ...................................................... 79
Aim of the chapter....................................................................................................... 79
Learning outcomes ...................................................................................................... 79
Essential reading ......................................................................................................... 79
Further reading............................................................................................................ 79
7.1 Introduction .......................................................................................................... 79
7.2 Trust ...................................................................................................................... 81
7.3 Norms, institutions................................................................................................. 84
7.4 Altruism and commitment ...................................................................................... 84
A reminder of your learning outcomes.......................................................................... 85
Sample examination questions ..................................................................................... 85
Chapter 8: Coordination and control: participation and democracy.................... 87
Aim of the chapter....................................................................................................... 87
Learning outcomes ...................................................................................................... 87
Essential reading ......................................................................................................... 87
Further reading............................................................................................................ 87
ii
Contents
8.1 Introduction .......................................................................................................... 87
8.2 Voting theory ......................................................................................................... 89
8.3 Capital, labour and organisational democracy ........................................................ 90
A reminder of your learning outcomes.......................................................................... 93
Sample examination questions ..................................................................................... 93
Chapter 9: Organisation change, evolutionary and adaptive approaches ........... 95
Aim of the chapter....................................................................................................... 95
Learning outcomes ...................................................................................................... 95
Essential reading ......................................................................................................... 95
Further reading............................................................................................................ 95
9.1 Introduction .......................................................................................................... 95
9.2 Creationism ........................................................................................................... 96
9.3 Darwinian evolution .............................................................................................. 97
9.4 Lamarkian evolution .............................................................................................. 99
9.5 Neo-institutionalism .............................................................................................. 99
A reminder of your learning outcomes........................................................................ 100
Sample examination question .................................................................................... 100
Chapter 10: Vertical boundaries ......................................................................... 101
Aim of the chapter..................................................................................................... 101
Learning outcomes .................................................................................................... 101
Essential reading ....................................................................................................... 101
Further reading.......................................................................................................... 101
10.1 Introduction ...................................................................................................... 101
10.2 Introducing strategy........................................................................................... 107
10.3 Vertical contracting and strategic choice ............................................................. 109
A reminder of your learning outcomes........................................................................ 111
Sample examination question .................................................................................... 112
Chapter 11: Horizontal boundaries .................................................................... 113
Aim of the chapter..................................................................................................... 113
Learning outcomes .................................................................................................... 113
Essential reading ....................................................................................................... 113
Further reading.......................................................................................................... 113
11.1 Introduction ...................................................................................................... 113
11.2 Diversification.................................................................................................... 113
11.3 Sociological and psychological approaches ......................................................... 115
11.4 The development of diversified companies .......................................................... 117
A reminder of your learning outcomes........................................................................ 118
Sample examination question .................................................................................... 118
Chapter 12: Hierarchical boundaries .................................................................. 119
Aim of the chapter..................................................................................................... 119
Learning outcomes .................................................................................................... 119
Essential reading ....................................................................................................... 119
Further reading.......................................................................................................... 119
12.1 Hierarchies ........................................................................................................ 119
12.2 Some properties of hierarchies ........................................................................... 120
12.3 Constructing a hierarchy .................................................................................... 122
12.4 Empirical relationships ....................................................................................... 125
12.5 Designing organisations .................................................................................... 126
A reminder of your learning outcomes........................................................................ 130
Sample examination questions ................................................................................... 130
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MN3127 Organisation theory: an interdisciplinary approach
Chapter 13: Is there one best way to organise? ................................................ 131
Aim of the chapter..................................................................................................... 131
Learning outcomes .................................................................................................... 131
Essential reading ....................................................................................................... 131
Further reading.......................................................................................................... 131
13.1 Introduction ...................................................................................................... 131
13.2 Efficiency and effectiveness ................................................................................ 132
13.3 Comparison of models ....................................................................................... 133
A reminder of your learning outcomes........................................................................ 135
Sample examination question .................................................................................... 135
Appendix 1.1: Qualitative causal diagrams ........................................................ 137
Appendix 1.2: Network analysis – an introduction ............................................ 139
Appendix 4.1: A simple principal–agent model.................................................. 141
Appendix 5.1: Introduction to decision theory and game theory ...................... 143
Decision theory.......................................................................................................... 143
Game theory ............................................................................................................. 144
Appendix 5.2: Levels of analysis ........................................................................ 149
Appendix 6.1: A simple model of sequential bargaining ................................... 151
Appendix 6.2: Bargaining failure........................................................................ 153
Appendix 9.1: Introduction to evolutionary game theory ................................. 155
Appendix 9.2: Logistic growth – an introduction ............................................... 159
Appendix 10.1: Transaction cost analysis (Williamson’s analysis) ...................... 161
Appendix 12.1: The nature of hierarchy ............................................................. 163
Appendix 12.2: Administrative costs .................................................................. 165
Appendix 12.3: Horizontal differentiation and size ........................................... 167
Appendix 13: Sample examination paper .......................................................... 169
iv
Introduction
Introduction
Welcome to MN3127 Organisation theory: an interdisciplinary
approach, which is offered under a number of degree and diploma
programmes.
This is an interdisciplinary course drawing centrally upon psychology,
sociology, economics and, to a lesser extent, management theory. The
subject guide is structured around readings from two textbooks. One is
written substantially from an economic perspective on organisations or
firms (to use the economists’ favoured term). The other adopts a much
more psychological and sociological standpoint.
You might well ask why I adopt an interdisciplinary approach. For
instance, many courses carry the titles ‘organisation theory’ (largely a
sociological term) and ‘organisation behaviour’ (largely a psychological
term). ‘Organisation theory’ and ‘organisation behaviour’ are more often
than not taught independently of each other and both almost completely
separately from theories of the firm/organisation deriving from economics.
In my view, however, this is wrong. It is no longer intellectually sensible
to proceed in this manner. Each discipline has its own contribution to
make and one can only begin to understand the structure and functioning
of organisations by incorporating insights from each. Sometimes they
complement each other, sometimes they invite alternative interpretations
and sometimes they are in conflict – though much less often than many
suppose.
Economists inevitably pay more attention to organisations with a clear
economic purpose (firms) whereas the other disciplines take a wider
viewpoint embracing any sort of organisation (for example, churches,
prisons and so on). Of course these also have their economic aspects. The
central difference in emphasis is upon those organisations that are held
together by monetary incentives and those that are otherwise coordinated,
for example, by cultural norms or power and coercion. As we shall see,
however, most organisations use a mixture of mechanisms designed to
hold them together.
This subject guide will concentrate upon ‘economic’ organisations
though both textbooks invite you to think about a more varied menu of
organisations.
I hope that you enjoy this guide and wish you good luck with your studies.
Aims and objectives
This course explores the ways in which organisations can be designed
(by management or others) in order to achieve their objectives. It will
expose you to the ways in which economists, psychologists and sociologists
address this and related issues. It is, therefore, an interdisciplinary course,
comparing and contrasting the contribution of the core social science
disciplines to the study of organisations. The course draws upon both
theoretical and empirical materials and you will be encouraged to draw
upon your own local knowledge in pursuing your studies. There will be
an emphasis (though not exclusively) on organisations set up with an
economic objective.
1
MN3127 Organisation theory: an interdisciplinary approach
Learning outcomes
At the end of this course and having completed the Essential reading and
activities, you should be able to:
• describe the essential features of organisations
• discuss the factors shaping these features
• describe the evolution of different organisational designs/types
• discuss how managers may build and change organisations
• describe how different organisational forms impact on the individual
within organisations.
How to use this subject guide
The aim of this guide is to help you to interpret the syllabus. It outlines
what you are expected to know for each area of the syllabus and suggests
relevant reading to help you to understand the material. It must be
emphasised that this guide is intended to supplement the textbooks,
not replace them.
It is important to appreciate that the different topics covered are not
self-contained. There is a degree of overlap between them and you are
guided in this respect by cross-referencing between different chapters. In
terms of studying this subject, the chapters of this guide are designed as
self-contained units of study, but for examination purposes you need to
have an understanding of the subject as a whole.
Reading advice
Essential reading
This subject guide is structured around readings from two textbooks. They
are:
Buchanan, D. and A. Huczynski Organizational behaviour.(London: Prentice
Hall, 2010) seventh edition [ISBN 9780273728597].
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008) fourth edition [ISBN 9780273681977].
I shall refer to these texts respectively as ‘B and H’ and ‘D and S’
throughout the subject guide. Occasionally I shall refer to other books
and papers where I feel that these two Essential reading texts do not
adequately cover the requisite material. Unlike many other subject guides,
you can, by and large, follow the course from the pages of the two texts.
However, they often refer you to copious further reading, so if there is a
particular part of the course you find interesting you may wish to follow
your own interests.
Detailed reading references in this subject guide refer to the editions of the
set textbooks listed above. New editions of one or more of these textbooks
may have been published by the time you study this course. You can use
a more recent edition of any of the books; use the detailed chapter and
section headings and the index to identify relevant readings. Also check
the virtual learning environment (VLE) regularly for updated guidance on
readings.
You can study the course perfectly well by restricting your attention to
the subject guide, the two essential texts and the occasional additional
references provided. I have, though, attempted to keep the latter to a
2
Introduction
minimum. The readings from the textbooks are indicated at appropriate
points in the text of the subject guide. The guide does not provide a
summary of the readings but rather tries to achieve a theoretical synthesis.
In respect of learning activities, opportunities to stop and criticise
and practical examples or cases, both texts provide these along with
summaries. I have provided learning outcomes in this subject guide which
complement those provided in the textbooks. In both textbooks, the
central concepts are listed in the left-hand margins.
Further reading
Please note that as long as you read the Essential reading you are then free
to read around the subject area in any text, paper or online resource. You
will need to support your learning by reading as widely as possible and by
thinking about how these principles apply in the real world. To help you
read extensively, you have free access to the VLE and University of London
Online Library (see below).
Other useful texts for this course include:
Abell, P. ‘Is rational choice theory a rational choice of theory?’ in Coleman, J.S.
and T.J. Fararo Rational choice theory. (Newbury Park, CA; London: Sage,
1992) [ISBN 9780803947610].
Abell, P. ‘A model of informal structure (culture) of organisations’, Rationality
and Society 8(4) 1996, pp.433–52.
Abell, P. and D. Reyniers ‘The emergence and viability of participating firms’
in Munshi, S. and B.P. Abrahams (eds) Good governance, democratic societies
and globalisation. (Thousand Oaks, CA: Sage, 2004)
[ISBN 9780761998488].
Alvesson, M. and H. Willmott (eds.) Critical management studies. (London;
Newbury Park, CA: Sage, 1992) [ISBN 9780803984554].
Arrow, K.J. Social choice and individual values. (New York: Wiley, 1970) second
edition [ISBN 9780300013641].
Besanko, D., D. Dranove and M. Shanley Economics of strategy. (Chichester:
Wiley, 1996) [ISBN 9780471598497].
Burns, T. and G.M. Stalker The management of innovation. (Oxford: Oxford
Unversity Press, 1994) [ISBN 9780198288787].
Campbell, J.L., J.R. Hollingsworth and L.N. Lindberg Governance of the
American economy. (Cambridge: Cambridge University Press, 1991)
[ISBN 9780521408271].
Carroll, G.R. and M.T. Hannon The demography of corporations and industries.
(Princeton, NJ; Chichester: Princeton University Press, 2004)
[ISBN 9780691120153].
Fligstein, N. The transformation of corporate control. (Cambridge, MA; London:
Harvard University Press, 1990) [ISBN 9780674903593].
Grossman, S. and O. Hart ‘The costs and benefits of ownership: a theory of
vertical and lateral integration’, Journal of Political Economy 94(4) 1986,
pp.691–719.
Guillen, M.F. Models of management: work, authority and organization in
comparative perspective. (Chicago, IL: Chicago University Press, 1994)
[ISBN 9780226310361].
Industrial Democracy Group Industrial democracy in Europe revisited. (Oxford:
Oxford University Press, 1993) [ISBN 9780198287865].
Kreps, P. ‘Corporate culture and economic theory’ in Alt, J. and K. Shepsle (eds)
Perspectives on positive political economy. (Cambridge: Cambridge University
Press, 1990) [ISBN 9780521398510].
Lukes, S. Power: a radical view. (Basingstoke: Palgrave Macmillan, 2005)
second edition [ISBN 9780333420928].
Milgrom, P. and J.R. Roberts Economics, organization and management.
(Englewood Cliffs, NJ: Prentice Hall, 1992) [ISBN 9780132246507].
3
MN3127 Organisation theory: an interdisciplinary approach
Miller, G.J. Managerial dilemmas. (Cambridge: Cambridge University Press,
1992) [ISBN 9780521457699].
Mills, A.J. and P. Tancred Gendering organizational analysis. (Oxford: Pergamon
Press, 1992) [ISBN 9780803945593].
Muthoo, A. Bargaining theory with applications. (Cambridge: Cambridge
University Press, 1999) [ISBN 9780521576475].
Noble, D.F. Forces of production. (New York; Oxford: Oxford University Press,
1986) [ISBN 9780195040463].
Powell, W. and P. DiMaggio (eds) The new institutionalism in organizational
analysis. (Chicago, IL: University of Chicago Press, 1991)
[ISBN 9780226677095].
Richardson, G.P. Feedback thought on social science and systems theory.
(Philadelphia: University of Pennsylvania Press, 1991)
[ISBN 9780812213324].
Richerson, P.J. and R. Boyd ‘The evolution of human ultrasociality’ in
Eibl-Eibersfeldt, I. and F.K. Slater (eds) Ethnic conflict and indoctrination.
(Oxford: Berghahn, 2001) [ISBN 9781571817662].
Scott, W.R. and S. Christensen The institutional construction of organizations.
(Thousand Oaks, CA; London: Sage, 1995) [ISBN 9780803970700].
Teece, D. ‘Towards an economic theory of the multiproduct firm’, Journal of
Economic Behaviour and Organization 3(1) 1982, pp.39–63.
Tomer, J.F. The human firm. (London: Routledge, 1999)
[ISBN 9780415199278].
Vanek, J. The labor-managed economy. (Ithaca, NY: Cornell University Press,
1977) [ISBN 978081409554].
Wasserman, S. and K. Faust Social network analysis. (Cambridge: Cambridge
University Press, 1994) [ISBN 9780521387071].
Whitley, R. and P. Kristensen (eds) The changing European firm. (London:
Routledge, 1996) [ISBN 9780415130004].
Williamson, O.E. ‘The economics of organization: The transaction cost
approach’, American Journal of Sociology 87(3) 1981, pp.548–77.
Works cited
Alchian, A.A. and H. Demsetz ‘Production, information costs and economic
organization’, American Economic Review 62(5) 1972, pp.777–95.
Blau, P.M. and R.A. Schoenherr The structure of organizations. (New York: Basic
Books, 1971) [ISBN 9780465082407].
Braverman, H. Labor and monopoly capital. (New York: Monthly Review Press,
1974) [ISBN 9780853459408].
Chandler, A. Strategy and structure. (Cambridge, MA: MIT Press, 1962)
[ISBN 9780262530095].
Child, J. Organisation: a guide to problems and practice (London: Sage, 1984)
[ISBN 9781853960147].
Coase, R.H. ‘The problem of social costs’, Journal of Law and Economics 3 1960,
pp.1–44.
Elster, J. ‘Social norms and economic theory’, Journal of Economic Perspectives
3(4) 1989, pp.99–117.
Lawrence, P.R. and J.W. Lorsch Organization and environment. (Boston: Division
of Research, Harvard University, 1967) [ISBN 9780875840642].
Mintzberg, H. Mintzberg on management. (New York: Free Press, 1989)
[ISBN 9780029213711].
Nelson, R.R. and S.G. Winter An evolutionary theory of economic change.
(Cambridge, MA: Belknap Press, 1982). Reprinted 2006
[ISBN 9780674272285].
Pugh, D.S. Organization theory. (Harmondsworth: Penguin, 1990)
[ISBN 9780140250244].
Roberts, J. The modern firm. (Oxford: Oxford University Press, 2007)
[ISBN 9780198293750].
4
Introduction
Online study resources
In addition to the subject guide and the Essential reading, it is crucial that
you take advantage of the study resources that are available online for this
course, including the VLE and the Online Library.
You can access the VLE, the Online Library and your University of London
email account via the Student Portal at:
http://my.londoninternational.ac.uk
You should have received your login details for the Student Portal with
your official offer, which was emailed to the address that you gave
on your application form. You have probably already logged in to the
Student Portal in order to register! As soon as you registered, you will
automatically have been granted access to the VLE, Online Library and
your fully functional University of London email account.
If you have forgotten these login details, please click on the ‘Forgotten
your password’ link on the login page.
The VLE
The VLE, which complements this subject guide, has been designed to
enhance your learning experience, providing additional support and a
sense of community. It forms an important part of your study experience
with the University of London and you should access it regularly.
The VLE provides a range of resources for EMFSS courses:
• Self-testing activities: Doing these allows you to test your own
understanding of subject material.
• Electronic study materials: The printed materials that you receive from
the University of London are available to download, including updated
reading lists and references.
• Past examination papers and Examiners’ commentaries: These provide
advice on how each examination question might best be answered.
• A student discussion forum: This is an open space for you to discuss
interests and experiences, seek support from your peers, work
collaboratively to solve problems and discuss subject material.
• Videos: There are recorded academic introductions to the subject,
interviews and debates and, for some courses, audio-visual tutorials
and conclusions.
• Recorded lectures: For some courses, where appropriate, the sessions
from previous years’ Study Weekends have been recorded and made
available.
• Study skills: Expert advice on preparing for examinations and
developing your digital literacy skills.
• Feedback forms.
Some of these resources are available for certain courses only, but we
are expanding our provision all the time and you should check the VLE
regularly for updates.
Making use of the Online Library
The Online Library contains a huge array of journal articles and other
resources to help you read widely and extensively.
To access the majority of resources via the Online Library you will either
need to use your University of London Student Portal login details, or you
5
MN3127 Organisation theory: an interdisciplinary approach
will be required to register and use an Athens login:
http://tinyurl.com/ollathens
The easiest way to locate relevant content and journal articles in the
Online Library is to use the Summon search engine.
If you are having trouble finding an article listed in a reading list, try
removing any punctuation from the title, such as single quotation marks,
question marks and colons.
For further advice, please see the online help pages:
www.external.shl.lon.ac.uk/summon/about.php
A note about the appendices
At the end of this guide there is a series of appendices which have been
provided to supplement various chapters. I think that it is important for
you to have an opportunity to look at the mathematics which supports the
theories and arguments, and it also provides you with more detail on some
of the theories mentioned in the chapters. I must stress that you do not
need to be able to use or apply the mathematics; as I mentioned above, the
Essential reading for this course is the two core textbooks. The appendices
are purely additional information for those of you who want to understand
and explore the subject in more depth.
Syllabus
1.
Introduction
• Attempts to define organisations of differing types and differing
objectives. Normative and positive theories.
• Division of labour, specialisation, productivity, economies of scale and
the problem of coordination (motivations/incentives and information).
• Markets and organisations as alternative coordinating mechanisms.
Contrasting market and employment contracts (incentives, risk sharing
and information assets).
• The market–organisational contractual continuum. Competitive
markets, ‘real’ markets, long-term contracts (fixed cost to cost plus),
joint ventures, alliances, informal networks, franchising, etc.
• Coordination and role of: motivation/incentives, communication/
information/knowledge, bargaining power and authority, culture/
norms/trust/commitment, democratic process.
• Introduction to the nature of hierarchical organisations.
• Vertical boundaries (make-buy).
• Horizontal boundaries (divisional, conglomerates, etc.).
• Hierarchical structures (size, span, depth).
• Ownership/governance.
2.
Theories of boundaries
• Transaction costs; assumptions, bounded rationality, opportunism,
incomplete contracts; transactional characteristics, asset specificity,
uncertainty, complexity, frequency. Team production and externalities.
• Property rights theory.
6
Introduction
• Monopoly power, information knowledge and rents, competitive
advantage.
• Role of managerial objectives/motivation.
• Role of legislation (national variations).
• Ideology.
3.
The evolution of organisations
• Evolution of contracts.
• Evolution of organisational types: peer groups, multifunctional; multidivisional, conglomerates, alliances, networks, long-term (relational)
contracting. Centralised v decentralised organisation (discretion).
4.
Studying organisations
• Organisation, group and individual levels of study and their
interrelationship.
• Contribution of statistical models and case studies.
• Contribution of elementary game theory (one-shot and repeated).
• Contribution of network (graph theoretic) models.
• Critical theories of organisation.
5.
Organisations as contractually coordinated mechanisms
• Taylor, standardisation, rationalisation and scientific management;
‘Fordism’.
• Theories and critiques of bureaucracy.
• Centralisation, decentralisation and discretion/incomplete contracts.
• Organisation as an algorithm.
• Control loss, coordination loss.
6.
Organisations as incentive/motivationally coordinated
mechanisms
• Introduction to principal–agent theory.
• Team production and externalities.
• Psychological models of motivation: human relations; human resource
management; group and team context (production); motivational
reactions to organisational design.
7.
Organisations as authority/power/coordinated mechanisms
• Nature of power. Authority and influence.
• Bargaining power.
• Sources of power.
• Power and participation/decentralisation.
8.
Organisations as information/knowledge distributively
coordinated mechanisms
• Coordination and information (games).
• Theory of teams.
• Hidden information/action.
• Demand for information and participation.
7
MN3127 Organisation theory: an interdisciplinary approach
9.
Organisations as ‘culturally’ coordinated mechanisms
• Nature of culture.
• Trust, leadership, sacrifice and commitment.
• Social capital.
• Corporate culture/ambient cultures.
• National business systems.
10. Determinants of hierarchal structures (shape)
• Contingency theory.
• Population ecology/institutional theory.
• Hierarchy (or hybrid organisation) as an optimal mechanism – given
operating environment – for combining: rules/contracts, incentives,
authority, information, culture.
11. Corporate governance
• Ownership and control; participation and organisational democracy.
Examination advice
Important: the information and advice given here are based on the
examination structure used at the time this guide was written. Please
note that subject guides may be used for several years. Because of this
we strongly advise you to always check both the current Regulations
for relevant information about the examination, and the VLE where you
should be advised of any forthcoming changes. You should also carefully
check the rubric/instructions on the paper you actually sit and follow
those instructions.
Structure of the examination
The examination for this subject is a formal three-hour unseen written
examination in which you will be required to answer four questions from
a choice of 12. A sample examination paper is included at the end of this
guide.
The Examiners attempt to ensure that all of the topics covered in the syllabus
and subject guide are examined. Some questions could cover more than one
topic from the syllabus since the different topics are not self-contained.
Examination preparation
You should ensure that you answer four questions, allowing an
approximately equal amount of time for each question. Remember to
devote some time prior to answering each question to planning your
answer, and please write clearly and legibly. You should ensure that the
question answered is the question posed, and not a pre-learnt answer that
has little bearing on the question. Take care to structure your answers
clearly by the use of paragraphs, and make sure your answers are closed
with a summary or conclusion.
You might want to illustrate your answers with the use of simple diagrams
like the ones that I use throughout this guide. You are welcome to do this
but please do not spend a lot of time drawing very precise diagrams with
rulers, etc. This is not necessary. A clear hand-drawn diagram is fine. You
may also want to refer to writers or theories that you have read about if
their work is relevant to the question. Don’t worry about this too much, or
waste your time by putting full references but, for example, ‘Powell and
8
Introduction
DiMaggio (1991)’ would indicate to the Examiners perfectly adequately
who or what you were referring to.
Remember, it is important to check the VLE for:
• up-to-date information on examination and assessment arrangements
for this course
• where available, past examination papers and Examiners’ commentaries
for the course which give advice on how each question might best be
answered.
9
MN3127 Organisation theory: an interdisciplinary approach
Notes
10
Chapter 1: Getting started
Chapter 1: Getting started
Aim of the chapter
To introduce and compare economic, sociological and psychological
approaches to organisations.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to define and explain the following terms
and concepts:
• organisations as control/coordination mechanisms
• assumptions of rational and self-interested behaviour/action
• ideal types
• division of labour
• transactions/exchanges; control/coordination; governance
• motives/incentives
• competitive markets
• normative and positive theory
• market–organisation continuum
• di-graphs and graphs
• roles/contracts/norms
• incomplete information/uncertainty
• discretion
• vertical, horizontal, hierarchical and financial boundaries.
Essential reading
Detailed section references are provided throughout the chapter.
Buchanan, D. and A. Huczynski Organizational behaviour. (London: Prentice
Hall, 2010).
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008).
Further reading
Milgrom, P. and J.R. Roberts Economics, organization and management.
(Englewood Cliffs, NJ: Prentice Hall, 1992) Chapter 1.
Miller, G.J. Managerial dilemmas. (Cambridge: Cambridge University Press,
1992) Chapter 1.
1.1 Introduction
All societies that we know of seem to possess some kinds of organisations;
they are probably cultural universals. Organisations are, however, not easy
things to define as they are, particularly in modern societies, rather varied
in nature. It is, nevertheless, useful to open with a definition, in order to
focus our studies. We may start as follows:
11
MN3127 Organisation theory: an interdisciplinary approach
Organisations are constructed mechanisms for controlling
and coordinating human activities and symbolic and physical
resources in order to achieve certain objectives.
Activity
Now read Section 1.1 in D and S.
A great deal of organisation theory is concerned with describing and
explaining the occurrence of different sorts of mechanisms for achieving
control and coordination. Although there is no settled consensus about the
definition of these central concepts, let us start with the following.
Control mechanisms are the means by which the actions/behaviour of actors
(sometimes individual human beings, sometimes groups or collections of human beings)
are motivated in order to achieve the objectives of the organisation.
Coordination mechanisms are the means by which the actions/behaviours of actors
(again, individual or collective) are brought into alignment with each other in order to
achieve the objectives of the organisation.
Note here that the terms action and actors are sociological in derivation.
Psychologists may refer to behaviour whereas economists may refer to
behaviour and agents. Sociologists distinguish between action, which
means motivated or intentional behaviour, and behaviour itself.
In regard to the above definition of organisation, you should note that:
• organisations are usually consciously constructed (but by whom?) with
an objective in mind (but whose objective?)
• there may be differing opinions within an organisation about what its
objectives are or should be
• there may be many different mechanisms for controlling and
coordinating human activities both within and outside organisations
• the objectives of an organisation may change over time
• organisations can be more or less effective (efficient) in achieving their
objectives.
We shall study these issues, among others; you might, however, ponder
two fundamental questions at this early stage in your studies:
• Why are some human activities coordinated/controlled within
organisations whereas others are not?
• How are (should) the boundaries of organisations (be) drawn?
If you know the answers to these questions, you don’t really need to study
this course. If you don’t, then I hope the course will prove helpful and
interesting.
The study of organisations: a multidisciplinary approach
Until quite recently it was largely sociologists and psychologists who
studied organisations. Management theorists also made a contribution.
They all asked questions about how organisations impacted upon
human activities and vice versa. Pugh (1990) defines organisational
behaviour (the favoured term of psychologists) as follows:
The study of the structure and functioning and performance of
organisations and the behaviour of groups and individuals within
them.
12
Chapter 1: Getting started
Activity
Now read Chapter 1, pp.1–5, in B and H.
Economists traditionally evidenced little interest in the ‘structure and
functioning’ of organisations (or firms as they would call organisations
with an economic objective). Firms were almost invariably treated as
‘black boxes’ with the particular objective of maximising profits (often in
a competitive market environment; see Section 1.3). Thus, questions were
not normally posed as to how their internal arrangements (control and
coordination mechanisms) achieved this objective. Indeed, quite often
the profit-maximising objective was pictured as being a consequence of
competitive evolutionary forces which drive out firms that do not
operate according to this particular objective (see Chapter 9).
Recently, however, this situation has changed and now, as D and S’s
book testifies, we have several economic approaches to organisations. So
modern organisation theory increasingly must become a multidisciplinary
endeavour, combining ideas from economics, management theory,
psychology and sociology. Some other disciplines like anthropology
and operations research also have relevant things to say. Unfortunately,
multidisciplinarity is not entirely acknowledged in the respective
disciplines, with the result that studies of organisations still tend to evolve
independently of each other and there are currently no textbooks which
straddle the disciplinary boundaries. Indeed, most books carrying the title
‘organisation theory’ are written almost exclusively from a sociological
perspective. Psychologists tend to use the phrase ‘organisation behaviour’.
Furthermore, the level of sustained rigour, so essential in modern social
science, is markedly different across the disciplines. Much economics,
but little psychology and sociology, is expressed mathematically. Although
mathematics is not essential to rigour, it is very helpful, but – failing
mathematical exposition – clear prose is most important. You will,
unfortunately, encounter texts which are far from transparent, particularly
in the sociological tradition. I shall try to avoid referencing such texts
though you will find them referred to in Buchanan and Huczynski’s book –
these authors tend to use the term ‘difficult’ to describe them.
It is useful to start with a brief overview of the differing perspectives
adopted by each discipline when studying organisations.
Activity
Now read and compare Chapter 1 in D and S with Chapter 1 in B and H.
The economists’ approach to the study of organisations
Economists integrate their theories of organisation (or firms as they
call organisations with an economic objective) into a standard theory
of production. You will probably have encountered this theory in your
introductory economics.
Activity
To revise, if necessary, read Section 2.4 in D and S.
1
Economists will almost invariably assume that economic actors (or
agents)1 will behave/act rationally. They will usually seek to understand
the ‘structure and functioning’ (control and coordination) of organised
firms, assuming that those involved are rational optimisers (they may,
Be careful: this term
is used both generally,
as here, and, more
specifically, in principal–
agent theory; see
Chapter 4.
13
MN3127 Organisation theory: an interdisciplinary approach
however, relax this assumption in various ways – see Chapter 10). In so
doing, they will unfailingly ask us to centre our attention upon the balance
of costs and benefits in pursuing different courses of action and, thus, on
how to make the best use of resources – namely, the optimal or efficient
allocation of resources. Clearly, although this way of thinking is most
relevant to firms, economists do invite us to apply it to all organisations.
Although the conception of rational action or behaviour is technically
quite difficult to tie down (you may have encountered formalisations of
expected utility theory in your economics units), practically it implies
an assumption whereby individuals (agents) are deemed to seek (i.e.
have preferences for) the best outcome they can secure for themselves,
given the range of opportunities they face (i.e. their opportunity set).
These opportunities and preferences are also often deemed to be given
(exogenous). If not, then the factors shaping preferences and opportunities
are usually regarded as independent of each other. Furthermore,
economists will usually, though not invariably, concentrate upon monetary
consequences to measure the success of outcomes. The two key words
are ‘best’ and ‘themselves’. Strictly speaking, rationality only implies
choosing the best (i.e. optimal) course of action, given the preferences
(or utility functions) and opportunities of the actor. However, economists,
at least initially, usually assume, in addition, that individuals look out
for themselves (i.e. they have self-regarding sentiments). That is to say,
they disregard possible altruistic (positive other-regarding) and spiteful
(negative other-regarding) sentiments (see Chapter 7). Furthermore,
they often assume that actors have identical preferences (homogeneous
preferences). Whatever assumptions they may eventually make, they are
adamant that any theories of organisation should be derivable from the
choices of individual actors. This is sometimes described as methodological
individualism, reductionism or getting the micro foundations right.
Sociologists, as we shall see, are much less inclined to worry about micro
foundations. Indeed, one tradition invites us to take an organisation as the
unit of analysis.2
2
See Appendix 5.2.
Those of you who have not encountered much economics before may well
feel alarmed by this lengthy list of assumptions. You should recognise,
however, that most economists do acknowledge that they are theoretical
simplifications. Indeed, they are willing to relax most of them, other
than optimality (though even this may be weakened: see Chapter 10 on
bounded rationality). You will find both sociologists and psychologists
criticising economists for making unreal assumptions.
Although economists do not often use the term, you might want to
interpret self-interested optimisation as an ideal type3 and later compare
it with some of the sociologists’ ideal types.
The most fundamental question that economists address in respect of
organisation theory is why certain exchanges of goods and services
(transactions) between actors take place in markets whereas others occur
within organisations (firms). As you might expect, they will try to find an
answer in terms of self-interested optimisers. In so doing they will make
use of another ideal type – perfectly competitive markets.
Activity
Now read Section 2.6 in D and S.
14
3
You may have come
across this in course
SC1021 Principles of
sociology.
Chapter 1: Getting started
Although we shall investigate later, in detail, the choice between market
and organisational transactions, it is worth commenting here upon the
way in which an answer is provided. The following assumptions are made.
• The division of labour, which is driven by exogenous (i.e. given
or assumed) technological forces, generates a pattern of potential
(economic) transactions.
• These transactions could be controlled and coordinated (governed)
by either the price mechanism in the (competitive) market or by
organisation control and coordination. Another way of expressing this
divide is between a market contract and an employment contract. You
will find that economists think in terms of efficient contracts. Later I
shall ask you to compare the economists’ use of the term ‘contracts’
with the sociologists’ term ‘rules’.
• There are various costs and benefits attached to each type of
‘governance’.
• The governance chosen will/should maximise net benefit. (We will
return to the distinction between ‘will’ and ‘should’ below.)
In fact, although this is the standard manner in which ‘transaction costs’
economics analyses the problem, one needs to be a little cautious. As
we shall see later, what transaction costs show is that, under certain
circumstances, an organisational transaction will produce more net
benefit than a market transaction. However, it does not follow that an
organisation makes an efficient use of resources. All it will show is that
organisations, in those circumstances, are better than the market. One
would need additional theoretical ideas to show that the organisation is
‘first best’ (i.e. efficient).
Let us now assume that an organisation is chosen. The major contribution
of economists to organisation theory is principal–agent theory (PA
theory).
Activity
We will study principal–agent theory later but you might now like to look at the
beginning of Chapter 7 in D and S.
PA theory seeks to answer the question: what sort of incentives (usually
monetary ones) must a (rational) principal (which for the moment might
be the owner-manager of a firm) set, in order to motivate (i.e. control)
their (rational) agent in order to contribute the agent’s efforts to achieve
the principal’s objectives (usually profit maximisation)?
So PA theory, as formulated, is a theory of optimal incentives that controls
the activities of the agent. If we now extend the idea to two or more
agents then it is a matter of coordination (see the opening definition of
an organisation). It is important to recognise that PA theory is a general
theory of how one person or group of persons can get others to work
effectively for them.
Economists’ theories of organisation can be used positively (i.e. to
describe and explain how organisations actually do control and coordinate
their constituent activities) and normatively (i.e. to describe and explain
how organisations should control and coordinate their activities). You
should recognise here that the ‘should’, in the economists’ conception of
normative theory, ultimately relates to the efficient allocation of scarce
resources. As we shall later find, because neither psychologists nor
sociologists start their enquiries from this standpoint, they do not draw a
15
MN3127 Organisation theory: an interdisciplinary approach
sharp distinction between positive and normative theory. Their objectives
are more often than not directed at positive theory. But be careful here:
the positive use of theory is not the same thing as positivism (i.e. broadly
the idea that the physical and social sciences have identical explanatory
logics).
Activity
If you are not familiar with the above issue, you might read pp.19–25 in B and H.
The psychologists’ approach to the study of organisations
Psychologists, who usually use the term ‘organisational behaviour’, address
two main issues.
1. How do organisational features (e.g. their control and coordination
systems) impact upon individual and group behaviour within
organisations?
2. How (to what extent) does individual and group behaviour contribute
to the achievement of organisational objectives (which may be much
broader than economic ones)?
Activity
Now read Chapter 1 in B and H.
Psychologists may or may not assume that behaviour (i.e. action) is
optimal but, generally, assume (or find evidence for) a much broader
range of motivating factors than economists do (for example, status,
self-esteem, work satisfaction, personal or group power and so on).
Furthermore, they are more likely than economists to assume individual
differences in motivations. B and H refer to this as the ‘organisational
dilemma’ (p.19).
You should eventually ask the question as to whether this picture of
diverse heterogeneity among individual human beings (the organisational
dilemma) can be made consistent with the economists’ PA model. A
principal would have to design incentive systems which acknowledge
the more elaborate and diverse preferences (utility functions) of his/
her agents. Furthermore, principals may themselves have non-economic
objectives, like a desire (economists’ term: a ‘taste’) for power.
Psychologists also explore altruistic motives under the heading of
commitment: individuals may be committed to an organisation or
part thereof, in the sense that they may make sacrifices for others in the
organisation. Whereas economists will usually assume that people arrive
at an organisation pre-equipped with clear preferences (constructed from
beliefs and values), psychologists study how preferences constructed
from beliefs (truth), affects (likes/dislikes) and values (good and
bad) are acquired within organisations. Like sociologists (see below)
they emphasise learning, socialisation and behavioural modification.
Furthermore, since they entertain individual differences, they engage
with issues about ‘controlling and coordinating diverse personality types’.
Studying and categorising personalities inevitably leads to a consideration
of the emotional side of human beings (emotions like openness,
hostility, impatience and ambition). There is a marked contrast in how
psychologists and economists start thinking about the action/behaviour of
individuals in organisations. Economists, as we have seen, will start with
a simple ideal-type model of individuals. Psychologists, on the other hand,
will often emphasise the ‘organisational dilemma’ in incorporating a wide
16
Chapter 1: Getting started
variety of dispositions. Such disputes may undermine at least a simple
common-sense notion of rational action.
Both economists and psychologists also recognise that organisations
are significantly controlled and coordinated by the flow of human
communication. Again, whereas economists treat the issue in an abstract
way in terms of information distributions – ‘who knows what and will
rationally impart or conceal what’ (Chapter 2), psychologists concentrate
upon much finer-grained distinctions. They have developed descriptive
theories of different sorts of communication (e.g. verbal/non-verbal,
impression, management and so on).
Finally, whereas economists tend to assume that individuals perceive
the world ‘the way it is’ (despite many philosophical reservations about
this), psychologists find room for misperception and systematically biased
perception.
All this might incline you to the view that the two disciplinary approaches
are deeply incompatible. But this would, I think, be over-hasty. You
must always, in adjudicating between different models of individuals
(some more detailed than others), ask the question: ‘What am I trying to
explain?’ If, for instance, you are trying to understand the difference in
performance between firms then a rather simple model of the individual
will probably suffice. If you want to explain the differing experience of
church-goers at their place of worship, then a much more detailed model
of perception, communication and emotional response will be needed.
One of the advantages of theories like PA is that they can be adjusted to
incorporate richer models of human beings.
Don’t be over-hasty in finding irreconcilable differences (as some
practitioners of particular approaches often are) between different
intellectual traditions.
The sociologists’ approach to the study of organisations
Sociologists, while addressing identical questions to those posed by
psychologists, have in addition placed their study of organisations in a
much wider context. They have asked questions like: what impact do
organisations have upon society at large: how do evolved systems of
beliefs and values (i.e. culture) and the distribution of power in society
influence the ways in which organisations are structured and function (are
controlled and coordinated)? Furthermore, while pondering these ‘macro’
questions, they engage with issues about the appropriate way to conceive
of social (or organisational) science.
The sociological study of organisations has been strongly influenced
by Max Weber’s ideal type of bureaucracy.4 Broadly speaking, Weber
thought that the control and coordination of activities within modern
organisations are achieved by formally specifying the rules of appropriate
behaviour or action for most organisation participants (certainly, the
organisationally subordinate participants – think of those working on a
production line).
4
If you have access to
it, you may also like to
re-read the section on
Weber in course SC1021
Principles of sociology.
A bureaucracy is, for Weber, characterised by (among other things):
• an exogenously generated division of labour
• a hierarchical authority/power structure
• formal rules of behaviour/action.
A useful way to think about a bureaucracy is as an algorithm specifying
the standards (i.e. a set of interrelated rules) of appropriate activity
for each organisational participant (compare this with a completely
17
MN3127 Organisation theory: an interdisciplinary approach
automated system). If the appropriately specified rules are followed (a
big if!) then control and coordination should be achieved. Clearly there is
some similarity between the economists’ concept of employment contract
and the sociologists’ concept of rules.
You will eventually need to understand how sociologists use and further
develop the idea of bureaucracy, but for the moment, note that, in contrast
to the economists’ perspective, the concepts of power and authority (see
Chapter 6) are brought into prominence. Indeed, Weber spoke of ‘rational
bureaucratic authority’ as the mechanism for controlling and coordinating
a modern organisation (but note when he was writing). Observe the word
rational here. Weber used the term to mean an efficient means to an end;
so bureaucracies are conceived as efficient collective mechanisms (means)
for achieving a given objective. We now know, however, that this is a very
partial picture. Precisely what Weber meant by rational is much disputed,
but we can assume that he was pretty much in accord with the economists
in his use of the term. So, for the moment, a bureaucracy is a mechanism
which is deemed to result in an efficient allocation of resources.
Sociologists (and psychologists) also place considerable emphasis upon
social norms as a mechanism of achieving, and, indeed sometimes
offering resistance to, organisational control and coordination. By ‘social
norms’ they mean widely accepted beliefs about appropriate standards
of behaviour (action) in specified circumstances. Social norms (which
should be contrasted with personal norms) can arise from the wider
society (societal norms) or a section of society (e.g. social class norms)
or even be generated within organisations. You will need to distinguish
between mechanisms that generate social norms and mechanisms that can
rely upon, or are indeed needed to defeat, already existing norms. Social
norms have a contingent feature: people tend to follow them only as long
as others do so. You should draw a distinction (though it is not always
done) between rules (after Weber) and social norms. Both enjoin certain
sorts of behaviour or action but rules don’t necessarily have to be widely
accepted.
Sociologists usually see social norms as a component part of culture. This
latter concept, as we shall see later, is very difficult to tie down – there are
literally scores of different definitions in the literature. It relates, however,
to the ‘symbolic and physical resources’ mentioned in our opening
definition of organisation. ‘Corporate culture’ (whatever it might mean) is
sometimes described as a controlling and coordinating mechanism which
is either generated within an organisation or draws upon the ambient
culture surrounding the organisation.5
Sociologists (and recently some economists) have come to study how
‘institutions’ impact upon organisation design. The basic idea is that,
rather than trying to understand how organisations are structured and
function in terms of individual motivations, one starts with a received
(exogenous) way of doing things (an institution) which is then copied.
Since social norms are also propagated in this manner, it is sometimes a
little difficult to know why we need both terms. Institutions are, however,
often best interpreted as bundles of norms and ways of looking at the
world (social cognition). For instance, institutions have been defined by
Powell and DiMaggio as: ‘cognitive, normative and regulative structures
and activities that provide stability and meaning to social behaviour’. We
shall look at institutional ideas in Chapter 12.
The study of organisational change tends to divide economists and
sociologists. Since economists usually want to study organisations that are
18
5
See Chapter 7.
Chapter 1: Getting started
at an efficient equilibrium, change is not placed at the centre of things.
Organisations that are not in equilibrium are treated as of little interest.
The exceptions to this way of reasoning are evolutionary models, that we
shall study in Chapter 9. Sociologists pay more attention to change and we
shall distinguish between adaptive and selection-based models. The latter
often operate through an understanding of birth and death rates.
Finally, sociologists and some economists have taken an interest in
how democracy or voting procedures might be used as a control and
coordinating mechanism (see Chapter 8). For instance, contrast a firm
owned by shareholders on the basis of one share one vote; a consumer
cooperative where each member consumer has a vote; and a producer
cooperative where the ‘workers’ control and coordinate on the basis of
equal voting power.
An initial comparison of the three differing perspectives
You have encountered, but in outline only, three differing disciplinary
perspectives about effecting the control and coordination of human
activities within organisations. They suggest the following mechanisms:
• rationally designed monetary incentives (employment contracts)
• broader incentives (rational or otherwise?)
• rules of behaviour/action
• power and authority
• norms and culture
• democratic precepts.
You might be troubled at this stage, wondering how economists can
apparently ignore much of the complexity in human motivation and
relationships which the other two disciplines seem to wish to embrace.
Many non-economists voice such complaints about economics. One needs,
however, to be careful in making this sort of complaint.
In the final analysis, economists are concerned to understand how
individuals respond to relative price changes (or, more generally, the
balance of benefits and costs). They would argue that, characteristically,
human motivations remain unaltered through these changes and, as a
consequence, one can isolate the effect of price changes without delving
into broader matters. You should think carefully about this as you progress
in your studies. Notice that this argument is not exclusive to ‘monetary
prices’; it could equally be applied to balance and costs of a non-pecuniary
nature.
Activity
At this early stage in your studies you should try preliminary answers to the following
questions:
• To what degree are the various approaches of organisation theory compatible with
each other?
• To what degree are they contradictory?
• Do they complement each other?
I would not expect you to have clear answers at this stage. Although we have tended
to follow the economists and think in terms of firms, you should get into the habit of
thinking about organisations in general. For instance, hospitals and churches – do you
think the above-identified control and coordination mechanisms apply to these sorts of
organisation?
19
MN3127 Organisation theory: an interdisciplinary approach
1.2 Division of labour, specialisation and productivity
Introduction
All disciplines are agreed that the need for organisation largely arises
because of the division of labour. In a society of self-sufficiency there
would be no division of labour between individuals, no need for exchange
of goods and services (transactions), nor any organisations except perhaps
the family and organisations of social control. But note, even within the
family there is usually a division of labour.
A division of labour is defined as the splitting of activities into
component parts which are then performed separately.
Activity
Now read ‘The pin factory’ on p.5 in D and S.
The division of labour leads to specialisation, and increased specialisation
can lead (but see Section 2.2) to increased productivity (i.e. output per
unit of input, such as time or effort).
Activity
Read Sections 1.2 and 1.3 in D and S.
It is often useful to express these simple ideas in terms of a diagram, as in
Figure 1.1 (also see Appendix 1.1 of this guide).
Division of labour
(+)
Specialisation
(+)
Productivity
Figure 1.1
Economists often consider a division of labour as given (exogenous) and
then ask how organisations and markets can be built upon it. Alternatively,
they see it as driven by competitive market forces that procure an optimal
division of labour, leading to optimal productivity.
Some sociologists, on the other hand, study how the division of labour
is generated both within organisations and in the wider society. That is
to say, they search for explanations of why the division of labour takes a
particular direction – the assumption often being that, rather than being
optimal in a narrow economic sense, it is shaped by issues pertaining to
power and authority.6
Scientific management (Taylorism)
Activity
Now read Chapter 13 in B and H and compare it with Section 1.2 in D and S.
Scientific management and its extension, Fordism, have until recently been
extremely influential in ‘work design’ – or what we might term the detailed
20
6
See Chapter 6.
Chapter 1: Getting started
division of labour. Fordism is sometimes described as ‘Taylorism plus the
production line’.
The basic idea is that human beings may react negatively to ‘too much’
fragmentation of activities and this may reduce their productivity or
increase the difficulties in achieving coordination and control. We shall
return to these issues (see Section 3.2) and also to the associated concept
of de-skilling. Nevertheless, keeping this potential line of criticism in mind,
it is still useful to start our analysis with an exogenous division of labour
necessitating some mechanism of control and coordination.
1.3 Coordination: markets and organisations
Introduction
If we assume that an exogenous division of labour leads to improved
efficiency, then we need to pose two strongly interrelated questions:
1. How should (normative theory) and how are (positive theory)
activities, generated by the division of labour, controlled/incentivised/
motivated?
2. How should (normative theory) and how are (positive theory)
exchanges (transactions), generated as a consequence of the division of
labour, coordinated?
The questions are interrelated in the sense that individuals need to be
controlled/incentivised/motivated to coordinate their activities. However,
in this section we concentrate upon coordination.
Activity
Now re-read Sections 1.4 and 1.5 in D and S.
D and S identify two distinct methods for coordinating activities (you may
read these as ideal types – later we will complicate the picture):
• organisation coordination
• competitive market coordination.
I call these ‘methods’, not mechanisms, since each (particularly
organisation) may involve a number of the mechanisms identified at the
end of Section 1.1.
We will return to the market/organisation choice in a moment.
Coordination and di-graphs
At this stage it will prove helpful to develop diagrams which can depict
transactions/exchanges.
Activity
Now read Appendix 1.2 of this guide.
Consider a division of labour generating a sequence of activities (a
production line would be an example) as in Figure 1.2.
Output/Input
Activity/Agent 1
Output/Input
Activity/Agent 2
Output/Input
Activity/Agent 3
Activity/Agent 4
Figure 1.2
21
MN3127 Organisation theory: an interdisciplinary approach
The points (nodes) represent activities performed by distinct agents,
where the output of one agent becomes the input of the next one down
the line (a sequence of arcs). Figure 1.2 is a di-graph. We shall find that
di-graphs or graphs are often constructive in depicting various features
of organisations, so you should familiarise yourself with the basic ideas.
Note that they can be used at different levels of aggregation. The di-graph
in Figure 1.2 could, in principle, be further decomposed in the division of
labour so the activities could be disaggregated into a finer picture. At a
more aggregate level the di-graph in Figure 1.3 depicts rather aggregate
activities.
Oil extraction
Shipping
Refining
Wholesaling
Figure 1.3
Each of the aggregate activities might be a separate organisation or they
may all be integrated into a single organisation embracing oil extraction
to retailing of refined products or any other combination. It would be
interesting to know which is the most efficient arrangement or, failing this,
why one arrangement is found rather than another.
Market coordination
Activity
Read Sections 2.5 and 2.6 in D and S.
If transactions are coordinated through the (perfectly competitive)
market, then the equilibrium price is a ‘sufficient statistic’ (see D and S)
in effecting both control and coordination. Note carefully the conditions
necessary for one to be able to say that markets are perfectly competitive.
If the four individual activities depicted in Figure 1.2 were to be so
coordinated, then agent 1 would sell his/her output to agent 2, 2 to 3
(both at equilibrium prices) and so on down the chain. In Figure 1.3, at
a higher level of aggregation, the price mechanism would coordinate the
various organisations, though they themselves would presumably have an
internal division of labour. You may encounter the term value chain to
describe chains of transactions at any level of aggregation.
The competitive market at equilibrium also guarantees the optimal (i.e.
Pareto efficient) level of trade (exchange or transaction). This is a very
neat guarantee, but all is dependent upon the perfect-market assumptions.
What would happen if there were not many buyers and sellers and/or the
parties to trade were not fully informed? We can’t answer these questions
at the moment. But notice that if all (exogenously generated) transactions
were to be embedded in perfectly competitive markets then, in theory, all
transactions could be controlled and coordinated by market prices. In such
a world, there would apparently be no need for any organisations – at
least those which coordinate transactions – at all.
Organisational coordination
If the activities in Figure 1.3 were to be brought into a single organisation,
then the flow of inputs and outputs would not normally (though there
are exceptions) be coordinated by the price mechanism but rather by an
organisational mechanism. This is the subject matter of our future studies.
22
Retailing
Chapter 1: Getting started
Again a diagram may help to fix ideas. Consider a transaction between A
and B, then the choice between coordinating it using a market or an
organisation can be depicted as in Figure 1.4.
Coordinator/Manager
B
A
A
Price mechanism
B
Figure 1.4
Note that the organisational choice assumes a coordinator/manager
with, shall we say, a hierarchical relation to both A and B. We might also
assume here that the coordinator will need to motivate/control A and B
– perhaps using a variety of those mechanisms we earlier identified. We
now have what we might term a hierarchical division of labour. The
coordinator/manager can also be described as having span of control of
two.7
7
See Section 1.6.
One way of describing the adoption of an organisation as in Figure 1.4 is
to say that the price mechanism is suppressed in favour of an administered
or planned transaction. Another way of describing this situation is to
say that the choice is between ‘buy’ (market) and ‘make’ (organisation).
Yet a further locution is to contrast a purchasing with an employment
contract. You could now imagine putting various types of organisational
coordination onto the transactions depicted in Figure 1.3.
Although many organisations are constructed by coordinating transactions
(the term ‘vertical integration’ is often used), activities can also be brought
into an organisation where there is no obvious transaction, as in Figure 1.5
(the term ‘horizontal integration’ is often used).
B
A
Input
Output
Input
Output
Figure 1.5
I say ‘obvious transaction’ because, as we shall see later, there may be less
obvious transactions relating to the horizontal division of labour.
Markets and organisation in economics
We can imagine a given (i.e. exogenous) division of labour generating a
network (di-graph) of potential transactions. There are then two idealtypical coordination methods:
1. All the transactions in the network (di-graph) are coordinated by
markets (no organisations).
2. All the transactions in the network (di-graph) are coordinated by an
organisation (a planned economy).
23
MN3127 Organisation theory: an interdisciplinary approach
Activity
For further reading on this, see Milgrom and Roberts (1992) Chapter 1.
This is a very abstract, but nevertheless useful, way of thinking about
the choice between a market and a planned economy. Of course all
economies (even those described as planned) comprise a mixture of plan
(organisation) and market. But I hope you will agree that the intriguing
questions are: firstly, where should the boundaries of organisations be
drawn on the network (the normative question)? Secondly, where are they
actually drawn (the positive question)? And, finally, if the answers to these
two questions are different – why so?
1.4 Coordination and information
The economic perspective
Activity
Read Section 1.6 in D and S.
Economists tend to interpret the (rational) choice between market and
organisational coordination in terms of the information available to the
potential contracting parties (e.g. the information required to enter into
a purchasing or an employment contract). In the ideal typical world of
perfectly competitive markets where all contracting parties are deemed
to possess all the information required to make fully informed rational
choices (about past, present and future contingencies), they are indifferent
between market and organisational coordination. It is when information is
incomplete (and in practice it nearly always is) that the choice is pertinent
for contracting parties.
Note, in passing, that this argument would not work if parties had a taste
for power, which, in turn, is only generated inside organisations (see
Chapter 6).
You might now begin to think in terms of the choice between ‘real’
markets (rather than perfectly well-informed competitive markets) and
organisations.
Activity
Read Section 2.5 in D and S.
Economists distinguish between:
• complete contracts – where all the relevant information (i.e. all possible
contingencies, past, present and future are covered) is available to the
contracting parties when the contract is entered into
• incomplete contracts – where all the relevant information is not
available to at least one party.
A diagram might help you to appreciate the possible distribution of
relevant information between contracting parties – call them A and B (see
Figure 1.6)
24
Chapter 1: Getting started
Rectangle: Complete
information
A
A’s private information
(asymmetric information)
B
Common
information
B’s private information
(asymmetric information)
Figure 1.6
From Figure 1.6 you should distinguish:
• complete information
• common information
• private information/asymmetric information.
We progress, therefore, to the viewpoint whereby the rational choice
between organisation and ‘real’ markets is one of information and
incomplete contracts. Thus you will later encounter the idea that an
organisation is a nexus of (incomplete) contracts, particularly in what I
have termed the hierarchical division of labour.
Activity
You might like to make a preliminary reading of Section 7.5 in D and S, though you will
not find it easy at this stage.
Organisation theory becomes a search for optimal or efficient non-market
contracts. You will find as we progress that whenever economists analyse a
situation (normatively or positively) in terms of contracts, they raise issues
about:
• optimal incentives (see Chapter 4)
• the distribution of information – who knows what
• the optimal distribution of risk and uncertainty.
This is because in a world of incomplete contracting one cannot be certain
about the future and therefore the allocation of resources is a risky/
uncertain business.
So organisations and markets can, from an economist’s point of view, be
studied as the interplay of:
• incentive mechanisms
• information-revealing mechanisms
• insurance or risk/uncertainty sharing mechanisms (who bears the risk/
uncertainty?).
The sociological and psychological perspective
Activity
Read Chapter 6, pp.174–96, in B and H.
Chapter 6 in B and H will give you a good idea of how important both
psychologists and sociologists view communication to be (i.e. the flow
of information between individuals and groups) for the functioning of
organisations. They are entirely in accord with economists in this respect.
25
MN3127 Organisation theory: an interdisciplinary approach
Psychologists, however, study the process of information transmission
in much more detail than economists. For instance, they study nonverbal communication, and link communication into issues surrounding
organisational power and manipulation (see Chapter 6) and culture
(see Chapter 7). But they agree that information/communication always
underpins coordination and control (including markets, of course).
We shall see later how economists envision the strategic manipulation of
information (in a world of incomplete and asymmetric information) in
order to gain advantage. You should eventually seek to link the detailed
psychological study of communication to the economists’ approach to
information revelation in designing incentive mechanisms.
Sociologists, as we have noted, tend to analyse organisations from the
standpoint of the operation of rules. Although you will not find the
idea addressed in your textbooks, it is useful to find a parallel between
sociologists’ use of the term rules and economists’ conception of
contracts. Both words are used to describe what – attendant upon the
division of labour – actors/agents (should) do in differing circumstances
(contingencies).
Economists will almost invariably regard employment contracts (complete
or incomplete) as coordinating and controlling activities through the
use of appropriate financial incentives and monitoring (i.e. observing
compliance with the contract). So, information flows and distributions
are tied into this way of looking at organisations. Sociologists, on the
other hand, are more likely to consider a wider range of mechanisms, but
notably power and authority, in enforcing the rules. Note that economists
are divided as to whether organisations and employment contracts do or
do not involve power relations (see Chapter 6). A lot depends on how
we eventually define this difficult concept. But sociologists often regard
information asymmetries as indicative of power differentials – those with
relevant information are relatively powerful compared to those without it.
Weber’s ideal type of bureaucracy may be equated with the economists’
ideal type of complete contracts. Both, of course, serve as exaggerated
benchmarks enabling us to reason about what would happen under
‘ideal’ circumstances. But notice that if, as we argued earlier, we have
complete contracts then the choice between organisation and market is
not determined. So if we choose to equate complete contracts and rules,
we are then inevitably held to the idea whereby if a perfect Weberian
bureaucracy could be realised (i.e. an algorithm written covering all
possible contingencies), then control and coordination could equally
be achieved in a market or an organisation. So, the argument for
organisation, or shall we say partial bureaucracy, arises only in default,
when a complete bureaucracy cannot be so designed.
Although not expressing themselves in this manner, a number of
sociologists working within the Weberian tradition have suggested that as
uncertainties increase, we encounter the limits of bureaucracy. Uncertainty
(i.e. incomplete information, particularly about the future) implies that it
is not possible to specify in advance the appropriate rules (to complete the
contract). So, organisations arise when rules can only partially control and
coordinate activities. You will find that many different words are used by
sociologists to describe the level of uncertainty – for example, turbulence,
unpredictability, noise, and so on. It is best, however, to use the term
‘uncertainty’ as it is common to economics and sociology.
26
Chapter 1: Getting started
We might find a common picture as in Figure 1.7.
Incomplete
information
(+)
(+)
Uncertainty
Incomplete
rules
Figure 1.7
The question now arises as to how organisational control and coordination
are to be achieved when the contracts/rules are incomplete (as they
always are, but to differing degrees); that is to say, when information
about controlling and coordinating activities is incomplete. Sociologists
use the terms formalisation and standardisation to describe the
degree to which an organisation is bureaucratised or explicitly rule
governed (see Chapter 11).
It is useful to have a concept for situations where contracts/rules (i.e.
pertinent information) are incomplete. Economists use the terms residual
or extra-contractual control; sociologists, unfortunately, use many
words, but I suggest we use the term discretion. I shall use both terms,
depending on context.
If the contracts/rules which are designed to achieve the coordination and
control of activities are not fully specified, then how should the residual
control/discretion be handled? Much of organisation theory is concerned
with this issue. All organisations are a mixture of contractual and
discretionary mechanisms. Economists will seek to understand the balance
between the two in terms of the costs and benefits of gathering additional
information to reduce the degree of incompletion. Figure 1.8 summarises
our arguments so far.
Incomplete
information
(+)
(+)
Uncertainty
Incomplete
rules
(+)
Discretion
Figure 1.8
Note that this way of thinking can still lead to either a market or an
organisation.
Activity
Can uncertainty-generated discretion be best handled within the framework of a market
(where price is a sufficient statistic) or an organisation (where employment contracts will
operate)?
Both psychologists and sociologists recognise that individuals may, in
various systematic ways, not perceive things in an entirely ‘objective’
manner, but their perceptions can have real behavioural consequences.
(There are some social scientists who even reject the whole notion of an
objective reality.) It is important to distinguish between systematic factors
affecting perception and random mistakes.
Activity
Now read Chapter 7 in B and H. You should use the chapter as a resource – it is not
necessary to commit its contents to memory.
Economists have also recently begun to study systematic cognitive
departures from expected utility theory. The ideas are referred to as
27
MN3127 Organisation theory: an interdisciplinary approach
prospect theory. For instance, people are often ‘overconfident’
(underestimate the probability of events that carry negative utility
(value)). Economists are currently strongly divided over the extent
to which the precepts of prospect theory should be incorporated into
mainline theory.
1.5 Organisational control and coordination
Introduction
Activity
Now read Chapter 3 in D and S.
In the previous section I urged you to find an intellectual parallel between
two ideal types – Weberian bureaucracy and complete contracting. The
real world is more complex. Organisations are coordinated and controlled
by diverse mechanisms, sometimes complementary, sometimes alternative
(substitutes) to each other. D and S, in Section 3.2, review six mechanisms
identified by Mintzberg (1989).8 These, in some ways, cut across the two
ideal types. Standardisation of work processes, standardisation of outputs,
standardisation of skills and standardisation of norms are each finer-grade
distinctions of the rules/contract concept.
Activity
Now read Chapters 14 and 15 in B and H.
This subject guide will be organised rather differently from either of your
textbooks in order to bring into relief the impact of the three disciplinary
approaches. In passing we have identified several major mechanisms for
controlling and coordinating activities (and also resources) in the context
of incomplete contracts. Let us think of these in the context of a simple
principal–agent (PA) relationship.
• Formalised rules/contracts: P designs the contract in order to
control A’s activity.
• Incentives: P designs an incentive mechanism for A. Incentives may
involve anything that motivates A.
• Monitoring: P observes A. P can observe either A’s input (e.g. effort)
or A’s output, or both.
• Power and authority: P uses her/his (bargaining) power/authority
to shape A’s contract/activity. A uses her/his (bargaining) power in the
same manner.
• Cultural: P uses or generates beliefs/values in order to achieve A’s
compliance (e.g. commitment).
• Democratic: P and A use a voting mechanism to shape contracts/
activities.
Note that I have not included information in this list as all the mechanisms
involve flows of information.
Many organisations make use of a mixture of some or all of these
mechanisms. You should recognise that there is no settled agreement
about how to conceptualise the range of control and coordination
mechanisms. You will have to compare different schemes and make your
own judgement as to what is most useful.
28
8
Note: the coordination
mechanisms are:
• mutual adjustment
• direct supervison
• standardisation:
•
of work
•
of outputs
•
of skills
•
of norms.
(Mintzberg, 1989,
p.102).
Chapter 1: Getting started
Activity
For further reading, see Miller (1992) Chapter 1 and Milgrom and Roberts (1992) Chapter 1.
The market–organisation continuum
So far you have learned to think about whether exchanges/transactions
should (or empirically do) take place in a market or an organisation. You
have, of course, no answer as yet. But before we begin to fashion one it is
essential to realise that the boundary between the two is not clear.
Activity
Now read Section 3.4 in D and S.
Organisations might make use of internal markets – that is to say, they
may use a price mechanism, often shadowing (attempting to copy)
the price that would operate in an external market to exchange goods,
services or capital. They may also be more or less centralised. There are,
in addition, many hybrid forms which have some features of markets and
organisations. Furthermore, ‘ideal markets’ – or, indeed, markets even
closely approximating perfect competition – are rare.
Activity
Now read Sections 2.5 and 2.6 in D and S.
It is useful to think in terms of an organisation–market or contracting
continuum as in Figure 1.9.
Perfect
comp
market
‘Real’
market
Long-term
contracting
Hybrid
organisations Franchising
Decentralised Centralised
organisation organisation
Figure 1.9
Activity
There are some new terms here like long-term contracting and franchising. We shall
develop these ideas later, but for the moment think of yourself as a manager/entrepreneur
requiring a component to complete your product (e.g. a windscreen for a car); where on
the continuum should you locate your acquisition of the component?
1.6 Hierarchy and the boundaries of the firm/
organisation
Introduction
Activity
Now read Section 8.4 in D and S and Chapter 14 in B and H.
Four main boundaries of organisations can be recognised:
• vertical
• horizontal
• hierarchical
• ownership/financial.
29
MN3127 Organisation theory: an interdisciplinary approach
Vertical boundaries
It is easiest to introduce the vertical boundary concept by way of an
example. Consider the process running from crude oil extraction to retailing
of petroleum to the consumer, depicted as a di-graph in Figure 1.3.
Each of these sequential vertical transactions can, in principle, be governed
at any position on the contractual continuum (Figure 1.9). Note also that
Figure 1.3 is constructed at a level of aggregation whereby each node
could be further disaggregated to a finer level of vertical transaction or
division of labour.
But let us simplify for the moment to the extreme poles of the continuum –
market and centralised organisation. There are many possible ways of
coordinating the transactions lying in between:
• all the transactions are markets using the price mechanism (buying and
selling)
• all the transactions are vertically integrated in one large organisation
running from extraction to retailing.
If all the transactions are governed by markets, then we have five
independent firms, but then these firms could vertically integrate
backwards or forwards (except of course oil extraction, which can only
forwardly integrate, and retailing, which can only backwardly integrate).
The vertical boundaries of the firm/organisation are determined by the
pattern of integration down vertical chains (sometimes called value
chains).
Clearly, what we eventually want to know is: where should/are the
boundaries (be) drawn?
Horizontal boundaries
If an organisation integrates more than one vertical chain of activities,
usually as separate departments/divisions, then this is referred to as
horizontal integration (see Chapter 11).
Hierarchical boundaries
When activities are integrated into an organisation then it is usual for
the control and coordination to be structured as a hierarchy. We will later
study why this is so (Chapter 12). A rather simple hierarchy is depicted in
Figure 1.10 below.
Figure 1.10
Note that a hierarchy is a graph (see Appendix 1.2 of this guide).
There are a number of important associated concepts:
• Size of the organisation, N (N = 9 in Figure 1.10).
• Size of the bottom level, n (n = 6 in Figure 1.10).
• Spans of control, s. The number of immediate subordinates to a
superordinate (s = 3 and 2 in Figure 1.10.)
30
Chapter 1: Getting started
• The number of levels (sometimes called vertical span), L (L = 3 in
Figure 1.10).
• The administrative component (N – n). (N – n = 3 in Figure 1.10).
• The number of hierarchical relations (N – 1).
Note that given n (the exogenous division of labour), as s increases (for
whatever reason) then L (the hierarchical division of labour) decreases
and vice versa. The hierarchal shape changes. Organisation theory is
concerned with explaining why hierarchies take on different shapes in
differing circumstances.
It is usual to compare hierarchies with non-hierarchical peer groups.
Activity
Now read Section 8.4 in D and S.
Small organisations (up to where n is approximately 15) sometimes adopt
a peer group organisation. Peer groups are also sometimes democratically
coordinated.
Ownership/financial boundaries
At this stage we cannot say very much about these issues. The questions
are: who should/does provide the capital (debt and equity) and who owns
and controls the physical and certain symbolic (e.g. brands) assets of the
organisation? These are often the same people, but not necessarily so.
You should recognise that we are dealing with complex contractual and
principal–agent problems.
Activity
You might like to read Section 7.2 in D and S.
A reminder of your learning outcomes
Having completed this chapter and the Essential reading and activities,
you should be able to define and explain the following terms and
concepts:
• organisations as control/coordination mechanisms
• assumptions of rational and self-interested behaviour/action
• ideal types
• division of labour
• transactions/exchanges; control/coordination; governance
• motives/incentives
• competitive markets
• normative and positive theory
• market–organisation continuum
• graphs and di-graphs
• roles/contracts/norms
• incomplete information/uncertainty
• discretion
• vertical, horizontal, hierarchical and financial boundaries.
31
MN3127 Organisation theory: an interdisciplinary approach
Sample examination question
1. Compare and contrast the assumptions economists and sociologists
make when analysing organisations.
32
Chapter 2: Organisational control and coordination: information and knowledge
Chapter 2: Organisational control and
coordination: information and
knowledge
Aim of the chapter
To introduce how it is that information underpins the various control and
coordination mechanisms which an organisation might adopt.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to define and explain the following terms
and concepts:
• adverse selection
• moral hazard
• information and monitoring
• information, power and authority
• information and culture.
Essential reading
Detailed section references are provided throughout the chapter.
Buchanan, D. and A. Huczynski Organizational behaviour.(London: Prentice
Hall, 2010).
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008).
2.1 Introduction
As we have observed in the previous chapter, there are several different
ways of controlling and coordinating an organisation, but underpinning
them all is the distribution of information and knowledge – who knows
what, who needs to know what, who is willing to reveal what they know
and who can use what they know and others don’t know to their own
advantage and to others’ disadvantage.
Activity
Read Sections 4.1 to 4.3 in D and S.
In recent years, economists have developed a whole sub-discipline
(sometimes called ‘information economics’) and many of its insights are
appropriate to organisation analysis – particularly the choice between
markets and organisations (see the continuum in Figure 1.9). It is
important to understand the information implications inherent in the
concept of sufficient statistic implied by the ideal typical perfectly
competitive market. At equilibrium, the price signal contains all the
information a potential purchaser requires – the competitive forces of the
perfectly competitive market have already driven out any substandard
purveyors. So the purchaser has only to make a decision about the
quantity of a good, which is homogeneous across all potential purveyors,
33
MN3127 Organisation theory: an interdisciplinary approach
which he or she wants to purchase. Furthermore, the purchase will have
no appreciable impact upon the price. So, at equilibrium, the heroic
assumptions about complete information are no longer required.
Putting it another way: the search costs in locating a suitable purveyor
and the risks of being deceived are absent. A wonderful result – but how
are purchasers to know that they are facing a perfectly competitive market
at equilibrium? In practice also, as we have noted, many markets are
likely to be neither perfectly competitive nor necessarily at equilibrium.
Organisation analysts, while appreciating the important intellectual
role that competitive markets play in organising our thoughts, need to
understand the significance of unevenly distributed information in less
tidy situations. Nevertheless, setting out the assumptions that underpin
ideal typical models helps us to be explicit about the implications of
progressively relaxing them.
You should fully understand the following two concepts:
• Adverse selection (sometimes called hidden information, precontractual hazard or an ex ante information problem). Adverse
selection arises when one or more parties have private (i.e. not easily
observable) information/knowledge relevant to a potential transaction.
There is thus information asymmetry before the transaction is entered
into. You should recognise that both organisations and real markets
can be impacted by adverse selection problems. The question is (ceteris
paribus),1 which is the best (least costly to monitor/risky) choice when
confronted by adverse selection?
1
Latin: ‘other things
being equal’.
• Moral hazard (sometimes called hidden action, post-contractual
hazard or an ex post information problem). Moral hazard arises when
a party to a transaction/contract subsequently has an incentive (postcontract) to use their private information/knowledge to act in a way
that is not observable to the other party but is to their own advantage
and to the disadvantage of the other party.
It is important to recognise that it is the anticipation of adverse selection
and moral hazard that can make it difficult for otherwise willing parties
to enter into a mutually beneficial transaction/contract (organisation
or market or hybrid). So, although moral hazard is post-contractual, its
anticipation can be pre-contractual and, unless resolved, can prevent a
transaction from being realised. If so, then the outcome will be Pareto
inferior. That is, both parties could be better off, or one better off and the
other not worse off, if the transaction could be arranged.
The information asymmetries inherent in situations where adverse
selection and moral hazard occur enable actors to act strategically or
opportunistically.2 They can and may take advantage of their private
information and available unobservable actions. Clearly an interesting
question is whether organisational mechanisms can be put in place that
will either induce individuals to reveal their information or make their
actions more visible.
Activity
One – if only a partial – view of the choice between organisation and market
coordination is in terms of addressing adverse and moral hazard problems. For instance,
would ‘buying’ an input rather than ‘making’ it address the issues more efficiently? You
can’t fully answer this question yet – but think about it.
34
I hope the above line of analysis has made you appreciate the idea that
information has value. Not surprisingly, economists have developed ways
of measuring it.
2
We will cover this in
Chapter 10.
Chapter 2: Organisational control and coordination: information and knowledge
Activity
Now read Section 1.4 in D and S.
Decision trees
Pay attention also to the concept of a decision tree, which is another
example of a graph structure (see opening section of Appendix 5.1). Trees
of this sort will prove useful when we come to study strategic interaction
and game theory (see Appendix 5.1 of this guide).
2.2 The psychologists’ and sociologists’ approach
Although traditional organisation theory (i.e. the creation of sociologists
and psychologists) refers to neither adverse selection nor moral hazard
(the terms do not appear in the subject index in B and H), the idea of
taking advantage of private information and knowledge is widespread. You
have already studied Chapter 6 in B and H.
In Chapter 1 of this guide we identified several control and coordination
mechanisms which we shall study in the following chapters. But let us now
see how information issues enter into each of them.
Organisation monitoring
We can interpret an organisational hierarchy as, among other things, a
complex monitoring mechanism. It is sometimes said that in a hierarchy,
directions flow down and information flows up. The basic building
blocks of a hierarchical organisation are, indeed, spans of control.
An organisation is the union of a set of spans of control. Spans of
control are sub-organisations where a line manager (P) supervises
a number of ‘subordinates’ (agents A, B,…). Note that it is useful to
think of hierarchically structured spans as a cascade of principal–
agent relationships. We noted earlier that monitoring can be achieved
by gathering information (observing) on an agent’s input (effort,
application, etc.) or output (some measure of performance). If these are
deterministically related, it does not matter which. The difficult issue
arises when it is difficult/costly to observe either of them or when the
relationship is not deterministic (see Chapter 4).
Imagine, for instance, you are supervising a number of research scientists
in a Research and Development department where it is difficult to observe
either the effort put in or who is responsible for the scientific discovery. No
amount of information gathering is going to make this an easy monitoring
problem. But monitoring usually takes place in the context of incentives.
Assuming for the moment that P’s objectives are the ones that matter, is
it possible to design incentives for A… which obviate the need for close
monitoring? Note that, in effect, the perfectly competitive market, with its
attendant concept of sufficient statistic, achieves precisely this. One way of
interpreting perfect markets is as a control and coordination mechanism
which requires minimal or no monitoring and thus flows of information.
Alternatively, an organisation will also usually meld monitoring and
incentives. But observe that the incentives may be much broader than
economic ones.
Activity
Consider how a church or army might control and coordinate its activities. (Not many
people advocate markets in these contexts!)
35
MN3127 Organisation theory: an interdisciplinary approach
Let us assume a simple organisation where P spans A and B which is
structured, following Weber, as a rule/contract-governed bureaucracy.
P then designs the algorithm which specifies, as far as possible, A and
B’s activities. In general, as we have seen, the rules, because of inherent
uncertainties, will not cover all conceivable future contingencies
(incomplete contracting) so situations will arise where there will be
potential discretionary activities. In this context it is analytically useful to
distinguish between monitoring (and information flows) which are:
• designed to understand whether the contract/rules are followed
• designed to control and coordinate discretionary activities.
Monitoring is subject to adverse selection and moral hazard problems,
which now (once we are inside an organisation) will concern not only
the relationship between A and B but also their hierarchical relationships
with P. Will A and B reveal to P, and P to A and B, appropriate ex ante and
ex post private information? We shall need some game theory to address
these problems.
Activity
Now read Chapter 9 in B and H. Pay particular attention to the pages which cover the
famous ‘Hawthorne experiments’. Pay particular attention to ‘chiselling’, ‘squealing’ and
‘rate busting’. These are all, from the standpoint of organisational design, examples of
information asymmetry.
Organisation power and authority
Many sociologists urge that ‘information is power’. This would perhaps
be better expressed as ‘asymmetric information confers power’. We shall
discuss these difficult issues in much more detail in Chapter 6. The
central question which arises now is how the distribution of information/
knowledge in an organisation determines the way it is controlled and
coordinated and, thus, perhaps also its objectives. If people have different
objectives (e.g. workers and managers, or prison supervisors and
inmates), it is not unreasonable to assume that they will use their private
information to their advantage. Adverse selection and moral hazard
can influence people’s bargaining power. However, the hierarchical
division of labour is usually based upon a division of knowledge
(expertise), which also can be seen as a source of legitimation. Those in
hierarchically superior positions with relevant knowledge are accepted as
being appropriately qualified to exert power (i.e. give directions). Weber’s
concept of rational bureaucratic authority is so constructed: experts have
specialised knowledge which others respect and which leads them to
confer authority upon the experts. More generally, the mechanisms which
transmute power into authority are, according to many psychologists and
sociologists, central to the functioning of organisations.
Sociologists raise far more fundamental issues about the connection
between knowledge and power. They detect power relations to the degree
that one actor (individual or collective) can, in some manner, affect the
beliefs, affects and values of another actor. Sociologists often express
this as determining the discourse. So you will encounter expressions like
‘dominant discourse’ or ‘hegemonic discourse’. We might refer to this as
the ‘thought control’ conception of power. If I want to control you, can I
‘make you’ want/believe/like what I want (e.g. follow the dictates of my
rules/contract – perhaps even without further incentives)? These sorts of
control mechanism are highly complex and difficult to study. This does
not mean, of course, that they are not important. Since beliefs, values and
36
Chapter 2: Organisational control and coordination: information and knowledge
affects are also conceptually part of another difficult concept – culture
– there is a connection to be drawn between the concepts of power and
culture. There is a significant divide between those who see cultural
control and coordination mechanisms as part of the story about power
(many sociologists) and those who don’t (many of those small number of
economists who think about these issues).
Activity
Now read pp.57–58 in B and H.
We might ask here how an economist would address these issues. We
noted earlier that economists usually start with individuals blessed with
(exogenous) often homogeneous preferences (utilities) and options. These
options are believed to lead, often probabilistically, to consequences upon
which the actor places value (utility). The actor then chooses the best
option. This picture can be quite difficult to establish, but eventually we
finish with the maximisation of expected utility. This appears to be very
different from the sociological approach. But one way of beginning to
reconcile them, which we shall study later, is to make either or both of
the preferences and opportunities endogenous. This can, under certain
assumptions, open up the economists’ picture to the idea that this
endogenisation is a species of power relationship.
Reading this way can also link into issues of perception. Can one actor
constrain the perceptions of another and, thus, limit the second’s
recognition of available options? This is a very tricky problem to study.
Many Marxist scholars favour this interpretation of power relations
between capital/management and labour. They will refer to ‘hegemonic
culture’, meaning, at least in part, that one group in society exerts ‘power’
over another by limiting its perception/cognition about what is possible or
feasible (see Chapter 6).
Organisation and culture
We have just noted that there can be a close theoretical alliance between
coordination and control through power and authority and by cultural
means. If either society or a section of society or, indeed, an organisation
itself can in some way inculcate beliefs (i.e. knowledge), then this can
impact upon control and coordination – sometimes making it easier,
sometimes harder.
Particularly important components of cultural control and coordination
are trust and commitment. If A and B both believe they can productively
transact with each other, but are diffident because a complete contract
cannot be signed (adverse selection issue), they may resolve their
diffidence if they can trust each other not to take advantage of the postcontractual situation (moral hazard issue). Commitment can play a similar
role. So trust relations in the wider society can alter the relative costs and
benefits of transacting in markets and organisations and can supplant
power mechanisms.
Organisation and democracy
People can choose to control and coordinate their joint activities by various
democratic procedures. Small peer groups sometimes use a form of direct
participatory democracy based upon the principle of one person one
vote. Larger groups, even when adopting a democratic procedure, usually
develop a hierarchical division of labour and are more likely to adopt some
form of representative democracy. Different forms of enfranchisement
37
MN3127 Organisation theory: an interdisciplinary approach
can arise. Representative organs can be seen as agents of their electorate
(principal).
Whereas a Weberian bureaucracy usually attempts to legitimate a
hierarchical power distribution in terms of competence (rational
bureaucratic authority), a democratic organisation may resort to what
we might term rational democratic authority. People see unequal power
as legitimate because of the underlying democratic principles. Whatever
structure is adopted, members of the organisation need information to
enable them to participate as well-informed organisational citizens.
A reminder of your learning outcomes
Having completed this chapter and the Essential reading and activities,
you should be able to define and explain the following terms and
concepts:
• adverse selection
• moral hazard
• information and monitoring
• information, power and authority
• information and culture.
Sample examination questions
1. Explain how asymmetric information may influence the control and
coordination mechanisms in an organisation.
2. What, if any, is the relationship between organisational culture and
authority?
38
Chapter 3: Coordination and control: monitoring
Chapter 3: Coordination and control:
monitoring
Aim of the chapter
To provide an understanding of how an organisation can be conceived as a
monitoring mechanism.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to define and explain the following terms
and concepts:
• observations of inputs/outputs
• role of Taylorism/Fordism
• control loss
• de-skilling
• technology and organisation control.
Essential reading
Detailed section references are provided throughout the chapter.
Buchanan, D. and A. Huczynski Organizational behaviour. (London: Prentice
Hall, 2010).
Further reading
Guillen, M.F. Models of management: work, authority and organization in
comparative perspective. (Chicago, IL: Chicago University Press, 1994).
3.1 Introduction
Activity
Now read Chapter 13 in B and H.
One way of analysing an organisation is as a monitoring mechanism. The
hierarchical division of labour is then viewed as a complex monitoring
structure. In practice, of course, monitoring is mingled with the other
mechanisms we have identified, particularly incentive mechanisms, but it
is analytically insightful to separately consider hierarchies as monitoring
mechanisms. By and large, it is sociologists and to a lesser extent
psychologists who have studied the variety in these mechanisms. This is
why the extensive reading you have just done is found in B and H’s book.
Economists have usually linked monitoring with incentives in PA theory, by
asking questions about optimal incentives. We shall study their approach
in the next chapter. You should nevertheless recognise that monitoring and
incentives are inextricably linked: the more effective the latter, the less of
the former one needs.
As we noted in Chapter 2, there are two fundamentally different ways P
can monitor A. For example, a first line manager or supervisor (P) can
monitor a worker (A) by observing their output (e.g. product) and by
observing their input (e.g. effort). The choice is only relevant when output
39
MN3127 Organisation theory: an interdisciplinary approach
is not a known (by P) deterministic function of input. For the moment let
us assume P and A are individuals and that P is A’s hierarchical ‘superior’.
So it is P who is monitoring A, who in turn is in P’s span of control. Indeed,
for the moment, P has a span of one. All this might sound so obvious as
not to be worth saying, but when we come to study power mechanisms
we shall see that it is sometimes averred that the hierarchical division of
labour is a process of mutual monitoring up and down a hierarchy. Let us
put this idea to one side for the moment and take what we might quite
naturally term a ‘top-down’ viewpoint. P would, in a conventional sense,
be called A’s manager.
Some important terminological issues, nevertheless, arise in making
economists’ and sociologists’ perspectives on monitoring consistent with
each other. When referring to monitoring, economists usually mean ‘costs
of observing’ or perhaps even ‘costs of observing and drawing useful
conclusions’. So, if P can ‘costlessly’ observe A’s output or input or infer the
latter from the former, there is literally no need for monitoring. Perfectly
competitive markets at equilibrium prices have this characteristic. Some
sociologists, though, assume (often implicitly) that there is no such thing
as costless observation so they find that monitoring is universal. But
as long as we are aware of this and interpret ‘monitoring mechanisms’
as costly, then no difficulties should arise. Of course, economists have
standard ways of talking about the efficiency of monitoring mechanisms
which equate benefits and costs at the margin (see Chapter 4).
Two further points. First, you will find economists also using the term
‘signalling’, whereby the motive to reveal information for monitoring
purposes can be examined. Second, economists sometimes distinguish
between verifiable observations/signals which can be described ex
ante1 and verified ex post2 to a third party (e.g. a court of law) and can
be used to specify a formal contract, from observations which fail this
test. The latter are more likely to be associated with what sociologists call
informal monitoring. In sum, it is probably useful to distinguish between
the following:
• ‘Costless’ observation of inputs/outputs (usually some sort of ideal
type).
• Monitoring costs: the cost of the time and effort devoted to
observing inputs/outputs. The costs of the administration component
(see Chapter 10) may be partially attributable to monitoring costs,
though the administrative hierarchy has many other costly functions.
• Monitoring intensity: the time devoted to monitoring, which will,
of course, imply monitoring costs.
We may formulate the monitoring (and incentive – which we will study in
Chapter 4) problem as follows:
• Assume the output of A is dependent solely upon A’s ‘effort’.
• P knows this to be the case.
• P can observe/monitor A’s output and infer the ‘effort’.
• In so far as the observation of A’s output is straightforward, P will
have to devote few resources to monitoring A. P’s span of control
(supervisions of A) can go up. P has no need to monitor A’s input, which
we might assume would be more costly (i.e. constantly watching A).
If however, either P does not know the relationship between A’s effort
and output; or P cannot ‘easily’ observe A’s individual output (e.g. A is a
member of a group/team which produces a ‘collective output’ (see Chapter
5)); or A’s output is dependent upon his/her effort and other factors which
40
1
Latin: ‘as a result of
something done before’.
2
Latin: ‘after the fact’.
Chapter 3: Coordination and control: monitoring
are costly to observe by P, then, under any of these conditions, P will face
a more difficult monitoring problem. P will have to devote time and effort
in attempting to overcome the monitoring problems (monitoring costs
and intensity). This will negatively impact the span of control of P. If,
furthermore, the performance of various agents in a span of control are
interdependent (see Chapter 12) then it will be the span of coordination
which is affected. In practice, organisational monitoring combines a
mixture of observing inputs and outputs.
Sociologists, following Weber, picture a bureaucratic organisation as
utilising procedures whereby P both sets the rules for A (implicitly signs
the contract with A) and monitors A’s performance. A span of control
(remember that a hierarchy is built of spans of control) is thus, on this
reading, a mechanism for both directing and monitoring. Your intuition
should tell you that, other things being equal, the more time/effort P has
to put into these activities, the lower his/her span of control will be (i.e.
number of subordinates).
If we extend the picture to situations which, because of uncertainty,
cannot be entirely covered by rules/contracts (i.e. incomplete contracts)
then discretion will arise. This complicates monitoring. The discretion
can be either decentralised to A or centralised with P. If it is decentralised
then P will monitor, ex post, A’s decisions in handling the discretion. If it is
centralised, P will handle the discretion him/herself and issue appropriate
directives. We will study these issues in Chapter 12. As you might
expect, they will have an impact upon the span of control and thus the
hierarchical division of labour.
An organisational hierarchy can be viewed as a complex structure
(depicted as a graph) designed to coordinate and control human activities
through direction and monitoring. Figure 3.1 depicts a simple hierarchy
with various spans of control and a depth of four. Ultimately, we shall be
interested in what determines this variation (see Chapter 12).
Peak coordinator
Second line supervisors
First line supervisors
‘Production line’
Figure 3.1
It is natural to think of the bottom of the hierarchy as the ‘production line’
– though this might be a rather awkward term if we are talking about,
say, a church. As we move up the levels we encounter first line supervisors
(with, in Figure 3.1, spans of two and three) and then second line
supervisors with spans of two; and so on. Viewed this way, the hierarchy is a
structure of cascading P–A relationships devoted to directing and monitoring.
This enables us to introduce an important concept – control loss.
(Unfortunately neither textbook introduces the concept.) If we continue
41
MN3127 Organisation theory: an interdisciplinary approach
to take a top-down standpoint on the objectives of the organisation then
we can envisage it as lines of control running downwards from the peak
coordinator. There are as many links in a line as the depth of the hierarchy.
The hierarchy depicted in Figure 3.1 has 10 such lines. For a hierarchy to
effectively control and coordinate the activities of its constituent members,
the activities of ‘production line’ members must contribute to the objectives
of the first line supervisor which, in turn, must contribute to the objectives
of the second line supervisor, and so on up to the peak coordinator. To
the degree that this is not the case then there will be control loss. Since
we have incorporated the idea of coordination into our definition of
organisation, we might also refer to coordination loss (see Chapter 12).
To get an impression of the nature of these important concepts, you might
think in the following terms: attach an (independent) probability number
to each link in a hierarchical line of control measuring the extent to which
the activities of the subordinate member contribute to the objectives of the
immediate superior. Then the control loss down the line is computed by
multiplying these numbers together and subtracting from 1. If they are all
100 per cent, then there is perfect control or no control loss. If, however,
any depart from 100 per cent, then we find control loss. Notice that the
longer the line (the depth of the organisation), the more likely it is that we
shall find control loss and even small departures from 100 per cent will
have a dramatic effect (for example, multiply 0.99 together four times).
As your reading will have revealed to you, the balance of scholarly activity
has centred upon the direction and monitoring of the ‘workforce’ or
bottom layer in organisations. Taylorism (or scientific management) and
its development as Fordism have had a profound impact upon the study of
direction and monitoring.
3.2 Taylorism and Fordism
Taylorism (which we encountered along with its alternative name
scientific management in Chapter 1) is a process whereby activities
(sometimes called jobs or tasks) are decomposed into simpler components.
Taylorism can facilitate the production line, which with the addition of
mass consumption is usually referred to as Fordism. The term ‘Fordism’ is
thus used to describe a wider socio-economic phenomenon which became
pre-eminent in industrialised economies until the 1970s. Taylorism/
Fordism spread from the US to other advanced economies from the decade
following the First World War, and though its credentials were called into
question in the latter half of the twentieth century it continues to have a
hold on the organisation of work and design of organisations.
Once again, using a di-graph depiction is helpful. Figure 3.2 illustrates
some decompositions.
(a)
(b)
Complex task
C
D
A
B
B
A
A
B
C
(Decomposed tasks)
Figure 3.2
42
D
C
D
Chapter 3: Coordination and control: monitoring
In Figure 3.2a the complex task is decomposed into four simpler tasks
which are sequentially organised. The operational procedures for each task
are then formulated as relatively simple rules and targets (routinisation).
In general the work flow can be depicted as a di-graph, and the other
di-graphs in Figure 3.2 are possible examples. Taylorism focused upon the
lowest level in the hierarchical division of labour although the ideas also
had some impact upon the decomposition of managerial tasks.
Decomposing complex tasks into simpler ones reduces the difficulty
(costs) of monitoring (unless people resist – see Section 3.3) by increasing
the transparency between inputs and outputs. Other things being equal,
it should increase the spans of control of first line supervisors and
accordingly decrease the administrative costs (overheads). It should
increase the capacity of management to control and coordinate labour
by making performance more transparent and simplifying the incentive
system. It also enables managers to reap the benefits of mass production,
economies of scale and increasing plant utilisation rates.
Although Taylorism and Fordism were initially applied to manufacture
(particularly automobiles), the ideas can be applied to the provision of
services and to people servicing and handling organisations. It is generally
held that, although Taylorism was devised and proposed as a ‘scientific’
method of organising (controlling and coordinating) human activities, it
had wider implications:
• It de-skilled some categories of labour (Section 3.3), though the story
about de-skilling and re-skilling is a complicated one.
• It reduced the bargaining power of labour; in the terminology
developed here, Taylorism decreased, by simplifying tasks, the
information asymmetry about the nature of work which traditionally
benefited skilled labour. It also reduced the degree to which the
production process could be held up by units of labour – they became
more easily replaceable. However, as the system evolved, labour also
was increasingly demotivated to use any residual ‘tacit information’ to
improve production.
• It increased the bargaining power of management and ultimately the
owners of organisations; management’s adverse selection and moral
hazard problems in monitoring labour were reduced.
• It created a role for two new categories of labour – namely,
maintenance and quality control workers – both removed from direct
involvement in production but with significant bargaining power. They
became essential to the smooth running of particularly the production
line (Fordism – see below). A new form of information asymmetry
evolved, conferring power with respect to management. These workers,
being in relatively small numbers, were able to use their bargaining
power to elevate their relative wages.
• It facilitated the transition from skills-based to mass trade unions.
Activity
Much has been written about the causes, consequences and diffusion of Taylorism which
falls beyond the boundaries of organisation theory per se. You might, however, in this
respect like to read Guillen (1994).
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MN3127 Organisation theory: an interdisciplinary approach
Taylorism was an American invention and it is argued that the particular
circumstances of North American society were conducive to its genesis
and growth. In this respect the potential of home mass markets and the
relative disorganisation of skilled labour and lack of trade unions are often
cited. Accordingly those societies (e.g. Germany) where neither or both of
these conditions were present proved less hospitable to its spread.
It is important to understand what Taylor and those who advocated
his ideas had in mind when describing their prescriptions as scientific.
Firstly, the label ‘scientific management’ clearly gave a legitimacy to
the prescriptions; to describe something as scientific is to imply that it
is in some sense correct. But, more importantly, Taylor believed that
the precepts of scientific management would, if systematically applied,
guarantee improved efficiency and thus both management/owners and
labour could share in the fruits of this improvement. The fragmentation
of labour and appropriate incentives would, indeed, lead to a Pareto
improvement (i.e. all could be better off) though this terminology was not
used. When Taylor was promoting his ideas the US was very much in thrall
to the ‘progressive movement’, which embraced science and technology as
the harbinger of the good society.
Taylor tended to see people very much as most economists do: as
motivated solely by financial incentives and as effort-shy. He also believed
that quality would be improved and monitoring costs reduced with the
routinisation of production tasks. The design of the fragmented labour
process was clearly, in Taylor’s mind, also the prerogative of management.
Though these may have been reasonable assumptions, particularly in
North America, in the early part of the twentieth century, they became
progressively less convincing as the decades passed (see Chapter 5).
Furthermore, in societies with deeply embedded cultural traditions which
commit people to the intrinsic value of skilled work, the diffusion fared
less well.
Fordism may be defined as Taylorism, developed as the production line,
along with a strong emphasis on economies of scale (minimising unit
costs) and mass consumption. It is thus usually used to describe the period
in advanced industrial societies from the development, by Henry Ford,
of the production line (1914) up to the 1970s. Since then, the virtues of
the production line have increasingly been called into question, but not
entirely so, and the phrase ‘post-Fordism’ is sometimes used to characterise
this subsequent period.
44
The production line evolved, courtesy of Taylorism, from craft-based
production. In craft production, the product (e.g. an early automobile)
occupied a fixed position on the factory floor and components were
conveyed from stock (inventory) and assembled at this point. The stock
might have been produced in-house or bought in (‘make or buy’; see
Chapter 10). The information required to effect coordination and control
was significantly in the hands of the skilled workforce. Contracts (rules)
were not formalised and highly incomplete. Management was accordingly
to a degree dependent upon the goodwill of the workforce and inevitably
decentralised much discretion to the shop floor. The effort level exerted
by individual workers was by no means transparent to management
though the group output was. Organisations were relatively small by
later twentieth-century standards and had wide spans and few levels. The
system was probably reasonably stable as long as the potential power (see
Chapter 6) of skilled workers was used for the benefit of the organisation/
management. This absent control loss becomes a serious problem. Taylor
very much saw scientific management as undermining the power of skilled
workers.
Chapter 3: Coordination and control: monitoring
The production line, in contrast, conveyed the product to a sequence of
fixed production positions (micro-vertical integration). Skilled labour
gave way to semi-skilled labour and the amount of buying-in declined.
Individual effort levels became more transparent to management and
determined by the speed of the production line. Contracts (rules) became
formalised and more complete. Discretion was almost eliminated. First line
spans of control remained high, reflecting the ease of monitoring. As we
have noted, spans were also, in so far as they were formalised, high under
skilled labour assembly. This brings out the point that identical spans
can originate for quite different reasons. In the case of skilled assembly,
decentralised discretion and cooperative labour relations permitted high
spans. The assembly line, on the other hand, achieved the same objective
by reducing discretion and simplifying the monitoring.
Payment systems (see Chapter 4) were rather variable, probably reflecting
the increasingly contested nature of the speed of the assembly line. Time
pay (wage rates) led to annual disputes about rates whereas payment by
results led to continual, often costly, negotiation between management
and labour (see Chapter 5).
The success of the production line and mass production depended upon
mass consumption. Ford facilitated this by boosting the wages of his
workers and introducing credit, enabling them to purchase the cars they
had produced. As the emphasis upon consumption spread throughout the
industrial economies, it is sometimes claimed that this encouraged the
state to engage in demand management and paved the way for Keynsian
economics. By the 1960s auto workers were among the highest paid in
industrial societies and this fuelled a debate about the role of the ‘affluent
worker’.
Production line technology proved less attractive in those countries
(e.g. Germany) where skilled labour persisted, where small companies
continued to play a strong role in the economy and where national mass
markets were more difficult to establish. As the twentieth century wore on,
Fordism became increasingly vulnerable to a number of socio-economic
developments both in the advanced and in the industrialising economies:
• Low-wage industrialising countries could adopt the assembly line, etc.,
and undercut the high-wage economies (Japan, Korea, Malaysia…).
• Mass consumer markets began to sunder into more specialised
markets, which also increasingly placed emphasis upon product quality
(sometimes called the ‘BMW effect’). This often required cooperation of
labour and increased discretion, particularly in respect of quality.
• Flexible technologies were developed.
• Resistance to the assembly line de-skilling.
3.3 The de-skilling debate
Activity
Now read Chapter 13 in B and H.
Although the division of labour in the assembly line did increase
productivity, it was explicitly designed to reduce worker skills. Work on the
production line is tedious (simple repetitive tasks; work rate controlled by
the speed of the line; little pride in production or product; no involvement
in the design of work; boredom; minimal discretion and power, and so
on). The reaction of workers to these conditions was complicated, varying
45
MN3127 Organisation theory: an interdisciplinary approach
with individual characteristics, over time and with cultural context.
On the one hand, increased affluence enabled some to take an entirely
instrumental attitude to their work, accepting relative affluence as a
suitable reward for the unpleasant nature of their work experience. On
the other hand, others increasingly showed resistance, which produced
a serious monitoring problem. De-skilling was interpreted, particularly
by sociologists, as leading to both objective (i.e. via technology) and
subjective feelings of alienation from work and to proletarianisation (a
homogeneous unskilled labour force). This line of analysis was particularly
promoted by those of a Marxist persuasion (see Chapter 5). Braverman’s
book (1974) is the most sustained effort to argue that de-skilling was, at
that time, a near universal trend in capitalist societies. It is now almost
universally held that Braverman’s thesis was over-simple – varying trends
in what is often termed by sociologists ‘the labour process’ are now
acknowledged. B and H give a well-balanced overview of this debate –
the story is one of both up- and down-skilling. The important lessons we
can learn for organisation theory from this debate, which was not always
prosecuted in a politically detached manner, are as follows:
• Developments in technology can have a marked influence upon
patterns of monitoring (and also incentive systems) and thus on
organisational control and coordination and, ultimately, design.
• Sometimes, equally effective alternative technologies are available,
each respectively allowing more or less discretion to hierarchical
subordinates. This eventuality then creates a choice of technologies.
How this choice is resolved may depend on the relative power of
managers/owners and subordinates within firms and in wider society
(see Chapter 6). It may also depend on prevalent cultural values and
trust between management and subordinates (see Chapter 7).
3.4 Technology, coordination, control and monitoring
Activity
Now read Chapter 3 in B and H.
Since Taylorism and Fordism have each had such a significant impact
upon control and coordination mechanisms, and thus on the design
of organisations, it is quite natural to ask the question as to whether
the production technology always has such an impact. The viewpoint
which suggests this is the case is sometimes called ‘technological
determinism’, which is contrasted with the idea of choice. You should,
however, use these terms rather carefully. A better term for the former
would be ‘a determinant’; thus technology would then be conceived
as one determinant among possible others in shaping the control and
coordination mechanisms (namely, monitoring, incentives, power
authority, etc.). Unfortunately the literature is not always analytically
precise and this comes out in B and H’s chapter (e.g. the concept of social
technology). For instance, issues of discretion and power, incentives and
monitoring are all run together.
Activity
Although these concepts are all ultimately interrelated, it is important initially to keep
them analytically separate. In this context it might prove useful for you to use the box and
arrow models introduced in Appendix 1.1 when reading B and H’s chapter.
46
Chapter 3: Coordination and control: monitoring
For the moment, we are interested in the degree to which technology
may determine the nature of monitoring. First, however, we need to
be clear about the converse term ‘choice’. It is important to distinguish
between: the choice of (production) technology and the choice of control
and coordination mechanisms (including monitoring) given a particular
technology.
B and H’s chapter is written from a sociological perspective. It might
be useful to consider how economists would address the issues raised.
Unfortunately, D and S don’t really discuss these issues.
Economists always start from the idea of choice. So firms (i.e. their
principals) will choose both a technology and control and coordination
mechanisms, but (assumed) competitive forces will constrain them,
eventually to adopt the most efficient procedures. So it is in this sense
that they are determined. I think this is the best way of interpreting the
term ‘determination’ in B and H’s chapter. It is implicit in the adoption of
a number of the work design systems they introduce you to but since, as
we noted earlier, sociologists and psychologists often fail to set their ideas
within the framework of efficient control and coordination, the reasoning
is unfortunately not made explicit.
The economists’ reasoning can break down under either of two
circumstances: firstly, if competitive conditions do not hold; or, secondly, if
there is ‘more than one best way’ of achieving efficient outcomes. B and H
call this latter possibility ‘equifinality’ but you should be cautious about
using technical-sounding terms where there appears to be no analytical
advantage in doing so. If either of these conditions obtain then there is
scope for ‘choice’ in the sense that B and H use the term.
If there is choice in either of the above respects, then other factors
will shape the technology chosen, the job design and the control and
coordination mechanisms (including monitoring) adopted. It has been
suggested that principals and their managerial agents may continue to
choose technologies and job designs that minimise the skill and discretion
(and thus the bargaining power) of workers. There is, however, no
systematic evidence of this.
B and H introduce a number of attempts to alter the production line. They
include:
• job enlargement (reducing the fragmentation in the division of labour)
• job enrichment (increasing discretion/autonomy)
• job rotation (multiple jobs)
• autonomous work groups (increasing the discretion/autonomy given to
work teams which self-manage their division of activities)
• flexible specialisation
• self-management
• empowerment
• lean production.
You should make sure you understand how each of these terms is used and
how they are interrelated.
All post-Fordist attempts to redesign the organisation of work now
acknowledge the importance of conceiving of a social-technical system.
This merely means that when adopting a technology and designing jobs,
it is imperative to take into account not only the anticipated efficiency of
the monitoring mechanism but also people’s reactions to the job design. In
47
MN3127 Organisation theory: an interdisciplinary approach
particular, it is important to know whether the nature of work or the job
will influence their level of motivation and willingness to innovate. These
issues are, however, best considered under the heading of incentives.
Activity
Now read the recap and revision section of Chapter 3 in B and H.
As we noted at the start of this chapter, from an economist’s perspective,
the need to monitor activities within an organisation in theory only arises
if the incentive (motivation) mechanism fails to perfectly align agents’
activities with the organisation’s (the principal’s) objectives. This is more
likely to occur to the degree to which the organisation faces uncertainties
of one sort or another and, thus, to the allocation of discretion. At one
extreme the manager (principal) may decentralise discretion to an agent,
trust the incentive mechanism, and monitor the output. Alternatively,
the manager may centralise the discretion and issue directives as to the
appropriate activity. A production system can thus be characterised by a
number of key variables:
• the degree of environmental uncertainty
• the mix of routinisation and discretion depending on the level of
uncertainty
• the design of the system; determined by P or jointly by P and A
• the incentive mechanism; individual or group/team
• monitoring individual and group
• discretion; centralised with P or decentralised with A
• innovation; centralised with P or joint with P and A.
It may be useful to distinguish between a number of ideal types which
parallel the typology given in B and H. I shall formulate these in terms of
principal P and agents As.
Type 1
• Uncertainty is ‘low’.
• P designs a routinised (rule-intensive) production system (i.e. jobs
which may or may not be interdependent).
• P contracts with As on an individual incentive basis.
• P monitors the output of As.
• Discretion is low (absent in the extreme case).
• Innovation is low.
Type 2
• Uncertainty is ‘moderate’.
• P designs a limited routinised (rule-intensive) production system.
• P contracts with As on an individual incentive basis.
• P monitors the output of As.
• P centralises the discretion.
• Innovation is determined by P.
48
Chapter 3: Coordination and control: monitoring
Type 3
• Uncertainty is ‘high’.
• P designs very limited routinisation and the distribution of discretion
(centralised with P or decentralised with As).
• P contracts with As on an individual basis.
• P monitors discretionary performance.
• Discretion decentralised to As.
• Innovation determined by P.
Type 4
• Uncertainty is ‘very high’.
• P and A jointly design the production system.
• P contracts with As on a team (economists’ term) or group basis.
• P monitors group performance.
• Discretion decentralised to the group of As.
• Innovation jointly determined by P and As.
A reminder of your learning outcomes
Having completed this chapter and the Essential reading and activities,
you should be able to define and explain the following terms and
concepts:
• observations of inputs/outputs
• role of Taylorism/Fordism
• control loss
• de-skilling
• technology and organisation control.
Sample examination questions
1. Discuss some mechanisms which you think might reduce the level of
control-loss in an organisation.
2. ‘Organisations are mechanisms designed to enable hierarchical
superiors to monitor subordinates.’ Discuss.
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MN3127 Organisation theory: an interdisciplinary approach
Notes
50
Chapter 4: Coordination and control: incentives and motivation
Chapter 4: Coordination and control:
incentives and motivation
Aim of the chapter
To introduce and contrast principal–agent theory with other motivational
theories.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to:
• define and explain the conclusions of simple principal–agent (PA)
theory under different assumptions about information and risk
• discuss various theories of motivation and evaluate their utility.
Essential reading
Detailed section references are provided throughout the chapter.
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008).
4.1 Introduction
It would be difficult to deny that a prime mechanism which provides
control and coordination within many organisations is the incentive
system. Individuals and groups carry out activities which contribute to the
objectives of the organisation because they are provided with incentives
to do so. These incentives might be very varied, though, depending upon
the factors which happen to motivate individuals. Economists emphasise
financial incentives whereas psychologists and sociologists try to
incorporate a much wider range of motivations.
All the positions on the market–organisation continuum (Chapters 1 and
10) can be viewed as occasioning different types of incentive mechanisms.
At one end, perfectly competitive markets offer incentives for a buyer
and seller to trade at an equilibrium price. At the other end, a centralised
hierarchical organisation makes use of the employment contract (usually
incomplete), specifying a rate of remuneration to control and coordinate
activities.
The question, though, is what sort of remuneration? Some possibilities
are:
• pay by ‘effort’ exerted; forcing contract
• pay by results (PBR) or by output
• pay by time – wage rate
• promotion
• prizes for the best performance.
Economists have developed the most coherent theory of incentives.
Principal–agent (PA) theory is the result.
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MN3127 Organisation theory: an interdisciplinary approach
Activity
Now read Section 7.1 in D and S.
As D and S make clear, PA theory is very general. It can be applied to any
situation where one or a number of individuals (agents) pursue activities
(take decisions) on behalf of another individual (the principal). PA theory
is often introduced in terms of the separation of ownership and control
between the owners and managers of an organisation, and D and S follow
this procedure. In fact PA theory grew out of the debate over ownership
and control. However, the theory can equally be applied to the hierarchical
relations within organisations. Indeed a hierarchy can be viewed as a
series or cascade of PA relationships operating down the line. For the
moment, though, let us follow D and S and motivate the general theory in
terms of the specific relationship between owners and managers.
Activity
Now read Section 7.2 in D and S.
The possible misalignment of incentives between owners and managers
can be offset by a number of mechanisms:
• stock market prices
• the market for corporate control
• the market for managerial labour
• product market competition.
You should understand how each of these markets can impact upon
managerial behaviour and militate against managers pursuing their own
objectives.
D and S interpret PA theory as normative – how P and A should behave
given appropriate assumptions. It is, however, often used as a positive
theory.
Activity
Now read Section 7.3 in D and S. This section requires a little basic economics (e.g. the
shape of the indifference curves; curves of equal utility to the manager) but the argument
which is developed from Figures 7.1 to 7.4 is accessible to anybody who can interpret
graphs.
It should not surprise you at this stage in your studies that economists
study PA relationships in terms of both rational calculation and material
(financial) incentive/motives. As we shall see later, many other social
scientists are sceptical about either or both of these assumptions,
particularly in a positive sense, but sometimes in a normative sense also.
However, for the moment it is important to understand the basic ideas
behind the theory. You should pay particular attention to the role of
information – who is assumed to know what – in the reasoning. Many
of the interesting analytic conclusions arise when information is not
symmetric between P and A and where they have different attitudes to risk
(see below).
Section 7.3.1 in D and S links incentives into monitoring (see Chapter
3) and bonding. Bonding is often also referred to as credible precommitment. Both monitoring and bonding are costly; under the
assumptions of the model the manager bears these costs.
52
Chapter 4: Coordination and control: incentives and motivation
Activity
Now read Section 7.6 in D and S and Appendix 4.1 to this guide.
In the Appendix, I have provided a slightly different approach to PA
theory using only elementary mathematics (some would say it is oversimple). This reading brings out the relative role of fixed wage rate (w)
and payment by result (PBR) in designing optimal incentive contracts,
and introduces you to the flexibility of PA theory. The general lessons you
should learn are as follows:
• Incentive contracting depends upon the distribution of information
between P and A; in particular, can P observe (monitor) A’s effort or
not? (It is always, not unreasonably, assumed that A can do so.)
• Incentive contracts depend upon the risk-bearing attitudes of both P
and A.
• PBR gives full marginal returns to A but also imposes risk on A. A
fixed wage rate, on the other hand, puts the risk onto P but reduces A’s
return.
Assumptions of simple PA models
• P wants to control (definition of organisation) A’s activities so that A’s
effort (input) contributes to P’s goals (assumed to be the objectives of
the organisation). Putting it another way, P wants to eliminate control
loss (see Chapter 3).
• Output depends on A’s effort and other random factors (e.g. the
weather in D and S’s example of strawberry production).
• A does not like effort (at an increasing marginal rate).
• A has an available alternative (outside) reservation income/utility. A
therefore enters into the contract with P on a voluntary basis. Thus, for
many economists, the contract is not conceived as involving a coercive
power relation operating between P and A (see Chapter 5).
• Alternative information and risk assumptions:
Case (1) P can observe (monitor) A’s effort (so can A) – symmetric
information. The optimal contract is then a forcing contract.
Case (2) P cannot observe (monitor) A’s effort (A can) – asymmetric
information.
• Optimal contracts now depend upon risk assumptions:
– P and A are both risk-neutral; then a franchising/rent contract is
optimal.
– A is risk-averse and P is risk-neutral (a reasonable assumption in
many situations); then the optimal contract is risk-sharing and A will
receive a fixed wage component in her remuneration.
Case (3) P can observe a signal (i.e. imperfect or partial monitoring)
of A’s effort; then if, and only if, the agent is risk-averse, the contract
should reflect the signal. Otherwise the franchising contract is optimal.
Unlike D and S, I have not only referred to P ‘observing’ A’s inputs and
output but also placed ‘monitoring’ in brackets. Simple PA models assume
that observations, if they can be made, are made costlessly but are more
complicated (realistic models incorporate costs of observing and drawing
conclusions; see Chapter 3).
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MN3127 Organisation theory: an interdisciplinary approach
Activity
Now read Section 7.6.4 in D and S.
D and S identify two important extensions of the basic PA theory. First,
where one principal monitors several independent agents (note that I,
unlike D and S, insert the word ‘independent’ here). Thus, P has a span
of control over a number of agents each operating independently. If the
output of the As are interdependent then we need to think in terms of a
span of coordination – an idea we will return to later.
It is further assumed that P knows that the random inputs for each of
the As are identical (this fits the adjacent strawberry plot example rather
well but does not work if the plots are dispersed and experience different
climatic conditions). P can now compare the relative effort levels of the As
to the average level. Above- and below-average performance can only be
attributed to differences in effort level. If P is risk-neutral and the As are
risk-averse, then the optimal incentive contract will be proportional to: (1)
individual output and (2) average output.
The second extension is to many periods, so P repeatedly monitors
the performance of A. Again, if P is risk-neutral and A is averse then
P contracts upon A’s past performance. If A is also risk-neutral then a
franchise contract is optimal.
You should note that it is the assumptions about risk which make PA
theory particularly interesting. When P contracts with A using a fixed wage
rate as opposed to PBR then P is, in effect, insuring A against fluctuations
in A’s remuneration. Indeed, the major conclusion of the theory is that in
the absence of risk aversion on A’s behalf, the optimal relation is for P to
franchise A. Fixed (time) wage rates, which are often seen as closely allied
with organisations, arise because of A’s risk aversion. Organisations are
thus conceived as insurance mechanisms.
Activity
Now read Section 7.6.5 in D and S.
D and S urge you to be extremely cautious in applying PA theory to realworld problems. The theory furnishes an impressive system of interrelated
concepts which is central to modern organisation theory but at the cost of
rather extreme simplification. You need to match this intellectual elegance
with the much less systematic but empirically detailed approach of
sociologists and psychologists. So let us now turn in that direction.
4.2 The contribution of sociologists and psychologists
Basic PA theory is driven by certain basic assumptions:
• P and A are driven by material incentives/motivations.
• A dislikes exerting effort. P’s effort is not explicitly brought into the
picture, though designing the optimal mix of incentives and monitoring
may be conceived as such.
• The distribution of information (knowledge) between P and A.
• The relative risk attitudes of P and A.
54
Psychologists and sociologists have made the most significant impact in
terms of a richer picture of human motivation. They have also explored the
origins of differing risk attitudes and the impact of groups upon risk taking
(see Chapter 5). In addition, sociologists have repeatedly emphasised the
demotivating aspects of many types of organisations.
Chapter 4: Coordination and control: incentives and motivation
Activity
Now read Chapter 8 in B and H.
This chapter in B and H is very detailed and in some places conceptually a
little unclear. The landmark ‘theories’ you should become acquainted with
are:
• Maslow’s hierarchy
• equity theory
• expectancy theory (which you should contrast with the economist’s
expected utility theory; Chapter 2 in D and S)
• Herzberg’s theory.
Each of these theories offers a list of factors which, it is claimed, may
motivate individuals within organisations. B and H argue, however,
that the social scientific support for some aspects of most of them is
patchy. Furthermore, they may also be culturally specific. There is a good
recapitulation section at the end of the chapter.
As an organisational theorist you need to ask whether or not these theories
are relevant to organisational design. You might pay particular attention
to the section ‘The social process of motivating others’. This section starts
with Taylorism and introduces some important distinctions:
• intrinsic and extrinsic rewards
• job enrichment
• job enlargement
• job diagnostic surveys
• empowerment.
You will scarcely be able to avoid contrasting the intellectual styles of PA
and motivation theories. The former is often mathematically rigorous and
highly abstract; the latter is less rigorous but much more detailed and
empirically rich. Whether or not some of the broader motivational factors
could be incorporated into a more embracing PA theory is an interesting
intellectual challenge. But from an organisation theory standpoint one
would expect organisation design to take account of a richer set of motives
than purely financial ones. They may also vary across individuals, gender,
social class, culture nationality thus highlighting the distinction between
normative expectations and additional motivators and which may both
vary with these individual differences.
Activity
Study the diagram on p.262 of B and H.
With this diagram, it should be possible in principle to incorporate
all the various motivating factors instanced in the above motivational
theories into an extended PA theory. For instance, if you assume that
agents find more empowering work less costly, then the indifference
curve (I) in Figure 7.5 in D and S may not curve upwards as steeply
as the one indicated. Then W0 would reduce and R0 (the return to P)
would increase. The problem is that it is difficult to actually quantify
these effects. If we ask the question, ‘what, from a PA perspective, is the
optimal mix of empowerment and income?’ the mathematics is easy but
the practicalities are immense. But organisation theorists need to ask such
questions.
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MN3127 Organisation theory: an interdisciplinary approach
In order to get a grip on a very detailed and imprecise set of concepts, it is
useful to reason as follows.
Start with Taylorism and a hierarchical structure designed to control and
coordinate the division of labour (tasks), at the base of the hierarchy:
• Recombine some of the tasks (i.e. job enlargement), and also
decentralize some responsibilities (autonomy) to the ‘labourers’ (i.e.
job enrichment/empowerment).
• Assume this then increases satisfaction and motivation.
This may enable an increase in spans of control of first line supervisors
or even the eradication of a layer of management. Thus, the costs of
monitoring and control and coordination will accordingly be reduced.
A reminder of your learning outcomes
On completion of this chapter and the essential reading, you should be
able to:
• define and explain the conclusions of simple principal–agent (PA)
theory under different assumptions about information and risk
• discuss various theories of motivation and evaluate their utility.
Sample examination questions
1. How, if at all, do you think Maslow’s ‘theory’, if correct, would modify
the central conclusions of principal–agent theory?
2. How and why would you expect ‘job enrichment’ and ‘job enlargement’
programmes to influence the shape of organisations?
3. Explain why some organisation theorists conceive of organisations as
‘insurance mechanisms’. Do you believe this to be an important insight?
56
Chapter 5: Control and coordination: incentives, groups and teams
Chapter 5: Control and coordination:
incentives, groups and teams
Aim of the chapter
To develop frameworks for understanding the role that groups and teams
play in organisational analysis.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to define and explain the following terms
and concepts and assess their importance for organisational analysis:
• basic concepts of game theory
• team production
• theories of group formation
• role theory.
Essential reading
Detailed section references are provided throughout the chapter.
Buchanan, D. and A. Huczynski Organizational behaviour. (London: Prentice
Hall, 2010).
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008).
Further reading
Alchian, A.A. and H. Demsetz ‘Production, information costs and economic
organization’, American Economic Review 62(5) 1972, pp.777–95.
5.1 Introduction
Activity
Now read Appendix 5.1 to this guide, Chapter 5 in D and S (excluding Section 5.4) and
Chapter 22 in B and H.
I have invited you to start by reading the chapter in D and S and the
appendix devoted to game theory. In the previous chapter we studied
individuals; now we turn to groups (the sociologists’ and psychologists’
term) and teams (more favoured by economists). Groups/teams often
need to be the focus of attention in controlling and coordinating activities
in the service of an organisation’s objectives. Sometimes these groups can
be regarded as sufficiently ‘cohesive’ to treat them as ‘individuals’, but
other times not (see Appendix 5.2 in this subject guide).
Game theory, as the pre-eminent theory of strategic interaction, is central
to modern organisation theory. I shall assume in what follows that you
have thoroughly acquainted yourself with the basic ideas in D and S’s
chapter. You don’t need to be familiar with the section on auctions but I
would encourage you to read this section.
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MN3127 Organisation theory: an interdisciplinary approach
As you will see, game theory extends the idea of rational choice to situations
where ‘players’ need to take account of what other players have done or
might do when making their own decisions. Furthermore, they must assume
that the other players are also calculating likewise. It is often useful to
picture the different positions on the market–organisation continuum (see
Chapter 1, Section 1.5) as involving different strategic calculations.
5.2 The economists’ contribution
Activity
Now read Section 7.4 in D and S.
This section introduces the idea of team production. Note what this
formally means: the output of a group of individual agents does not
depend solely upon the sum of their individual inputs (e.g. skilled effort).
Inputs are not separable but complement each other. Alternatively, there
are production externalities (synergies) between the individuals so the
output of any one individual depends not only on their own input but
also upon the input of other individuals. Contrast this situation with
the independent strawberry farmers in Section 7.6.4 in D and S. Team
production thus entails for a principal a span of coordination rather than
a span of control. Coordination will be achieved when incentives (or
other mechanisms) motivate individuals to internalise the production
externalities.
D and S give us an informal rendition of a famous paper by Alchian and
Demsetz (1972) which claims to show why the entrepreneur who is
remunerated after all the other claimants have been rewarded should
control and coordinate (i.e. manage) enterprises, if the production is
based upon team production and the manager needs to be motivated to
‘offset shirking’ (i.e. slacking in Appendix 5.1 of this subject guide). The
authors’ argument, if valid, is in effect a justification of the capitalist/
entrepreneurial organisation of the firm. So read this section of D and S
very carefully, critically assessing each assumption in the argument. To use
a phrase we used earlier, it shows why capital should hire labour rather
than the reverse – a workers’ cooperative – where labour hires capital (see
also Chapter 8). Note here my use of the normative term ‘should’.
You will recognise that the idea of team production and the individual
propensity to shirk (free ride) can be characterised as an n-person
prisoner’s dilemma game. It will be rational for all individuals not to
internalise the synergies (defect) unless some guarantee can be found that
others will not do so. If shirking is not easily detectable then the collective
effort without coordination will be at the sub-optimal Nash equilibrium
rather than at the Pareto optimum. Furthermore, promises not to shirk are
not binding as there is no incentive to honour them. There are thus gains
to be had for all by finding the requisite coordination mechanism for the
team.
It may help, to fix these ideas in your mind, to think in terms of a simple
two-player prisoner’s dilemma as follows:
58
Chapter 5: Control and coordination: incentives, groups and teams
Co-op
Co-op
Defect
33
14
4>3>2>1
Defect
41
22
Now how can the players achieve the (3,3) outcome rather than the (2,2)
outcome?
It is useful to think in terms of a number of alternatives, some of which we
will explore in subsequent chapters:
• Repeated interactions can achieve a coordinated (Pareto) outcome (see
Chapter 7).
• Self-managed coordination (i.e. peer group self-management or
monitoring). Alchian and Demsetz discount this possibility (see Chapter
8).
• Cultural cooperative norms preventing shirking or enjoining credible/
trustworthy pre-commitments not to shirk (see Chapter 7).
• A motivated (by residual remuneration) specialised monitor (this is
Alchian and Demsetz’s favoured solution) with the ‘power or authority’
to punish shirking. I use quotes here for, as we shall see, these authors
are not keen to use these terms (see Chapter 6).
• Multilateral bargaining (see Chapter 6).
Since the Alchian and Demsetz model claims to detect a reason not only
for organisations but also for a particular governance arrangement, it
is sensible here to look at the variety of governance systems in the real
world.
Activity
Now read Sections 6.1, 6.2 and 7.7 in D and S.
Section 6.2 of D and S makes it clear that some economists have sought
to introduce more realism into their models, but often at the expense of
rigour. The behavioural theory of the firm pictures organisations
as a coalition of participants or stakeholders. It is recognised that the
inducements to participate vary across the different stakeholders and
each stakeholder may be motivated by multiple factors. D and S aver that
introducing a vector of inducements does not invalidate the mathematical
ideas underpinning PA theory. This is correct, though only if the different
factors can be put on a common scale – usually monetary equivalents. You
should ask yourself whether you think this is feasible. The behavioural
theory also allows for slow adjustment to alternative opportunities (an
information issue) through ‘aspiration levels’. Section 7.7 of D amd S
provides a succinct overview of PA theory.
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MN3127 Organisation theory: an interdisciplinary approach
5.3 The contribution of psychologists and sociologists
Social psychologists have been at the forefront in understanding the
process of group formation. Part 3, Chapters 10 to 13, in B and H gives
a very comprehensive overview of these achievements. You will, initially,
need to read these chapters selectively. Make sure you understand the
relevance of the main boxed concepts/ideas running down the left-hand
side of the pages.
Activity
Now read Chapter 10 in B and H.
Organisations can often be analysed as a structure of groups and it is
these which impact on the performance of the organisation. Whereas
economists derive their concept of team from non-separable production
functions (above), sociologists and psychologists take a broader view and
often use the words ‘team’ and ‘group’ interchangeably.
First, they distinguish a group from an aggregate of individuals. Groups
are collections of individuals (at least n = 2) who identify with the group
and develop various relatively durable relationships with each other.
Formal and informal groups are identified. Formal groups are part of an
organisation’s design, whereas informal groups evolve through interaction.
Informal groups often exhibit a tendency to homophily – that is, people
with similar characteristics tend to form such groups. Individuals may be
a member of more than one group, with the result that groups intersect.
It is often suggested that individuals that fall into more than one group,
provide an integrative function between the groups (boundary spanners
and information brokers), for example the linking pin model. The control
and coordination of an organisation has to acknowledge this sort of
complexity. To use D and S’s term, things are rather ‘messy’ and invite a
complex interplay of the control and coordination mechanisms we are
going to study. You should think of the inter-individual relationships in
graph-theoretic terms (see Appendix 1.2 of this guide); a set of different
relationships – communication, power, etc. – running over the same point
set. If you keep this picture in mind it will enable you to organise much of
the material in these chapters.
Directed relations like ‘communicates with’, generate a di-graph. Relations
like ‘interacts with’ generate graphs with symmetric relations. Alternatively
you can conceive of a structure of relations as a matrix: if the relations are
binary (only recorded as present/absent), then the entries in the matrix
will be 1 and 0; if the relations have values (e.g. intensity or frequency
of interaction) then the entries in the matrix are accordingly valued.
Concepts such as group cohesion can be derived from the proportion of
the possible relations that exist in a group. Many of the standard concepts
in graph theory are useful in the analysis of groups and organisations (inand out-degree, centrality and so on). You may find it useful to think of
the organisation as a formal hierarchy (a tree of who reports to whom),
with many other types of relations running over the same point set. Many
of these may be described as informal relations that may impact the way in
which the organisation is controlled and coordinated.
Types of group tasks are recognised though the definitions given are not
terribly rigorous. Additive tasks arise when each individual produces
the same output independently of others (economists’ separable
production). Conjunctive tasks are equivalent to non-separable
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Chapter 5: Control and coordination: incentives, groups and teams
production. Conjunctive tasks also invoke the role of the most productive
in influencing others in the group.
The Hawthorne studies, designed to test the efficacy of Taylorism, have
had a remarkable impact, culminating in the ‘human relations’ approach to
organisation:
• the Hawthorne effect is now widely recognised in social science; it
recognises that people’s behaviour (actions) can be significantly altered
by observing them. Hawthorn effects can either support or undermine
the control and coordination of organisations
• informal organisations/groups are also recognised as a universal aspect
of attempts to hierarchically control and coordinate human activities
(rate busters, chiselers and squealers are widely acknowledged)
• informal norms can have a either a positive or negative impact upon
efficiency (Chapter 7). That is to say that they can either support or
work against effective control and coordination.
Since both formal and informal groups are found within all organisations,
it is important to have some appreciation of how they evolve. Formal
groups usually follow the dictates of the organisation design and task or
job interdependencies (see Chapter 10). The informal structure of these
groups and those with no formal basis seem to follow certain patterns.
There have been many attempts to describe and explain the processes
which generate these patterns and B and H outline two – those of Homans
and Tuckman – though many others could have been outlined. You should
become acquainted especially with Tuckman though I don’t think it is
important to learn the various terms used. Notice that the central ideas are
best understood in graph theory terms.
Chapter 10 in B and H concludes with sections entitled ‘Groups and
teams’. Notice that the term ‘team’ here is not necessarily used in the
manner of economists – so be careful in your written work to define your
terms. The table distinguishing between teams and single leader work
groups is useful. Teams are here defined as groups which effectively selfmanage the control and coordination of their activities to fulfil a specific
purpose (see Chapter 8).
Activity
Now read Chapter 11 in B and H, but miss out the sections on power and status structure
as these will be covered in Chapter 6.
You have a powerful way of thinking about structure using the ideas from
graph and di-graph theory (see Appendix 1.2 of this guide). This should
enable you to organise the copious material in this chapter much more
effectively. Note that group structure is the pattern of (dyadic) relations of
differing sorts of power, status, communication, liking, role (expectations,
leadership, and so on) operating over the same point set (individuals).
Groups can also have external relations to members of other groups.
Putting aside for the moment power and status relations, let us
concentrate on the remaining types of relations. Clearly both a total
organisation, and the formal groups of which it is constituted, require a
communication structure in order to maintain control and coordination.
The standard interpretation of an organisation in terms of ‘directives
down and information (monitoring) up’ immediately suggests a twoway communication structure. A formal hierarchy may be regarded as
providing such formal communication channels either between individuals
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MN3127 Organisation theory: an interdisciplinary approach
or groups. The actual communication structure usually has, though, a
much richer network of connections than this. Notice that when we say
A communicates in some respect with B, and B with C, then this often
implies that A communicates with C without there necessarily being a
direct link from A to C. Large groups and teams that are coordinated by
a leader often develop a hierarchical structure where communication has
this property, not requiring face to face contact. However, smaller peer
groups may have a complete face-to-face communication structure (see
Chapter 12).
You might expect group communication to be incomplete but strongly
connected (make sure you understand what this means and why it is likely
to be the case). Some of the names of networks produced in B and H are
in my view rather confusing. First, it is important in any structural analysis
to distinguish directed and symmetric or reciprocated links/relationships.
Thus, whether we are dealing with a di-graph or a graph.
Second, it is also important to be aware that the position on the page of
the points has no meaning from a graph theory point of view, though it
is often convenient to consider those points mentioned previously as a
superior in the hierarchal sense (therefore a tree can be drawn with the
peak coordinator at the top of the page). To avoid confusion it is often
important when using graphs to adopt the convention whereby it is made
clear whether a hierarchical dimension is implied or not.
Communication patterns (who communicates with whom), can of
course be disaggregated to various types of communication (e.g. spoken,
written). Note that written communications are regarded as important in
the concept of Weberian bureaucracy (see Chapter 12). Bales’ interaction
process analysis, which is described by B and H, has proved useful in
many studies for charting the variety in possible interactions in groups.
However, when it comes to understanding the control and coordination
of organisations, it is far from clear that this level of disaggregation is
needed. Nevertheless, Bales’ distinction between task and maintenance
activity is important, as in the latter respect it draws attention to
emotionally positive and negative interactions, which provides a good
bridge to friendship and enmity relations, and their possible impact
upon control and coordination. B and H refer this to ‘liking structures’.
Individuals in organisations inevitably form friendships and, usually
to a lesser extent, enmities. The structures generated (who chooses
whom) have been widely studied and friendship choice tends to produce
homophilic patterns way beyond what one would expect if friends were
to be randomly chosen. Furthermore, reciprocated (mutual) choices
and triads of friendship links also occur disproportionally. These choice
patterns often provide the framework in which informal groups evolve
with individuals identified, and from which they can derive their attitudes,
norms and actions (see below). Groups based on friendship usually
facilitate help- and trust-based reciprocation between members (Chapter
7). Groups that also exhibit durability tend to develop role structures.
The concept of social role is introduced in B and H as a set of expectations
about appropriate activities that others hold of the occupant of a position/
identity in a group or organisation. Most sociologists would add to this
definition the idea of ‘normative’, making it normative expectations,
emphasising the institutionalised (see Chapter 7) nature of social roles.
When norms are stabilised into social roles then they are sometimes
referred to as being ‘institutionalised’.
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Chapter 5: Control and coordination: incentives, groups and teams
Once again, notice that the (normative) expectations can be envisaged as
a structure of relations (expectations about appropriate activities) running
between a set of positions. The in-degree (see Appendix 1.2 of this guide)
of a focal position gives a picture of the expectations by occupants of other
positions applied to an occupant of the focal position. The out-degree gives
the pattern of expectations the occupants of a given position have of the
occupants of other positions. So social roles provide a powerful way of
looking at durable groups and organisations. Roles continue to ‘exist’ when
a particular incumbent leaves the role and the expectations will be applied
to a new incumbent. Role structures can, therefore, outlive a particular
population of incumbents as long as not too many leave the group at one
time.
Role analysis is sometimes suggested as an alternative to rational choice
theory1 as a way of explaining why people act in the ways they do. It is
proposed that they follow the normative expectations appropriate to the
positions they occupy rather than make calculations about prospective
outcomes. Indeed, this picture once gained great currency in sociology.
All social systems were viewed as a set of positions or identities between
which normative expectations determined the appropriate activities. If
there happened to be contradictory expectations (e.g. if a father and
mother – two positions/identities – have contradictory expectations of
their child) then the child, as occupant of that role, experiences intra-role
conflict. How occupants of roles solve this sort of conflict then requires
additional theories. If a particular incumbent occupies more than one role
then the normative expectations across the roles may not be consistent –
then we encounter inter-role conflict. Various theories, some of which are
outlined in B and H, state that the same incumbent within a group, which
can exacerbate inter-role conflict, can hold multiple roles. The advantage
of looking at groups in organisations in terms of roles is that, given the
stability of a role structure to changes in incumbents, the control and
coordination of the group can be, relatively speaking, routinised (Chapter
12).
1
See Chapter 1; or you
may like to read about
Talcott Parsons in course
SC1021 Principles of
sociology if you have
access to it.
This picture of the control and coordination of activities, in the absence of
intra- and extra-role conflict, can quite naturally be described as being at
an equilibrium. People as occupants of positions merely follow the dictates
of the normative expectations of their roles. This picture has inevitably
been described by some critics as static and over-socialised. Furthermore,
one might also ask how the role structure and its inherent institutionalised
norms have evolved in the first place. As we shall see in Chapter 7, some
theorists assume that evolutionary stories can be told in terms of rational
self-interest, while others deny that this is possible.
You should note the connection we made earlier between norms, rules and
contracts. Taylorism could be viewed in terms of a role structure in so far
as the rules are institutionalised.
Next we turn briefly to B and H’s treatment of leadership. From an
organisational, control and coordination point of view, identifying the task
and emotional leaders of groups (formal and informal) enables managers
to treat these individuals as opinion leaders and to gain their compliance
is likely to achieve compliance of the other group members. Look at
‘individuals and groups’ in Chapter 12 of B and H. They document the
ways in which groups may shape the perceptions, performance, behaviour
and attitudes of group members. Putting it more generally, how it is that
groups may socialise members? I counted several concepts in this chapter,
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MN3127 Organisation theory: an interdisciplinary approach
deriving from the study of groups by various social psychologists. Rather
than learning all this material, what we need to do is to extract from the
welter of detail a framework appropriate to organisation analysis. There
are probably a number of ways this can be achieved but I suggest the
following:
First, recognise that we are ultimately interested in how groups may alter
the actions of individuals in such a manner that they may contribute or
hinder the control and coordination of an organisation. Also note that
this is possibly a two-way process – an individual may also alter the
actions of the other group members (conversion). For these socialisation
mechanisms to be operative we assume that individuals do not arrive
at the organisation already equipped to act in the specified manner as
a consequence of an ambient culture (see Chapter 7). I have used the
term socialisation here, but unfortunately many different words are used
in literature to describe how individuals derive their actions (and the
constituents of actions, beliefs, affects and values) from their social (e.g.
group) environment; influence, persuasion, learning and compliance are
examples among those terms you will encounter in B and H. We shall try
and disentangle some of these in Chapter 6. But for the moment, since
actions depend upon beliefs (what individuals conceive as true and false),
affects (what they like and dislike) and values (what are deemed as good
and bad), we can recognise three socialisation mechanisms: cognitive,
affective and evaluative. Furthermore, as noted above, actions are often
guided by norms. We can often ask how individuals are socialised into
accepting group norms (e.g. roles). One advantage of looking at things
in this particular manner is that it can be made consistent with the
economists’ perspective – in effect socialisation provides a possible route to
endogenising preferences and opportunities (Chapter 1).
Social psychologists recognise that individuals may be placed somewhere
on an identity continuum running from personal identity at one end to
group(s) identity at the other. Most individuals achieve, at least in part,
their self-esteem by a sense of belonging to (identifying with) groups (e.g.
professional groups or departments). The greater the level of identity
of group members, then the more cohesion the group will attain. The
greater the group cohesion then the stronger the socialisation within
the group. The greater the group cohesion then the more likely the
group will develop negative sanctions against infraction of group norms.
Extreme group identity can lead to de-indivdualisation, group think,
group distortion of perceptions (Asch experiments), and group obedience
(Milgram experiments). Furthermore, members of highly cohesive groups
can generate negative orientations to other out-groups leading to intergroup conflict. As noted above, groups tend to homophilia though the
source of homophilia, which can be rather complex (e.g. individuals with
similar intellectual orientations). Homophilic groups can enhance intergroup heterophobia. Homophilic groups tend to be less innovative than
heterophilic groups.
All of these considerations can have implications for how an organisation
with formal and informal groups might be controlled and coordinated.
Group cohesion can work in favour of, or against, effective control
and coordination. A highly cohesive group can lead to loafing (freeriding) or facilitation. The degree to which group processes operate
against organisational effectiveness need tends to suggest that simple
monetary incentives will not solve the problem, but the other control and
coordination mechanisms we have identified take on added importance.
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Chapter 5: Control and coordination: incentives, groups and teams
A reminder of your learning outcomes
Having completed this chapter and the Essential reading and activities,
you should be able to define and explain the following terms and concepts
and assess their importance for organisational analysis:
• basic concepts of game theory
• team production
• theories of group formation
• role theory.
Sample examination questions
1. Discuss the contribution that ‘role theories’ can play in organisational
analysis.
2. Explain what is implied by the term ‘team production’. What
implications does the term have for organisational analysis?
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MN3127 Organisation theory: an interdisciplinary approach
Notes
66
Chapter 6: Coordination and control: power and authority
Chapter 6: Coordination and control:
power and authority
Aim of the chapter
To conceptualise the role of the highly disputed concepts of ‘power’ and
‘authority’ in controlling and coordinating organisations and
quasi-organisations.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to define and explain the following terms
and concepts:
• bargaining power, power and impatience, risk aversion, outside
options, commitment strategies, asymmetric information
• contested concepts, force, power, inducement, influence or persuasion,
authority
• gender and power, Marxism and power.
Essential reading
Detailed section references are provided throughout the chapter.
Buchanan, D. and A. Huczynski Organizational behaviour. (London: Prentice
Hall, 2010).
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008).
Further reading
Alvesson, M. and H. Willmott (eds) Critical management studies. (London;
Newbury Park, CA: Sage, 1992).
Braverman, H. Labor and monopoly capital: the degration of work in the
twentieth century. (New York: Monthly Review Press, 1974).
Lukes, S. Power: a radical view. (Basingstoke: Palgrave Macmillan, 2005).
Miller, G.J. Managerial dilemmas. (Cambridge: Cambridge University Press,
1992) Chapter 2.
Mills, A.J. and P. Tancred Gendering organizational analysis. (Oxford: Pergamon
Press, 1992).
Muthoo, A. Bargaining theory with applications. (Cambridge: Cambridge
University Press, 1999).
Noble, D.F. Forces of production. (New York: Oxford University Press, 1986).
6.1 Introduction
It is often assumed that organisational activities are controlled and
coordinated by the power or authority exerted by one person or group
over another. Intuitively power is exerted when one actor is capable of
gaining the compliance of a subordinate by issuing threats. It is natural
to see organisational hierarchies as embodying distributions of relative
power. They are sometimes described as mechanisms for conveying
commands/rules from the top to the bottom. If it is deemed that those
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MN3127 Organisation theory: an interdisciplinary approach
issuing commands are entitled to do so, then the commands are regarded
as legitimate and it is usual to define legitimated power as authority.
Another way of expressing this is that PA relationships are power/
authority relations, rather than governed by incentives. It turns out,
however, that these innocuous-sounding ideas are fraught with conceptual
snags. Indeed, some social scientists have labelled the concept of power
as fundamentally contested. This is a rather fancy way of saying that no
settled definitions, acceptable to all, can be found.
Furthermore, it often proves empirically incorrect to regard organisations
solely as top-down power structures. An alternative view is to picture
organisations as a system of stakeholders (individuals, groups,
departments and so on) who bargain procuring outcomes proportional
to their relative bargaining power (e.g. the behavioural theory of the
firm – see below). Indeed, the realised objectives of the organisation may
be the product of bargaining. If so, then the control and coordination
mechanisms and objectives of an organisation are codetermined. I should
warn you that these are highly controversial issues about which there
are no settled viewpoints. Many economists (though not all) are rather
reticent about invoking the concept of intra-organisational power in the
context of competitive environments. A competitive labour market, they
aver, leads to voluntary employment contracts which do not entail any
power relationship between, shall we say, P and A. We will return to this
argument later.
Activity
Now read Chapter 6 in D and S.
In the context of the behavioural theory of the firm (which, remember,
is not the standard neoclassical model), D and S introduce you to the
idea of bargaining power. Economists have been at the forefront of
developing the concept of bargaining (power), often making use of gametheoretic precepts. Before we delve into some of the deeper issues about
organisation power, it is helpful to explore how they do this and then to
compare their approach to that of sociologists.
6.2 Bargaining and power
Unfortunately D and S do not analyse bargaining power in any depth but
I shall provide a non-technical overview in the following paragraphs. If,
however, you want to study things more thoroughly (not essential for
the course) then you might like to look at the early chapters of Muthoo
(1999).
Economists note that bargaining is a common relationship, both between
and internal to organisations. They want to understand bargaining from
the standpoint of rational actors. Let us motivate our analysis in terms
of bargaining between management (M) and labour (L) or perhaps
trade unions. What might determine the wage rate if there is room for
bargaining (i.e. the labour market is not competitive)? Remember, in
perfectly competitive labour markets, there is no room for bargaining over
wage rates. Assume M has a maximum she is prepared to pay L, P(max),
and L has a minimum she is prepared to work for, P(min).
If M and L can agree (contract) on a rate anywhere between P(max)
and P(min) then both are better off than if they fail to contract (Pareto
improvement). Thus, M and L have a common interest in striking a deal
but conflicting interests about where, between P(max) and P(min).
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Chapter 6: Coordination and control: power and authority
Bargaining is the process of reaching a voluntary contract which will stick.
There are two important aspects of bargaining:
• the outcome – the distribution of the ‘bargaining surplus’ (between
P(max) and P(min))
• efficiency – minimising the bargaining costs in reaching an outcome.
The theory of bargaining suggests factors which determine both the
outcome and associated bargaining costs. M has bargaining power to
the degree that the outcome is close to P(min) and M’s bargaining costs
are low. L has bargaining power to the degree that the outcome is near
P(max) and L’s bargaining costs are low.
Note that any division of the bargaining surplus is a Nash equilibrium (see
Appendix 6.1 of this subject guide).
The factors determining bargaining power are:
• bargaining time and impatience
• risk aversion
• outside options
• credible commitments
• asymmetric information.
We shall look at each of these and start with the assumption of complete
information.
Activity
Now read Appendix 6.1 of this subject guide.
Bargaining time and impatience
Assume both M and L would prefer to contract earlier rather than later:
that is, time to agreement constitutes a bargaining cost for both parties.
This often seems a very reasonable assumption. Then, other things being
equal, if L and M have equal impatience then they will split the bargaining
surplus equally (a particular Nash equilibrium). The general principles are
that, for both M and L:
• bargaining power is proportional relative to patience
• bargaining costs are proportional to impatience.
Note that to get simple results each party must be assumed to know both
the other’s patience and bargaining costs. In the context of sequential
bargaining (each making offers and counter offers), then backward
induction will indicate a Nash equilibrium at the outset (see Appendix 6.1).
Patience
Formal results aside, what determines relative patience?
• L and M’s available contracting alternatives (see below).
• M’s inventories and L’s saved resources or strike fund. Note that
the better off will in general have more patience and can therefore
distribute the bargaining surplus to their advantage. This picture thus
suggests that bargaining will exacerbate inequalities.
The strategies for increasing the bargaining power available to either party
are:
• reduce one’s own bargaining costs by increasing one’s patience
• decrease your adversary’s patience by increasing their bargaining costs.
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MN3127 Organisation theory: an interdisciplinary approach
Note, however, that these strategies will also be costly. Therefore, one
needs to balance these costs against prospective gains in terms of a
favourable outcome.
Risk aversion
There will always be a risk that bargaining will break down because
circumstances change (often described as ‘exogenous shocks’). There is,
thus, also an inherent risk in not settling now. So the relatively risk-averse
will have higher bargaining costs. Once again, one would expect those
with fewer resources to be relatively risk-averse.
Outside options
Assume M and L have the same patience and risk aversion; then they
should split the bargaining surplus in half. The leading idea is that if either
party has a credible alternative partner with a better offer then this will
increase their bargaining power. The party can use the credible threat to
contract elsewhere. Note that in perfectly competitive markets there is no
space for credible threats.
Commitment strategies
If either party can commit (prior to or during bargaining) to a division
of the surplus (‘I will not pay more than X’) that favours them and this is
seen as costly to abrogate, then they may increase their bargaining power.
The commitment is credible to the degree that stepping down is costly
to the party concerned. Commitment often works best when a bargainer
is bargaining on behalf of others; for example, a trade union leader who
would lose credibility with the membership if they stepped down. An
adversary will not call your bluff if the commitment is credible.
Asymmetric information
All the above approaches to the sources of bargaining power assume that
each party is fully informed about the opponent’s resources, preferences,
risk attitudes, commitment, etc. The underlying games are, as you would
expect, ones of complete information. In practice these assumptions
are often over-strong and we have to move to games of incomplete
information (see Appendix 6.1 of this guide). When information is not
complete, bargaining can be a bewildering mixture of processes. First,
learning about your opponent; second, communicating information about
oneself (perhaps false); and third, achieving an outcome. In general,
bargaining will be inefficient – bargainers will use private information to
their own advantage and send false signals. For example, in management–
labour bargaining M may be ignorant about L’s P(min), resources,
patience, risk aversion and outside options. Likewise M may also be
similarly misinformed or ignorant about L. This is why the simple model
in Appendix 6.1 of this guide is only really useful to gain an appreciation
of some basic concepts. In practice, bargaining raises issues about credible
threats and promises and haggling.
We will return to these issues after studying how sociologists and
psychologists approach the idea of power and kindred concepts.
6.3 Behavioural theory of the firm
You will have seen in D and S that the behavioural theory of the firm
is an attempt to introduce more realism into the theory of the firm
than that which is found in the neoclassical conception. The objectives
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Chapter 6: Coordination and control: power and authority
of the firm are interpreted as the bargaining outcome among several
stakeholders rather than being determined by the ultimate principal –
usually the owners. It provides a way of introducing bargaining power
and theory into our understanding of how organisations are controlled
and coordinated. It also introduces a richer model of individual motives
by suggesting that actual returns are compared with aspirations in
determining an individuals’ likelihood of accepting a contract appropriate
to the particular stakeholder. If returns (of whatever it is that motivates
individuals/stakeholders) are at least as good as aspirations then the
contract will stick, if not a search for alternatives will ensue. So, what
determines aspirations becomes a central analytical concern. However in
this respect, information about alternatives is often difficult to ascertain
due to information asymmetries, thus, lags in adjustment of aspirations are
likely. All of this is fairly remote from the picture whereby the competitive
markets determines the conditions under which stakeholders accept
contracts (of the employment, supplier, consumer). One of the important
conclusions of the behavioural theory suggests that transactions internal
to organisations, where there are inventory costs in maintaining the
transaction, cannot be coordinated without inducing conflicts between the
transacting parties. D and S consider the transaction between production
and sales managers.
6.4 Sociologists’ and psychologists’ approaches to power
and kindred concepts
Activity
Now read Chapter 22 in B and H.
Reading the above will give you a good impression of the conceptual
diversity attached to the idea of power
On first reading of this, don’t worry if you feel a little dismayed. It is
sometimes difficult to understand what is being said and where the
differing conceptualisations agree and differ. Unfortunately, some of the
writing in this area does not match the requirements of rigour of modern
social science. You should be rather wary of grand-sounding terms like
‘field of force relations’ as they are used so broadly and imprecisely as to
carry little clear analytical meaning. Giving a name to a complex set of
mechanisms (often with grand, apparently legitimising associations from
the natural sciences) is not really a contribution to social science. So you
will need to exert your own judgement when reading Chapter 22 in B and
H (this is not a criticism of B and H but rather of some of the literature
they review). As I said at the start of this chapter, many concepts are
highly contested. I shall later try to guide you through the maze but you
should recognise that it is my route and many would suggest alternatives.
Before looking at conceptual matters, let us think about the role of
power, however defined, in coordinating and controlling activities within
organisations. Let us go back to the basic idea (see Chapter 2) as to
whether a transaction should be left to the market or internalised in the
(hierarchical) firm. You might now like to think of a third possibility,
whereby the partner to the transaction could bargain, thus keeping the
transaction outside an organisation but not in the market (see Figure 6.1).
In competitive conditions (and equilibrium) there is, of course, no room
for bargaining. But in ‘real markets’ there is. However, in ‘real conditions’
the simple bargaining model, in Appendix 6.1, of this guide will not apply.
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MN3127 Organisation theory: an interdisciplinary approach
If extra-organisational bargaining is adopted as a third alternative, then all
the problems of adverse selection and moral hazard will be present,
resulting in ‘haggling’ and, thus, bargaining costs. Indeed, these conditions
which undermine the market as an appropriate transaction mechanism
also undermine bargaining.
Competitive
markets
Real markets
Extra organisation
bargaining
Figure 6.1
Activity
Now read Appendix 6.2 of this guide. You might also like to read Miller (1992) Chapter 2.
Appendix 6.2 gives you, in outline, reasons why bargaining between
organisations is likely to fail as a control and coordinating mechanism.
But of course organisations often do bargain. You should recall the point
I made in Chapter 1. Positioning a transaction on the continuum depicted
in Figure 6.1 is often a matter of ruling out some sorts of ‘governance’ in
favour not of the ‘first best’ but just a superior way of doing things.
You have already read Chapter 6 in D and S, which shows how advocates
of the behavioural theory of the firm introduce the concept of bargaining
power.
By way of comparison, B and H propose the ‘rational model’ of
organisation (broadly speaking, the classical economists’ model) is
compared with the ‘political model’ (i.e. the power perspective). The
key idea underpinning both the behavioural and political models is that
organisations are coalitions of individuals and various groups which
through their relative bargaining power determine:
1. the operational objectives of the organisation
2. the coordination and control of activities.
Notice how this departs from the incentives standpoint. There the
mechanisms which hold people together in pursuit of organisational
objectives are voluntarily entered incentive contracts. The political model,
on the other hand, puts power in this position. Needless to say, real
organisations are usually a bit of both.
You will notice when reading B and H that they counterpoise what they
term the rational (with an idiosyncratic definition) and the political
models of organisations. This nomenclature is, I think, unfortunate. As we
have already seen, a rational approach to bargaining is perfectly feasible.
I advise you to follow the distinctions used in this guide. Furthermore,
people may actually seek power; it may actually enter their utility
function/goals/motives, so they can then quite naturally be described
as rationally seeking power. Psychologists have studied the ‘need for
power’ and related concepts, the need for affiliation and the need for
achievement, which reminds us that the motives of individuals can vary
(see Chapter 2).
6.5 Contested conceptual matters
I fully expect that you will feel somewhat bewildered at this point in your
studies. There is a wealth of material to think about, but don’t become
discouraged.
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Organisation
Chapter 6: Coordination and control: power and authority
Economists study bargaining power from a game-theoretic standpoint,
which is sometimes rather technically demanding, and sociologists and
psychologists introduce us to a plethora of, often cross-cutting, concepts.
As organisation theorists we need a picture which is both consistent
with the precepts of bargaining power theory and which slims down the
sociologists’ and psychologists’ conceptual diversity.
First, it will not have escaped your notice that bargaining power theory
detects the presence of power in the ability of actors to determine the
division of a bargaining surplus according to their differing interests,
whereas sociologists tend to see power as an inter-actor concept, namely
the degree to which one actor can gain the compliance of another when
the latter has differing objectives/interests to the first. This difference in
focus should not cause concern: it is often possible to derive the latter
from the former. Consider M and L bargaining over a wage rate once
again. They arrive, given their relative bargaining power, at an ‘agreed
rate’. Then if M can get L to work at that rate we can quite naturally speak
of their relative interpersonal power. Recall that for any of this reasoning
to be applicable there must, from an economist’s point of view, be room
for bargaining in the first place – that is, some departure from perfectly
competitive conditions.
So let us look more closely at the inter-actor conception and continue to
motivate the argument in terms of the relationship between M and L. How
can M gain L’s compliance and, thus, control and coordinate their activities
in ways that are distinct from M providing incentives (not only financial
ones)? Distinguish the following types of mechanisms:
• force
• power
• inducement
• influence/persuasion or manipulation
• authority.
Force
This implies actual physical constraint: M is able to gain L’s compliance
using physical means. Note that this is not the same as using threats of
physical compulsion. Gaining compliance by force is not usually part of
organisational life except perhaps in extreme conditions – in prisons, for
instance.
Power
M is able to gain L’s compliance by the use of credible threats (negative
sanctions), including, possibly, the threat of force. Note that the threat to
remove rewards is covered by this definition. However, note also that this
would not amount to a credible threat if L has an equally good alternative
to move. It is this sort of reasoning that allows Alchian and Demsetz
(1972, Chapter 5), to aver that employment contracts are not underpinned
by power in perfectly competitive labour markets (see below).
Nevertheless, the behavioural theory of the firm and uncompetitive
markets surely allow for the use of threats (implicit or explicit) to maintain
coordination and control.
Inducement
M is able to gain L’s compliance by the use of rewards (positive sanctions).
But this looks like incentives (see Chapter 4), so why should we add this
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MN3127 Organisation theory: an interdisciplinary approach
term to our vocabulary of mechanisms? The reason is that some scholars
regard differential endowment of the assets which can be used to reward
L as a source of ‘power’. If this (contested) conceptualisation is followed
then transactions between unequally endowed parties always involves
a type of power; inducement among equals always embodies a sort of
power!
Influence/persuasion and manipulation
M is able to gain L’s compliance by changing L’s preferences/perception
of interests/perception of opportunities. Influence can, conceptually,
be subdivided into situations where: (a) M increases or maintains L’s
perception of opportunities, etc., and (b) when M restricts L’s perception
of opportunities, etc. The latter might be termed coercive compliance
or manipulation (or even indoctrination) and is certainly a species of
‘power’ in the generic sense.
The former, however, covers learning and socialisation and often group
pressure (see Chapter 5). Drawing conceptual boundaries between these
various concepts (often named in various ways) causes much philosophical
wrangling. The idea that language and discourse can be a source of
‘power’ is closely related to these distinctions, as is the concept of ideology.
The Marxist conception (see below) whereby the ruling ideas are the
ideas of the ruling class also fits this conceptualisation. Whether one
should think in terms of the manipulation of preferences or interests or
opportunities or, indeed, beliefs, values and affects which underpin them
is a moot point. If you want to chart your way around this conceptual/
philosophical thicket, then the best read is probably still Lukes (2005).
Economists show little sympathy for these sorts of debate, usually
regarding people as being able to ‘freely’ form preferences, perceive
opportunities and recognise their own interests.
Authority
In so far as L sees it to be legitimate that M has relative power/
influence/inducement over them, then the capacity to gain compliance is
defined as authority.1
As we noted earlier, in perfectly competitive conditions, inducements are
identical to incentives. Alchian and Demsetz (1972) write as follows:
It is common to see the firm characterized by power to settle
issues by fiat, by authority or by disciplinary action superior to
that available in the conventional market. This is a delusion.
The firm does not own all its inputs. It has no power of fiat, no
authority, no disciplinary action different in the slightest degree
from ordinary market contracting between two people. I can
‘punish’ you only by withdrawing future business or by seeking
redress in courts for any failure to honour exchange agreement.
This is exactly all that any employer can do.
Thus, for these authors (and for many economists), the move from
market to organisation/firm is not one that introduces power relations
into the process of coordination and control. Can we make this picture
consistent with the sociologists’ contrary viewpoint? Note first that if
the above conclusion is drawn in the context of complete contracting
and perfectly competitive markets then, as we saw in Chapter 1, there
is no way of choosing between organisational and market transactions.
If, nevertheless, an organisation is chosen then the Alchian and Demsetz
conclusion is probably correct. Some sociologists (notably Marxists, see
74
1
You may like to read
about Weber here, as
presented in course
SC1021 Principles of
sociology if you have
access to it.
Chapter 6: Coordination and control: power and authority
below) would still draw attention to any inequality in resources brought
to the transaction as being indicative of power – be it in a market or
an organisation. So for these scholars any position on the market–
organisation continuum would involve power unless, in some sense, the
resources they bring to the transaction are ‘equal’. Equality here is difficult
to define but it would mean that all parties to transactions would have the
same purchasing power given equilibrium prices.
However, in the world of incomplete contracts and ‘real markets’ (Chapter
1) is there any reason, in opposition to Alchian and Demsetz, to invoke
power relations? Most scholars would answer in the affirmative at
any point in the market organisation continuum. Various information
asymmetries (Chapter 1) and differential endowments enable bargaining
and, thus, ‘power’ to enter the picture.
6.6 Influence, groups and individuals
Groups – even organisations – can, as we saw in Chapter 5, socialise and
thus influence or manipulate individual members. I shall use the term
‘influence’ as defined above. Psychologists have studied these processes
more closely. They speak of group pressure and individual leadership but
also use many other terms. We have already encountered the Hawthorne
effect in Chapter 5.
Activity
Now read Chapter 11 in B and H.
You will need to read this chapter with caution as the authors often refer
to power when they are thinking in terms of what I have termed influence
(i.e. group processes changing people’s perceptions, beliefs and attitudes).
These ideas to a degree overlap the content of the next chapter on culture.
Again you are confronted with a cornucopia of overlapping ideas and I
would encourage you to try to fit them into a framework like the one I
have given you above.
Activity
As you read Chapter 11 in B and H, ask yourself what are the basic types of mechanisms
at work. Attempt to keep the number of concepts that you use to understand the various
mechanisms to a minimum. Make sure you cover the highlighted concepts on the lefthand side of the pages in B and H.
6.7 Gender and power
It is sometimes suggested that organisational life reflects male dominance,
and theory and description are accordingly not gender neutral. This
approach to organisations is part of a much broader critique of both
society and the social sciences as serving the interest and power of the
male gender. This shows up particularly in: (1) job design and (2) unequal
opportunities for women. There is also strong statistical evidence that
in many societies women earn, on average, less than men – even for the
same job; though the disparity is reducing in most countries. But why is
this pattern observed?
A number of explanations have been proffered for gender disadvantage.
First, certain jobs which attract lower incomes are regarded as more
appropriate to women – there may be strong norms to this effect. Even
women may regard these as legitimate and not aspire to promotion,
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MN3127 Organisation theory: an interdisciplinary approach
etc. So the query shifts towards the evolution of these norms and their
legitimacy (see Chapter 7). Second, because women are often temporarily
absent from the labour force for child rearing they may be less attractive
to employers. Third, women have different values about cooperation and
competition and organisational life with regards to male values (notably
more competitive). Women may also not ‘network’ as effectively as men
and networking improves prospects. There is recent evidence that mixed
gender teams perform better than single gender teams.
The question you might ask is – would you expect, if women were to
design the control and coordination system of an organisation, that it
would be different from male-dominated organisations?
Activity
Possible additional reading: Mills and Tancred (1992).
6.8 Marxism and power
Marxism construes productive organisation structures as a form of
domination. In capitalist societies it is capital that dominates labour.
The employment contract is objectively exploitative in the sense that,
according to the labour theory of value, capital expropriates labour’s
value creation (this is a highly contentious idea). In so far as labour fails
to recognise its exploited status, it suffers false consciousness or, to use
the concept developed in this chapter, it is (ideologically) manipulated
by capital. Labour has an objective interest in eradicating exploitation.
Thus productive organisations are the source of class dynamics in society
whereby labour comes to recognise its exploited status and eventually
mobilises to change society. Within the framework of this grand story,
organisation theory should chart the micro conflict and bargaining
between capital and labour.
Scholars working in the Marxist tradition often speak of ‘hegemonic
culture’, implying that culture (which for present purposes might be
conceived as languages, beliefs and values) plays a coercive role within
both organisations and wider society.
You have already encountered Braverman’s (1974) Labor and monopoly
capital analysis in Chapter 1 suggesting that scientific management/
Fordism, by de-skilling labour, increases the power of capital. Braverman
predicted that de-skilling would be extended to white-collar workers and
eventually to management. So, organisation theory itself, which interprets
these trends as purely in pursuit of efficiency, becomes one ideological
means of maintaining the supremacy of capital and we should accordingly
search for an alternative radical theory which has the objective of
eliminating exploitation and liberating labour.
Labour process theory enjoins us to recognise that the attempt to control
and coordinate is inherently unstable. For instance, Hyman writes as
follows:
The function of labour control involves both the direction,
surveillance and discipline of subordinates whose enthusiastic
commitment to corporate objectives cannot be taken for granted
and the mobilisation of discretion, initiative and diligence which
coercive supervision far from guaranteeing, is likely to destroy.
Empirical evidence does not lend support to Braverman’s Marxist-inspired
predictions. First re-skilling often takes place alongside de-skilling and
the differentiation in skills among workers is complex and not adequately
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Chapter 6: Coordination and control: power and authority
pictured in any simple model. It is probably true, however, to say that
these complex and ill-understood processes are shaped by bargaining and,
thus, shifting balances of power between different levels of management
and various groups of workers.
Activity
Possible additional reading: Alvesson and Willmott (1992); Noble (1986).
6.9 The role of power and allied concepts in organisation
theory
Few, but not all, would deny that organisations are often at least in part
hierarchical structures of power and perhaps influence – ‘commands
down and information for monitoring up’. Those in a position of power
characteristically design the organisation, appoint subordinates and select
a mixture of incentives and monitoring, and issue threats where and when
appropriate to maintain control and coordination in order to achieve
their objectives. But all of these things can be bargained about and the
behavioural theory of the firm captures the idea whereby multilateral
bargaining (of which, incidentally, there are at the moment no adequate
theories) among a wide range of stakeholders determines the outcome.
Contrast this picture, once again, with the classical theory of the firm
operating in perfectly competitive markets. This theory has very little to
say about organisation design; firms are black boxes compelled, if they are
to survive, to operate in a manner which benefits their principals. In this
abstract world there is no call, according to most economists, to evoke any
concept of bargaining or power or any related concepts. However, some
scholars even in this rarefied world would demur. They would say that the
exogenous assets that people are endowed with and bring to competitive
markets are sources of differing power (purchasing power). Indeed, some
would go so far as to construe differing genetic endowments – for which
we cannot claim any responsibility – that confer power. You need to think
about these issues though I suspect they will remain ‘fundamentally
contested’.
Modern social scientists study the socialising impact (be it influence or
manipulation) of social groups upon the individual by studying what
they term structural effects. For example, if we expect any individual’s
performance to be a function of his/her ability (however measured) and
level of motivation. Indeed, we expect these two variables to interact (i.e.
multiply) in their impact upon performance since motivation without
ability, or the reverse, is unlikely to generate much performance! This
however, only takes us part of the way in providing an explanation of
individual performance. It turns out that performance is also a function
of the performance, ability and motivation of those to whom the
individual is connected by, for example, friendship etc. (i.e. the network
of connections – Appendix 1.2). In large groups these effects can often be
proxied by the average levels of performance motivation and ability in the
individual’s group. Indeed, the story is even more complex because the
performance of individuals is also sometimes a function of the average
performance of the groups to which the individual’s membership group
is connected. These average effects are sometimes called endogenous
(in the case of performance) and exogenous structural effects. But in
addition, as we noted in Chapter 4, individuals can also ‘influence’ the
group. Contemporary social science is now enabling us to unpack the
two-way process under the rubric of coevolution. The technical problems
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MN3127 Organisation theory: an interdisciplinary approach
in so doing are, however, quite daunting. Nevertheless developments
like this are increasingly enabling us to address the cross level effects
discussed in Appendix 5.1. Meanwhile the lesson that organisation
theorists can take from these developments is that if we centre attention
upon organisation performance (i.e. achievement of objectives) then, in
so far as this is a function of individual performance, the networks that
individuals construct can have a profound impact. These networks may
provide channels for the exercise of power, inducement, influence and
manipulation.
A reminder of your learning outcomes
Having completed this chapter and the Essential reading and activities,
you should be able to define and explain the following terms and
concepts:
• bargaining power, power and impatience, risk aversion, outside
options, commitment strategies, asymmetric information
• contested concepts, force, power, inducement, influence or persuasion,
authority
• gender and power, Marxism and power.
Sample examination questions
1. Do you think that Alchian and Demsetz are correct in their analysis of
the employment contract?
2. Would you expect, if women were to design the control and
coordination system of an organisation, that it would be different from
male-dominated organisations?
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Chapter 7: Coordination and control: culture
Chapter 7: Coordination and control:
culture
Aim of the chapter
To understand how various components of ‘organisation culture’ can
contribute to organisation control and coordination.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to define and explain the following terms
and concepts:
• trust, reputations, helping culture, bilateral and multilateral reciprocity,
altruism, commitment
• norms and institutions.
Essential reading
Detailed section references are provided throughout the chapter.
Buchanan, D. and A. Huczynski Organizational behaviour. (London: Prentice
Hall, 2010).
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008).
Further reading
Abell, P. ‘A model of informal structure (culture) of organisations’, Rationality
and Society 8(4) 1996, pp.433–52.
Kreps, P. ‘Corporate culture and economic theory’ in Alt, J. and K. Shepsle (eds)
Perspectives on positive political economy. (Cambridge: Cambridge University
Press, 1990).
Miller, G.J. Managerial dilemmas. (Cambridge: Cambridge University Press,
1992).
Richerson, P.J. and R. Boyd ‘The evolution of human ultrasociality’ in EiblEibersfeldt, I. and F.K. Slater (eds) Ethnic conflict and indoctrination.
(Oxford: Berghahn, 2001).
7.1 Introduction
It is generally held that what we might broadly term cultural factors can
have an impact upon individual motivation and, thus, affect the control
and coordination of organisations. A problem, however, is that the idea
of culture itself is used to cover so many different phenomena – thus,
definitions abound. Sociologists tend to emphasis shared beliefs, values
and affects, which become embodied in norms about appropriate activity.
Economists have given the term ‘culture’ scant attention but they have
developed a remarkable literature on trust, a concept which many would
incorporate into a definition of culture. But beyond this it is to sociologists
and to a lesser extent psychologists that we have to look for inspiration
though, in addition, management theorists have also latched on to the
idea whereby corporate culture can have an impact upon corporate
performance. I think I should warn you that much of the writing in this
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MN3127 Organisation theory: an interdisciplinary approach
area is very diffuse; the research upon which it is based sometimes leaves
a great deal to be desired and it does not always come up to the standards
of modern social science.
Activity
Now read Chapter 19 in B and H.
The literature covered by B and H is rather descriptive but captures well
the diversity of conceptualisations. I do not think you should memorise all
the terms introduced, but rather try to develop an analytical framework,
which can construct ‘culture as a mechanism for control and coordination’.
Schein’s tripartite categorisation shows how varied are the phenomena
which can be allowed to fall under the rubric of culture.
Despite the diversity there is a common theme underlying the various
approaches to organisation culture which centres our attention upon
the sources of cooperative activity for the purposes of the organisation’s
objectives. In the context of our definition of organisation, in terms of the
control and coordination of symbolic resources and activities, we can see
organisation culture as one mechanism among several others for achieving
this objective. You might ask why I have shifted terms from coordination
to cooperation. I have done so to signal that the analysis of cultural
mechanisms is often best conceived in game theoretic terms where, in
the context of coordination games, the term cooperation is widely used.
However, the terms cooperate and coordinate are interchangeable. Of
course, cultural factors can also create patterns of cooperation which
are inimical to organisation objectives. Indeed, in the context of the
behavioural theory of the firm (Chapter 6), each stakeholder group could
conceivably cooperate in pursuit of its own bargaining power. The cultural
differentiation of groups/departments/functions in organisations can
impose significant coordination (integration) costs and lead to control-loss
(Chapter 12).
It will not have escaped your attention that the impact of culture upon
an individual is covered by the concepts of socialisation and, thus,
influence and manipulation as defined in Chapter 5. The impact of
culture denotes a mechanism, which can change peoples’ preferences by
adjusting their beliefs, values and affects. As recorded there, the concepts
used to denotate ‘power’ relations and cultural socialisation overlap. As
a consequence the contested nature of the concepts describing power
relations extends to cultural relations. For example, Marxist scholars will
interpret control and coordination achieved through cultural mechanisms
as variety of manipulation.
It is useful to distinguish between cultural factors that are generated
(evolve) within an organisation (probably at a cost) and those that derive
from the ambient culture(s). Hofstede’s approach to national cultures has
gained much prominence as has the Globe study which extends Hofstede’s
five dimensions of cultural orientation to nine. It is worth interpreting
Hofstede’s dimensions within the framework of control and coordination.
• Social orientation: cultural norms can differ in the extent to which
they emphasise the individual or the group/organisation (see below,
altruism) as the appropriate target in the process of control and
coordination.
• Power orientation: cultural norms can differ in the extent to which
they emphasise the use of power/authority to control and coordinate
activities.
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Chapter 7: Coordination and control: culture
• Uncertainty orientation: cultural norms can differ in the extent to
which they emphasise grasping opportunities.
• Goal orientation: cultural norms which emphasise the use of material
rather than wider incentives in control and coordination.
• Time orientation: cultural norms emphasising the short rather than
long term.
Management theorists tend to emphasise commitment to either the
objectives of entire organisations or to various groups or departments.
This can involve issues of altruism. Sociologists concentrate upon common
beliefs (including tacit assumptions), values and affects, often embodied
in social norms. They may also refer to institutions. Economists tend
to emphasise trust and reputation effects in repeated exchanges with
incomplete contracts and, thus, moral hazard (see Chapter 5 in D and S).
When trying to synthesise these apparently diverse approaches, cultures
should be conceived as mechanisms that increase the probability of
cooperative behaviour (activity) among a number of individuals (or
perhaps roles if we want to abstract away from specific individuals).
The scope of the mechanism then depends upon which individuals/roles
are involved – a group, a department, an entire organisation and so on.
Applying the ideas to roles rather than specific individuals would facilitate
the idea of institutionalised culture. So, on this reading, cultures are
mechanisms for handling adverse selection and moral hazard problems.
You should note this is a restrictive definition but one which, I think,
fits well the purposes of organisation theory. Cultures that undermine
cooperation can obviously exist but these would presumably not contribute
to the coordination and control of activities.
7.2 Trust
Activity
Re-read Sections 8.8.2 and 5.5.1 in D and S.
The basic idea here is that both the pre-contractual and post-contractual
hazards can, in principle, be overcome if the parties can trust each other
not to take advantage (behave opportunistically; see Chapter 10). The
issues at stake can best be analysed in terms of a simple ‘help’ or ‘trust’
game as depicted in Figure 7.1.
Payoffs
Help A
B
A
B
1
1
-1
2
0
0
Not help A
Help B
A
Not help B
B
Not help A
Figure 7.1
As you will notice, the game is a truncated form of the prisoner’s dilemma
with which you are already familiar. You will be able to see straight away
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MN3127 Organisation theory: an interdisciplinary approach
that the Nash equilibrium, when the game is played once, is mutual noncooperation/help because the first mover cannot trust the second mover to
cooperate when it is his/her turn to move. So the first mover anticipates
this and does not cooperate. As a consequence the second mover certainly
won’t cooperate. Note, it is immaterial whether the game is played as one
of perfect or imperfect information. The game in Figure 7.1 is set up as
one of perfect (and also, note, complete) information and I shall favour
this interpretation in what follows. Not surprisingly, the Pareto-efficient
outcome is not, at this juncture, achievable.
You might like to think about this game in rather more general terms
than those pertaining to formal contracts. Organisations, for their smooth
functioning, we may suppose, often depend upon mutual help. I help you
now, believing/hoping you will help me in the future when I need it. If
people are self-interested in the way that game theorists start by assuming,
then no help will be offered – the reasoning entirely parallels the precepts
of the trust game. A helping culture will not evolve although you and
I could both be better off if we could find some way of overcoming the
hazards and introducing such a culture. The first mover (helper) needs
to trust that the second mover will reciprocate by helping when needs
be. If they can, then the Pareto-efficient outcome is within reach. Indeed,
the problem can be re-described as one of achieving a relationship of
bilateral reciprocity. It might be useful to think of the helping culture
as an informal mechanism of bilateral reciprocity.
How might the first mover trust the second mover to reciprocate? One
possibility will no doubt have already occurred to you – if the players
are to play the game repeatedly with a reasonable probability, then
cooperation can be achieved (TFT – the folk theorem – etc.). It is perhaps
a moot point whether the term ‘trust’ is appropriately used in this context.
After all, the reasoning underlying the dynamics of an iterated game
depends entirely upon the rational self-interest of the players. Some
would want to preserve the term ‘trust’ for situations where people
will reciprocate even if it is not in their self-interest to do so. We might
call this altruistic trust (we will return to altruism below). This is a
conception which is closely allied to the psychologists’ use of the term
‘commitment’ (though, be careful – not the economists’ notion of ‘credible
commitments’ in D and S). Both trusting and being trustworthy can of
course be described as values. Furthermore, the outcome of trust games
depends upon the beliefs that the first mover (trustor) has about the
trustworthiness of the second mover (the trustee). So the approach we are
adopting is inherently compatible with the basic sociological interpretation
of culture as cooperative beliefs and values.
It is important (though not brought out in either text) to distinguish
between being able to trust, on the one hand, another’s motives, and on
the other, their ability/skill to realise certain objectives. I can trust that you
will intend to reciprocate and quite independently take a view on whether
you are capable of doing so. A trusting culture requires both sorts of trust.
It can be argued that organisational and some quasi-organisational
exchanges like long-term contracts are, unlike market exchanges,
constructed to sustain repeated interactions. Organisations can accordingly
aspire to fill the gaps in incomplete contracts with trust. If organisations
can rely upon recruiting members from an ambient culture where norms
of trustworthiness are widespread, then it may be able to operate with
a trusting culture even in the absence of long-term relationships. It is
sometimes suggested that the success of the Japanese economy a couple of
decades ago was so reliant.
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Chapter 7: Coordination and control: culture
Reputations for trustworthiness can also play a role. In a population of
individuals it may be important to build a reputation for trustworthiness if
third parties can observe others interact.
The other way in which cooperation can be sustained in the trust
situations is by command or authority. We can envisage one of the parties
or a third party enforcing the Pareto-efficient outcome. We would, of
course, not regard this as involving trust but a power mechanism
(see Chapter 6).
The picture I have given you so far only scratches the surface of the
complexities of cultural mechanisms. One important transition an
organisation can make is from a reliance upon bilateral reciprocity to
generalised reciprocity. Thinking in terms of a helping culture once again,
bilateral reciprocity can be sub-optimal. If, initially, A helps B, then when
subsequently A needs help, B may not be free to help A – it would be
better if ‘somebody’ in the organisation helped B. This situation is
generalised reciprocity and is depicted in Figure 7.2.
S
B
HA
HB
HB
HB
HA
S
HA
HA
A
HB
HA
HA
S
H
H
Somebody
Help
Not help
B
S
Figure 7.2
Activity
Now put in your own payoffs!
Clearly the problem of free-riding is exacerbated in moving from bilateral
to generalised reciprocity. Individuals can free ride on the group. But again
repeated interaction can find a cooperative equilibrium.
Although, as the term ‘corporate culture’ implies, facets of culture have
traditionally been interpreted as mechanisms for maintaining cooperation
within organisations, it is now recognised that these mechanisms can
operate between cooperative organisations at differing positions on the
market–organisation continuum. Furthermore, even though corporate
culture is largely conceived as a cooperative mechanism, offsetting the
problem of incomplete contracts, team production, externalities, and
so on, it is also recognised that the performance of organisations can
also depend upon intra-organisational competition between individuals
(promotion, for instance) and groups and departments. It may be useful
consequently to picture corporate culture as a mechanism for maintaining
the optimum mixture of cooperation and competition within an
organisation or group of organisations.
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MN3127 Organisation theory: an interdisciplinary approach
Activity
Since the two textbooks don’t really cover the issues of trust in any depth, you might like
to read Abell (1997); Kreps (1990).
7.3 Norms, institutions
Cultures are often conceived as comprising social norms which impact
upon activities and thus organisational control and coordination. Social
norms are rules about appropriate activities – what one should and
should not do in specified circumstances – but they are special sorts of
rules. They are social in the sense that they are shared by a community.
They are institutionalised to the degree that their violation carries
negative sanctions. They are internalised to the degree that their violation
induces a sense of unease, shame or guilt (internal sanctions). Clearly an
organisation’s objectives could be rather easily achieved if the Weberian
rules (see Chapter 2) or the algorithm which I referred to earlier were to
be internalised.
We have encountered the idea of norms earlier, in particular as
constituents of social roles attached to social identities. Social norms
(or more likely collections of norms) are sometimes referred to as social
institutions. All social scientists believe that some human activities, both
inside and outside organisations, are shaped by social norms. They differ,
however, in their interpretation.
Broadly speaking, economists will analyse social norms as ‘rules’ which
evolve (see Chapter 9) in situations which are repeatedly encountered,
in order to facilitate optimal, self-interested behaviour (or interaction in
a game-theoretic sense). They thus interpret them as an extension of the
basic precepts of rational choice (see Chapter 2). Sociologists – notably
Elster (1989) – find this simple assumption wanting. He argues that the
evolution and compliance with many social norms:
• cannot be derived from self-interested precepts
• are not optimal.
This opens the way to a very different interpretation of the role of social
norms. They become, using the term introduced in Chapter 6, influence
mechanisms. Marxists, in particular, construe social norms as part of
the machinery of ‘domination’ whereby one group (capital) maintains its
‘hegemony’ over another (labour).
7.4 Altruism and commitment
As we have noticed, most economists and many sociologists and
psychologists conduct their analysis assuming that individuals are selfregarding or self-interested. To use the economists’ term, they only gain
utility from their own personal welfare. The support of evolutionary
biology, which traditionally also figures self-interest, is sometimes evoked
to justify this assumption. More recently, biologists have explored the idea
that altruism can arise through evolutionary selection. Although still
controversial, an affirmative answer is often now given to this question
involving an equally controversial idea of group selection. Altruism is
a disposition whereby individuals gain welfare from the welfare of others
even at a cost to themselves. Sometimes participative altruism, where
costs to self are involved, is distinguished from the non-participative version
where only a passive welfare from others’ good fortune is recognised.
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Chapter 7: Coordination and control: culture
If we entertain the possibility of altruism in organisational life (e.g.
obtaining welfare from the success of the organisation in achieving its
objectives, or perhaps more restrictedly, groups or individuals within an
organisation) then we might also recognise that ‘spite’ may be involved.
That is to say, gaining welfare from the misfortune of the organisation,
etc. Notice that in some sense the assumption of self-interest is in a
‘neutral’ position between the extremes of spite and altruism. You might
like to think in terms of a motivational continuum running between these
extremes with self-interest in the middle.
There can be no doubt that the ‘other regarding sentiments’ play an
important role in many organisations, though they are rarely incorporated
into models of organisational control and coordination. In particular, if
altruistic norms can be engendered (perhaps at a cost) then this should
reduce control loss, the need for monitoring, power and directives
and so on. This, in turn, will increase spans of control and bring down
administrative costs. Needless to say, all of these mechanisms could be
used to controvert an organisation’s objectives or used by ‘coalitions’, in
the behavioural theory, to generate coalition cooperation.
Activity
If you would like to review these matters, see Richerson and Boyd (2001).
There is a branch of game theory – evolutionary game theory – which
is analytically useful in understanding the evolution of altruism and
commitment (introduced in Chapter 9).
A reminder of your learning outcomes
Having completed this chapter and the Essential reading and activities,
you should be able to define and explain the following terms and
concepts:
• trust, reputations, helping culture, bilateral and multilateral reciprocity,
altruism, commitment
• norms and institutions.
Sample examination questions
1. How can ‘corporate culture’ reduce the administrative costs of an
organisation?
2. What role can ‘norms’ play in achieving control and coordination in
organisations?
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MN3127 Organisation theory: an interdisciplinary approach
Notes
86
Chapter 8: Coordination and control: participation and democracy
Chapter 8: Coordination and control:
participation and democracy
Aim of the chapter
To understand the possible role of voting (democracy) in coordinating and
controlling organisations.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to define and explain the following terms
and concepts:
• labour and capital participation in ownership and management
• voting theory.
Essential reading
Detailed section references are provided throughout the chapter.
Buchanan, D. and A. Huczynski Organizational behaviour. (London: Prentice
Hall, 2010)
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008).
Further reading
Abell, P. and D. Reyniers ‘The emergence and viability of participating firms’ in
Munshi, S. and B.P. Abrahams (eds) Good governance, democratic societies
and globalisation. (Thousand Oaks, CA: Sage, 2004).
Arrow, K.J. Social choice and individual values. (New York: Wiley, 1970).
Industrial Democracy Group Industrial democracy in Europe revisited. (Oxford;
New York: Oxford University Press, 1993).
Miller, G.J. Managerial dilemmas. (Cambridge: Cambridge University Press,
1992) Chapters 3 and 4.
Vanek, J. The Labor-managed economy. (Ithaca, NY; London: Cornell University
Press, 1977).
8.1 Introduction
Yet another way we can conceive of controlling and coordinating activities
is by voting. Indeed, the traditional capitalist firm adopts voting on the
basis of one vote per share (notice: not one vote per person) but only at
its uppermost level of shareholders. Much speculation centres around
whether voting or more general participation in decision-making should
be extended elsewhere in organisations? We can easily imagine a group
of individuals coming together and adopting a voting procedure like
majority rule (but why not consensus?) in order to determine what should
be done. Indeed, professional partnerships are often built around the
principle of majority rule. Democracy or voting is sometimes contrasted
with hierarchical control and coordination of activities though, as we
shall see below, many avowedly democratic ‘organisations’ actually
develop hierarchical structures. Conversely, hierarchical organisations
often experiment with limited democratic procedures. In this context, the
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MN3127 Organisation theory: an interdisciplinary approach
terms ‘participation’, ‘power sharing’ or ‘empowerment’ are often used
interchangeably. The idea usually being that those with little discretion
in strictly hierarchical structures are afforded significant powers over a,
usually limited, range of decisions. This is then another way of describing
the decentralisation of an organisation (or who should be involved in
decisions).
Of course, voting (or indeed decentralisation) in order to decide what
should be done is – one thing – whether those affected will then comply
is another matter altogether. But the leading idea is that those who are
involved in decision-making, either individually or collectively, are more
likely to be motivated to comply (see below). Thus, if this is correct, then
the control and coordination of organisations can be enhanced. But if
majority rule is adopted as the voting procedure then, in particular, will
the minority accept the dictates of the majority? Those who advocate
organisation democracy, participation and so on usually have in mind that
democratic procedures will lend some democratic legitimacy (see Chapter
6) to collective decisions and consequently the outvoted will go along
with the decision. The argument that participation will induce motivation
has been used to justify all sorts of democratic experiments designed to
offset the ‘authoritarian nature of hierarchically structured organisations’
(see below) and it is in this more restrictive context that organisational
democracy is often discussed. In particular, should/do (i.e. normative
and positive questions) organisations allow some degree of participation
by workers (e.g. works councils or labour representation on boards)?
Indeed, if we choose to think along these lines, what about considering
more ambitious ideas like a labour partnership or cooperative? They do
exist, but not many – why? Neither of your textbooks cover these issues
adequately, so in this chapter I shall offer more additional reading than in
most of the others.
It may help to gain some overall perspective on these issues by looking at
the range of possibilities concerning firms or economic organisations – see
Figure 8.1. This figure captures, at a very abstract level, the alternative
ways in which capital and labour may be brought together for productive
purposes in the context of competitive markets.
Labour
partnership
100%
Labour
involvement in
profit
Equity
Ownership/options
Profit
Sharing
Works
council
Lab. on
board
Labour involvement in management
100%
Neoclassical
capitalist firm
Figure 8.1
On the vertical axis I have plotted the degree of involvement by labour in
profit, running from none to 100 per cent. The converse is, of course, the
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Chapter 8: Coordination and control: participation and democracy
involvement of capital. Here we are thinking in terms of profit sharing and
involvement in equity of those working in the organisation. The horizontal
axis plots the involvement of labour in the management (designing
and running) of organisations. Again this axis runs from no appreciable
involvement to full involvement. Notable points on this axis are works
councils (with limited power) and labour representation on the board. So
the neoclassical capitalist firm is located at the bottom left-hand corner of
the diagram – a firm which is both owned and managed by the providers
of capital. At the top right-hand corner we find the labour partnership
or cooperative, owned and managed by the providers of labour. We will
return to the various less complete possibilities below.
Activity
Now read Chapter 10 in B and H.
This chapter gives a comprehensive summary of various approaches to decision-making.
Many of the concepts discussed here have been reviewed elsewhere (risk, uncertainty,
rationality, prescriptive (normative) and descriptive (positive) and so on), though the
definitions given are often rather idiosyncratic to the authors. You need to understand
and retain the previously encountered concepts, but a lot of the detail in this chapter
should be treated as background reading as the relationship to organisational design is
only tangential. The recap section at the end of the chapter provides a good summary.
Note especially the summary of group versus individual decision-making and relate this
to Chapter 5. The categorisation of decision-making environments in terms of certainty
and uncertainty about cause and effect relations, and consensus and disagreement about
objectives, might be related to the arguments about information diversity introduced in
Chapter 5.
You might also like to look at Industrial democracy in Europe revisited (1993) which will
give you an impression of how participation in decision making in firms has been handled
in varous European countries.
As we have seen, the words ‘participation in management’, ‘empowerment’
and ‘participation in decision-making’ are often used almost
interchangeably. Furthermore, it is often left implicit that it is labour
participation which is being referred to. Participatory organisations
can range from labour partnerships (cooperatives) to modest levels of
decentralised decision-making autonomy in traditional hierarchies.
8.2 Voting theory
An essential feature of any democratic system is voting of some sort; for
example, majority rule, consensus or two-thirds majority. Introducing
voting theory will enable you to understand why coordination and control
on a democratic basis are rather difficult. The classical statement is by
Arrow (1963). He derived ‘the impossibility theorem’, the discussion
of which has dominated debates ever since he proved it. Rather than
referring to Arrow’s book, you might like to read a more accessible and
informal introduction, for instance, Chapter 3 in Miller (1992).
Arrow and those who followed his lead posed the problem as to how
well-behaved individual preferences (i.e. transitive rankings – see below)
over a set of options should be aggregated to a collective preference.
The aggregation rule (the social choice function) should produce a clear
prescription over all possible combinations of individual preferences
(universal domain). The impossibility theorem shows that it is not possible
to define such a rule if we impose upon it a number of rather reasonable
additional requirements. First, the collective preference should be
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transitive; so if A is collectively preferred to B and B to C then A should
also be collectively preferred to C. Second, the preference of A over B
should not depend upon which other options happen to be available
(independence of irrelevant alternatives). Third, if all the individuals
(the electorate) prefer A to B then B should not be the collective choice
(Pareto efficiency). You should be aware that this proof also assumes one
of the central tenets of economic thinking, namely that it is not possible
to compare the utilities of individuals. The problem falls away if we can
compute the comparative gains and losses to individuals.
The conclusion of this line of reasoning is that even if individuals do
feel bound by the outcome of democratic procedures (democratic
legitimation), they will not in general be able to find a decision rule to
effectively coordinate and control their joint activities. To use Arrow’s
picturesque term, they need to find a dictator; thus do we encounter yet
another apparent justification of a hierarchical organisation and ‘the right
to manage’? In particular, in the presence of team production technologies
(see Chapter 5) it is argued that it is difficult to see how a peer group
could solve the shirking problem using democratic procedures. They
would, it is urged, rapidly find the need for an authority figure who can
impose decisions. Of course, if this is so, could such a figure be elected?
Nevertheless, we do find many experiments with participatory democracy
in organisations, even occasionally labour partnerships based upon majority
rule and one member one vote. You should ask yourself how relevant you
feel the impossibility theorem is to organisation design. After all, much of
your reading has suggested that decentralisation of discretion, participation,
empowerment and so on might have a beneficial effect upon motivation
and commitment. Referring back to Figure 8.1, many economists, while
conceding that most modern economies have drifted somewhat from the
bottom left corner towards labour participation in both management and
profit/equity, find this reprehensible (efficiency reducing). On the other
hand, sociologists have tended to take the opposing view. So, let us now
examine some of these arguments more closely.
8.3 Capital, labour and organisational democracy
Look again at Figure 8.1. It is useful to compare the two extreme corners,
standing respectively for the classical capitalist firm and the labour
partnership or cooperative. We can then regard these as ideal types and
think in terms of the continuum of possibilities running between them.
By this point you should have become familiar in the preceding chapters
with the capitalist firm and it is possible to show that such firms
operating in perfectly competitive markets achieve a Pareto-efficient,
so-called general equilibrium. This result is regarded as one of the
great achievements of social science (economics) and is often used, not
uncontroversially, to justify competitive capitalism as the best way of
organising an economy and its constituent firms. It can, however, also
be shown that a system of labour partnerships operating in perfectly
competitive conditions will also reach an efficient equilibrium. So we
might ask why, historically speaking, there have been so few labour
partnerships. One answer is that labour is relatively risk-averse (see
Chapter 4) compared with the providers of capital and therefore prefers
not to be residually remunerated. Capitalists can spread their portfolio of
investments across lots of firms whereas labour cannot in practice spread
their labour likewise (recall the findings of principal–agent theory).
Most economists suggest that in the competitive evolution of economic
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systems, labour partnerships have been found wanting as a mechanism
for controlling and coordinating activities. Of course many non-economic
voluntary organisations are coordinated by various democratic procedures
among their members.
Nevertheless, notable and partially successful examples of labour
partnerships are the Mondragon cooperatives in Spain, the kibbutzim
in Israel and, for a period, the labour-managed market economy in the
former Yugoslavia.
Activity
If you are interested you might read Vanek (1977).
Despite the rather negative press which economists have afforded ‘labour
participation’, there is copious international evidence that various forms of
participation are popular. Some, however, is introduced by statute, like
co-determination in Germany, or works councils in many European
countries, and tax breaks for employee share option schemes in the USA.
We can again ask the question as to whether these institutions would
evolve as efficiency-enhancing mechanisms in the absence of the law. If
so, then why the law? We could even ask whether there might be factors
preventing the evolution of efficient forms – perhaps management as an
interest group distinct from labour resist what they see as an incursion on
‘the right to manage’. I don’t think anybody knows the answers to these
questions.
What is clear, however, is that many sociologists and psychologists believe
that they have evidence for the impact of ‘participation’ upon motivation.
Indeed, a mantra of human resource management is that participation
leads to commitment (see Chapter 7), with motivational consequences.
Given Figure 8.1, we can obviously distinguish between:
• participation in financial returns – profit-sharing and share options, etc.
• participation in management – designing, controlling and coordinating
an organisation.
Financial participation is often promoted as a mechanism for improving
motivation, though you will recognise that one must be cautious about this
proposition. Since the individual efforts (assumed costly) can scarcely be
measured and related to profit on an individual basis, profit is a collective
good in the organisation and consequently we encounter a prisoner’s
dilemma situation. Each ‘rational’ individual will attempt to free ride,
giving the inefficient Nash equilibrium. Of course, various cultural factors
(see Chapter 7) may, in turn, also undermine this conclusion.
In respect of participation in management or decision-making, it is
important to recognise that the proposal is that individuals have a
taste or preference for participation which, if satisfied, will show up in
commitment and motivation. The empirical evidence on these matters
is very mixed and much of the research fails to separate the effects of
financial and managerial participatory variables.
Activity
You might like to read Abell and Reyniers (2004).
The most general conclusion we might draw from the research suggests
that there is a modest impact upon performance of the interaction
between financial and participatory variables. In other words, both must
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MN3127 Organisation theory: an interdisciplinary approach
be present to have any impact upon performance. This effect may arise for
two reasons:
• an impact upon motivation
• an impact upon information sharing.
Let us now look at this latter argument. If markets and bargaining fail
and the organisational coordination and control of activities is resorted
to, then should the organisation be centralised or decentralised? Abstract
voting theory apparently favours centralised dictatorial mechanisms. The
ideal type would be rather like our earlier-encountered Taylor algorithm.
The subordinates would be akin to robots. This assumes that the central
authority is omniscient and omnipotent, signing complete contracts. In the
world of uncertainty, incomplete contracts and discretion (Chapter 2), the
question arises as to whether the discretion should be addressed centrally or
in a decentralised (i.e. participatory) manner. Decentralisation is favoured
by the argument that subordinates will possess relevant information which
the central authority will not also possess (asymmetric information). You
should, however, distinguish between two different ways of addressing
this question (unfortunately, they are often not clearly distinguished
in the literature). First, what we might term the economists’ stance –
decentralisation with suitable incentives in place will bring forth the optimal
provision of asymmetric information – we will refer to this in Chapter
12 as local knowledge. Second, and more of a sociological argument,
decentralisation may satisfy a preference for autonomy and thus enhance
the probability that the subordinate will reveal the information. The latter
argument can suggest more decentralisation than the former.
Even though decentralisation might reveal important information, it always
carries the risk that the granted autonomy it will be used by the agent to
pursue her or his own objectives which are inimical to those of the principal
– the likelihood of so-called control loss (see Chapter 12).
Activity
You might like to read Miller (1992) Chapter 4.
Miller discusses these issues under the auspices of the Sen paradox, which
is rather like the Arrow impossibility theorem. Sen shows that when,
within the boundaries of an organisation, there are at least two agents
that are each decisive over a particular decision, then it is impossible to
guarantee universal domain, transitivity and Pareto efficiency. Miller’s way
of addressing this paradox is to suggest that organisations reduce universal
domain by personnel selection – that is, by making sure agents don’t have
diverse preferences. But this in turn raises adverse selection problems for
the principal. Perhaps the principal might decentralise the selection of
personnel – local knowledge again? But this might lead back to diversity and
interdepartmental conflict, etc. (Lawrence and Lorsch (1967) Chapter 11).
The role that democratic procedure and, more modestly, participation/
power sharing/decentralisation should be allowed to play alongside other
mechanisms to achieve control and coordination of organisations, does not
attract a consensual standpoint neither among scholars nor practitioners.
Some have advocated power sharing/democracy for firms as a matter of
principle, pretty much as political democracy is usually advocated, while
others have sought to find the optimal role in terms of efficiency. It is the
latter perspective that has motivated social scientists of various sorts, but
it is difficult to find strong evidence-based policy promoting the optimal
level of participation versus what we might deem the standard hierarchical
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Chapter 8: Coordination and control: participation and democracy
procedures in achieving control and coordination. Indeed, it is likely that
the impact of participation varies strongly with the cultural environment
in which it is introduced (Chapters 7 and 9). Of course, we are limiting
our perspective to firms, many voluntary organisations adopt extensive
democratic procedures. We shall return to the issue of decentralisation in
Chapter 12.
A reminder of your learning outcomes
Having completed this chapter and the Essential reading and activities,
you should be able to define and explain the following terms and
concepts:
• labour and capital participation in ownership and management
• voting theory.
Sample examination questions
1. Contrast and compare organisations where capital hires labour and
where labour hires capital.
2. What are the limits, if any, of democratic organisation of work groups?
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MN3127 Organisation theory: an interdisciplinary approach
Notes
94
Chapter 9: Organisation change, evolutionary and adaptive approaches
Chapter 9: Organisation change,
evolutionary and adaptive approaches
Aim of the chapter
To understand how we can conceptualise the ways in which organisations
can evolve and change.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to define and explain the following terms
and concepts:
• organisational demography and density dependence
• evolutionary approach to organisational change.
Essential reading
Detailed section references are provided throughout the chapter.
Buchanan, D. and A. Huczynski Organizational behaviour. (London: Prentice
Hall, 2010).
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008).
Further reading
Besanko, D., D. Dranove and M. Shanley Economics of strategy. (New York:
Wiley, 1996).
Carroll, G.R. and M.T. Hannon The demography of corporations and industries.
(Princeton, NJ: Princeton University Press, 2004).
Nelson, R.R and S.G. Winter An evolutionary theory of economic change.
(Cambridge, MA; London: Belknap Press, 1982).
Powell, W. and P. DiMaggio (eds) The new institutionalism in organizational
analysis. (Chicago, IL; London: University of Chicago Press, 1991).
9.1 Introduction
Activity
Start this chapter by reading Sections 10.1 to 10.4 in D and S.
Organisations are established (born); can develop (adapt); are eventually
disestablished (die); can combine with one or more other organisations;
and, sometimes, split into two or more organisations. In developing or
adapting they can change any aspect of their structure or objectives. It is
useful to distinguish between kinematics, which only describe changes,
and dynamics, which explain changes.
D and S distinguish these approaches to dynamics:
• creationist
• Darwinian (evolution)
• Lamarkian (evolution).
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It is important for you to understand the assumptions of these differing
approaches to organisational change.
9.2 Creationism
Given everything that we have studied so far, ‘creationism’ is probably
the natural starting point. Our opening definition of an organisation as
a ‘constructed’ mechanism designed to coordinate and control human
actions and physical and symbolic resources would appear to invite the
study of change in terms of:
• an exogenous change occurring in the external or internal environment
of the organisation
• those who design the organisation calculating how to adapt the
organisation
• the adaptation being implemented (more or less successfully).
Neoclassical economists will explain this adaptation process by
incorporating the precepts of rational deliberation and choice (Chapter 1).
If the implementation is successful, the organisation will quickly attain a
new, efficient (cost-minimising) equilibrium. The study of off-equilibrium
organisations (which in a competitive environment will, in any case,
go to the wall) is regarded as being of little significance. This picture
can be somewhat tempered by introducing ‘search costs’ in finding the
appropriate adaptation and/or introducing satisficing solutions, especially
with complex and rapid environmental changes.
Those economists favouring the behavioural theory of the firm will study
the design and implementation process in terms of the bargaining power
of differing (satisficing) stakeholders. Satisficing may of course not only
lead to a ‘second best’ implementation.
Much of the sociological and psychological study of organisational change
(adaptation) is consistent with the approach adapted by economists, in
the sense that each discipline emphasises the adaptations constructed
by human actors. However, a central issue raised, particularly by
psychologists, is the reaction of humans to change. In adapting an
organisation, those involved (principals or stakeholders) must take
account of these reactions.
Activity
Now read Chapter 18 in B and H. You might also read Chapter 17 though the content of
this chapter is less central.
Chapter 18 of B and H will give you a very detailed understanding of the
reactions of humans to change. It may be worthwhile reading first the
‘recap’ to give yourself an overview. You should pose the question as to
how the mix of control and coordination mechanisms we have studied
could be used to address some of the human responses to change.
At various points in the previous chapters we have encountered
sociological conceptions of organisation change which concern wrangles
over the implementation of differing technologies. It is claimed that
the dynamics of technological change are not solely determined by
efficiency criteria, but rather by the outcome of disputes over retaining
control (power), in particular between labour and management. This
picture is consistent with the behavioural theory of the firm. There is
very extensive, often sociologically inspired, literature examining the
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Chapter 9: Organisation change, evolutionary and adaptive approaches
development of organisational strategies in order to maintain ‘sustained
competitive advantages’ (see Chapter 3 in D and S; and see Besanko
et al. (1996)). Although the details of this literature fall beyond the
boundaries of organisation theory per se, you should recognise that the
art of sustaining competitive advantage is usually a dynamic process as
competitors tend to compete away any current advantages a particular
firm/organisation might possess. You should, however, contrast this
approach with the dynamics of industries and markets with that advocated
by many economists outlined above. There we saw how the details of what
happened out of equilibrium (i.e. before competitive forces have eroded
any competitive advantage) are not deemed terribly important. The
‘theory’ of sustained competitive advantage, however, studies processes
whereby organisations (or their management) try to create, protect and
sustain a ‘non-equilibrium situation’. Managers are always driving for, and
protecting, some form of monopoly.
When it comes to comparing the ‘creationist’ with the evolutionary
approaches, it is assumed that all change is as a consequence of more
or less efficiency-improving choices. There is normally no mechanism
whereby one organisation imitates or ‘inherits’ characteristics from
others. Nevertheless, it is possible to build on such a mechanism (indeed,
the undermining of competitive advantage often takes the form of
emulating successful competitors). Imitation can be construed as rational
when others are clearly successful and search costs are high. Since
imitation is one of the basic mechanisms postulated by evolutionary
models, the line between creation and evolutionary models becomes a
little blurred.
Activity
Now read Appendix 9.1 of this subject guide.
9.3 Darwinian evolution
Darwinian evolutionary mechanisms explaining the dynamics of
populations of ‘species of organisms’ take the following form:
• A population of a species of organisms is born.
• Each inherits at birth various characteristics (genes) determined by the
characteristics of the parent(s) and some random variation.
• Certain characteristics (or combinations of characteristics) give
their possessors an advantage in a (possibly changing) competitive
environment (e.g. competition for food or sexual partners).
• The advantageous characteristics are more effectively transferred to
subsequent generations (e.g. the current generation has more sexual
partners or drives out less ‘fit’ individuals).
• Eventually the advantageous characteristics come to dominate the
population of organisms.
Could ‘organisations’ replace ‘organisms’ in this scheme of things? Some
problems are:
• What constitutes a ‘species’?
• Which characteristics are inherited at birth?
• What is the source of random variation?
• What is the nature of the competitive process(es)?
• What is the inheritance mechanism?
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MN3127 Organisation theory: an interdisciplinary approach
The approach which attempts to answer these queries is largely due to
Carroll and Hannan (2004), which is reviewed in D and S.
The important assumption of organisation demography is that the growth
of a number of types of organisation (i.e. a species) is determined by the
impact of variables upon the birth and death rates. Furthermore, these
variables are in turn caused by the number of the types in existence
(so-called ‘density dependence’). We can use the idea set out in Appendix
1.1 of this guide to picture these mechanisms (see Figure 9.1).
(+)
(+)
(+/0)
Legitimation
Birth rate
(–)
Number of
orgs.
(–)
(+)
Competition
Death rate
(–)
Figure 9.1
Equilibrium will be achieved when the birth rate is equal to the death
rate. Because of the particular non-linear assumptions that are made by
organisational demographers, the birth and death rates can be plotted as
in Figure 9.2.
Figure 9.2
Notice that above N≠ the death rate is greater than the birth rate and
the population will begin to decline. Many populations of organisations
initially grow in an S-shaped manner over time (so-called logistically) and
then eventually decline. In Appendix 9.2, I have shown you how a logistic
curve can be derived from simple density-dependence reasoning.
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Chapter 9: Organisation change, evolutionary and adaptive approaches
9.4 Lamarkian evolution
Activity
Now read Sections 10.5 to 10.9 in D and S.
Whereas Darwinian models picture organisations as adopting a particular
‘form’ at birth and maintaining that form (until death), Lamarkian models
allow the organisation to adapt to a (changing) environment. D and S use
Nelson and Winter, An evolutionary theory of economic change (1982) to
introduce Lamarkian ideas. The key idea is that organisations are bundles
of routines that can adapt when put to use. D and S review this line
of thinking extremely well, so I encourage you to read the appropriate
sections closely.
Activity
Try to construct a qualitative causal diagram to cover Nelson and Winter’s central ideas.
9.5 Neo-institutionalism
Activity
Neo-institutionalism is not adequately covered in either textbook. So read, for instance,
Powell and DiMaggio (1991).
Both Darwinian and Lamarkian models of organisational evolution assume
that organisations operate in a more or less competitive environment.
Indeed, they exhibit inertia and competition and may not find an efficient
equilibrium, but, ultimately, environmental selection plays a role. But
many organisations operate in environments where there is no clear
mechanism for driving out ‘poor’ organisations. Examples might be
schools, hospitals and civic organisations in the public sector. Neoinstitutionalists introduce the idea of an institutional environment which
can determine, at least in part, the ‘structure’ of organisations. As we saw
in Chapter 7, institutions can be conceived as bundles of rules. According
to institutionalists, such (exogenous) institutions can partially determine
the division of labour (along with ‘technology’) and the ‘legitimate’
governance of transactions. We might picture the ideas as in Figure 9.3.
Technology
Divison of
Labour
Governance
Structure
Institutional
Environment
Figure 9.3
Institutionalists go on to distinguish various mechanisms which account
for the impact of the institutional environment upon the governance/
structure of an organisation. DiMaggio calls them isomorphisms and
distinguishes them as:
• coercive, that is, the power of external agents to enforce arrangements
• mimetic, that is, inter-organisational copying
• normative, that is, the incorporation of various stakeholder ideologies.
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MN3127 Organisation theory: an interdisciplinary approach
As with the organisational demographers, institutionalists also tend to
picture organisations as adopting a governance/structure. Thus, according
to the model, unless the institutional environment happens to enjoin
‘optimal structures’ there is no drive towards efficient arrangements.
Activity
To what extent do you think institutionalism is consistent with a rational-choice
interpretation of organisational arrangements?
A reminder of your learning outcomes
Having completed this chapter and the Essential reading and activities,
you should be able to define and explain the following terms and
concepts:
• organisational demography and density dependence
• evolutionary approach to organisational change.
Sample examination question
1. Contrast the assumptions of Darwinian and Lamarkian models of
organisational evolution. Give examples of how different social science
theories have developed these.
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Chapter 10: Vertical boundaries
Chapter 10: Vertical boundaries
Aim of the chapter
To understand the factors that influence the ways in which transactions
on a vertical chain (value chain) should be/are located on the market–
organisation continuum.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to define and explain the following terms
and concepts:
• transaction cost economics
• strategic calculation.
Essential reading
Detailed section references are provided throughout the chapter.
Buchanan, D. and A. Huczynski Organizational behaviour. (London: Prentice
Hall, 2010).
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008).
Further reading
Besanko, D., D. Dranove and M. Shanley Economics of strategy. (New York:
Wiley, 1996).
Coase, R.H. ‘The problem of social cost’, Journal of Law and Economics 3 1960,
pp.1–44.
Grossman, S. and O. Hart ‘The costs and benefits of ownership: a theory of
vertical and lateral integration’, Journal of Political Economy 94(4) 1986,
pp.691–719.
Williamson, O.E. ‘The economics of organization: the transaction cost
approach’, American Journal of Sociology 87(3) 1981, pp.548–77.
10.1 Introduction
As noted in Chapter 1, we may regard the basic unit in organisation
analysis as an exchange or transaction generated in the division of labour.
The division of labour (exogenous/endogenous – Chapter 3) creates a value
or vertical chain; for example as shown in Figure 10.1(a) running from
crude oil extraction to the retailing of petroleum products. In so doing, we
operate at the level of organisations or firms (recognising that at a greater
level of disaggregation the points in the chain are also based on chains
at a finer-grained division of labour) and pose the question as to where
their boundaries should be located on the value chain. In fact the picture
is usually more complex than the one depicted in Figure 10.1(a). Activities
usually depend on inputs at all points down the vertical chain, as depicted
in Figure 10.1(b). So organisations or market exchanges could control and
coordinate each of these transactions. Furthermore, some of these inputs
may be common to the points on the main chain (see Appendix 1.2 in this
guide), like accounting services, in which case the picture looks more like
Figure 10.1(c). Note the use of di-graphs once again (see Appendix 1.2).
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Oil extraction
(a)
Refining



Retailing
Shipping
or pipe


Distribution


(b)





(c)
Accounting









Figure 10.1
In general we are asking the question as to whether a particular
transaction should be internalised (make) or left in the market (buy), as
depicted in Figure 10.2; that is, should any point on the chain be a
department/function/division or remain as an independent organisation.
For the moment we restrict our attention to this simple choice rather than
the more elaborate positioning on the market–organisation continuum
(Chapter 1). We shall return to the more elaborate issue later on.
Market
(price mechanism)
Organisation
Figure 10.2
Start by asking what the benefits and costs of using the market might be.
The benefits could include:
• Independent firms may be able to reap the benefits of economies of
scale (i.e. operate at an output that minimises unit costs) whereas
internal departments may not. Unless the firm itself can absorb all the
efficient output of the department, it must either operate below the
optimal output level or sell on to another firm. This might compromise
any information advantages of the purchasing firm (see below).
• Independent firms are more subject to market disciplines than
departments and may hold down those costs they can control
more effectively. Costs may be difficult to identify in departments.
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Chapter 10: Vertical boundaries
Firms might, though, attempt to replicate market incentives inside
organisations (internal markets). Tapered integration refers to a
situation where a firm is supplied partially by an independent firm
and partially by its own department. This allows their relative cost
structures to be compared.
• Independent firms (i.e. their managers) may have stronger incentives
to innovate when compared with managers of departments.
The costs of using the market might include the following:
• Private information may be leaked to independent firms – particularly
if there is a need to share technical information.
• The focal firm becomes to a degree dependent upon an independent
supplier (depending upon switching costs). Thus the latter has a power
resource (see Chapter 6) and may use it to hold up the focal firm.
• It may prove difficult to control and coordinate flows of goods and
services down a vertical chain of independent firms. This may be
particularly so where there is a need to fit the products closely. ‘Just-intime’ methods seek to overcome this problem and permit independent
firms often with long-term relational contracts (see below).
The way most economists (following Coase and Williamson) think about
the choice between a market and organisational exchange/transaction is
entirely predictable – choose the arrangement that minimises costs. The
innovation here is to introduce the idea of transaction costs – the costs
involved in making (controlling and coordinating) the transaction. They
are sometimes referred to as agency costs, and agency efficiency is found
where they are minimised. So, if both production costs (which relate to
technical efficiency) and transaction costs vary between organisational
transactions and market transactions, then the total costs should be
minimised.
Activity
Now read Chapter 8 in D and S. If you would like to read a slightly more comprehensive
economic approach to vertical integration, then read Besanko et al. (1996).
In a world of fully informed, rational actors where contracting is
complete, there are no transaction costs and the choice between market
and organisational exchange is of no consequence (at least as conceived
within this framework) unless production costs vary (which, again, they
should not under the same assumptions). It is because we relax both the
assumptions of full rationality and full information in the context of ‘real
markets’ (Figure 1.9) that transaction costs arise and the choice between
market and organisational transaction is pertinent. Transaction costs
theory is used both in a normative and positive sense (see Chapter 1).
The new assumptions are as follows:
• Individual bounded rationality: people are intentionally rational
but limitedly so. Individuals are neither able to make very complex
calculations nor to assimilate large amounts of information. As you
might expect, sociologists tend to like this assumption; they see it as
more realistic than the full assumptions of rationality.
• Opportunism: individuals are not only self-interested but behave with
guile. For example, in the context of game theory, individuals will issue
promises which are not credible, make use of asymmetric information
and they cannot be trusted.
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• Contracting about transactions is incomplete because of inherent
uncertainty and incomplete information.
• Contracting can thus lead to ex ante opportunism (namely, adverse
selection) and ex post opportunism (namely, moral hazard).
• These hazards will be exacerbated to the degree that there is little
choice of transacting partners and therefore reputations (see Chapter
7) in respect of third parties will not constrain opportunism – small
numbers exchange.
• Anticipated repeated interaction will make reputations important to
both parties but if in the process there is learning by doing, it is then
costly to later switch exchange partner. Williamson (1981) calls this the
‘fundamental transformation’ – it ties the parties into the relationship.
• Williamson also observes that parties to a transaction might have a
preference for a certain type of transaction in addition to the costs and
benefits. He calls this ‘atmosphere’. In effect Williamson is introducing
wider motives/utilities.
Although the vocabulary introduced by Williamson is rather daunting
at first sight, it has the advantage that it should enable you to link your
thoughts into many of the ideas you have already encountered.
Activity
Think of transactions as a prisoner’s dilemma or trust game. Both parties would like to
contract to achieve Pareto efficiency but each is wary of the other and in the absence of
some mechanism to offset this wariness, the exchange does not materialise – the Nash
equilibrium. So what mechanisms are available?
The mechanisms can be derived as follows. Competitive market – the
price as a sufficient statistic; here the prisoner’s dilemma does not model
the situation. Organisation – three possible mechanisms which can
produce the Pareto-efficient outcome rather than the Nash equilibrium are:
1. Authority and power.
2. Trust (cultural mechanisms).
3. Repeated transaction and reputation effects.
As we have seen in earlier chapters, alongside monitoring and employment
contracts (incentives), we expect organisations to avail themselves of
a mixture of these mechanisms. But note, if we think in terms of ‘real
markets’ rather than the ideal type of perfect markets, then the price
mechanism is not sufficient and perhaps these mechanisms might also
apply at different positions on the market–organisation continuum (see
Figure 1.9). We shall return to these matters later.
Transaction cost economics embraces not only an unorthodox model of
the individual but characteristic aspects (‘dimensions’, to use D and S’s
terminology) of transactions themselves that impact upon the transaction
costs.
Activity
Now re-read Chapter 8 in D and S.
The argument is that asset specificity (sometimes called ‘relation-specific
assets’), uncertainty/complexity of the transaction and frequency of
exchange all increase the likelihood that a transaction will be placed
(governed) inside an organisation (that is, make) rather than left to the
market (that is, buy). Asset specificity comes in different forms:
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• site specificity – adjacent sites, usually in order to economise on
transport and communication costs
• physical asset specificity – e.g. a pipeline delivering crude oil
• dedicated assets – assets of a particular buyer dedicated to a particular
relationship
• human asset specificity – skills dedicated to a particular relationship
which would be less valuable elsewhere.
So, we now have a predictive theory about vertical integration
alternatively labelled contracting out. By and large, empirical evidence
has supported transaction cost theory – particularly the impact of
complexity in the context of uncertainty – though one should bear in mind
what Williamson terms ‘atmosphere’. If there are widespread specific
preferences for organisation – for instance, managers might prefer the
power implied by organisation – this would complicate the picture.
Furthermore, other factors might influence the choice between market and
organisation. Regulation and taxation can confer advantages in deciding
where profits are generated. For instance, taxation might favour small
firms, and firms operating across different national tax regimes may find it
an advantage to contract out. An organisation might vertically integrate to
gain a monopoly or acquire information or to limit the flow of information
to competitors (see below). Given all these possibilities, it is perhaps
surprising that such strong empirical support for transaction cost theory is
found.
Appendix 10.1 in this guide gives a slightly more formal approach to
Williamson’s reasoning.
The transaction costs approach still leaves open two questions:
1. Will the integration, if appropriate, be backwards or forwards?
2. What type of organisation will be preferred – e.g. a centralised or
decentralised hierarchy? (I leave an answer to this question to Chapter
12.)
An extension of transaction costs theory called property rights theory
(which is not covered in D and S) provides an answer to the first question.
When a transaction is internalised within an organisation, then ownership
should (note the normative word) go to the party with the greatest impact
upon the post-contractual rents.
Activity
Although this theory falls beyond this course, you might like to read Grossman and Hart
(1986).
Property rights theory is essentially a theory of bargaining power (see
Chapter 6). Incomplete contracts mean that residual extra-contractual
control of assets is important. Ownership confers bargaining power over
operational decisions when enforceable contracts break down. Anticipation
of post-contractual hazards determines earlier investment decisions.
We now need to complicate the picture by reintroducing the market–
organisation continuum, as in Figure 10.3.
I use the term ‘continuum’ with a certain amount of licence as the
alternative positions on it vary in a number of respects and could
be reordered. The continuum runs from spot markets with perfect
competition, at one end, to integration or organisation, at the other.
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The question now is where should a given transaction be placed on the
continuum?
Figure 10.3
First, look at what I have termed ‘real markets’. Here we recognise that
in the real world the market environment is often far from perfectly
competitive. If the transaction is left to the price mechanism, then various
market distortions may undermine the price as a sufficient statistic. If, for
instance, a supplier holds a monopoly, then backwards vertical integration
may look attractive to a buyer. Likewise, a buyer might be tempted to
vertically integrate backwards in order to acquire information or to reap
benefits of vertical synergies (externalities).
Bargaining was discussed in Chapter 6. Organisations bargain using
their respective sources of ‘power’ though haggling costs usually demote
bargaining to an initial role before a contract is signed. Franchising was
also discussed in Chapter 4.
Long-term contracts (which will inevitably be incomplete) enable
organisations to engage in a protracted relationship. They often occur
between buyers and suppliers in a vertical chain. D and S introduced the
idea of ‘relational contracting’ (an equivalent term). Remember, whenever
you think in terms of contracts you need to think of the incentive, risksharing and information aspects (Chapter 2). Fixed-term contracts put
the risk of, say, increases in input prices to the supplier on the supplier’s
back. Cost plus contracts reverse the situation so that the costs can be
passed to the purchaser. Between these two extremes, various risk-sharing
contracts can be designed. If the buyer and supplier have differing risk
preferences then, other things being equal, an optimal contract can be
found apportioning the risk appropriately. Tapered organisations allow
an input to be provided partially by an internal ‘department’ and partially
by an independent supplier (see below). Alliances are usually based upon
long-term contracts and require a level of mutual trust and integrating
culture (Chapters 7 and 9). Joint ventures take alliances a stage further
by establishing a jointly owned and controlled organisation to control and
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Chapter 10: Vertical boundaries
coordinate the transaction. Joint ventures imply equity contribution from
both the supplier and buyer.
So the question where should a particular exogenously generated (by
the division of labour) transaction be placed on the market–organisation
continuum is the normative question. Alternatively, where is it placed
and why? The positive questions. Transaction cost economics claims to
be both normative and positive and answers both questions. The first
by minimising transaction and production costs! The second by testing
whether a given transaction, with certain characteristics (dimensions) is,
infact, placed to minimise such costs. But as we have seen, this is only part
of the story.
In summary, the choice of the position of any vertical transaction on the
market–organisation continuum in the presence of uncertainty may be
shaped by:
• economies of scale
• anticipated information leakage
• acquiring information
• relation-specific assets, complexity
• residual property rights
• market imperfections
• regulation.
But how are these various strands to be woven together? Unfortunately
there is, as far as I am aware, no embracing theory. Imagine you are
managing a company that manufactures widgets. To achieve this you need
to call on all sorts of inputs ranging from material components to service
functions like accounting, finance and human resource management, as
well as research, development and window cleaning. On the output side,
you need market research, marketing and after delivery service. Which
of these activities should be ‘in house’ and which should you buy in or,
indeed, use one of the other possibilities on the market–organisation
continuum? One extreme possibility might be to contract out everything
and just assemble widgets. Another might be to do everything in house.
Which strategy should you adopt?
10.2 Introducing strategy
The concept of corporate strategy and what many organisation theorists
term strategic choice is deployed to address the complex issues of
framing a response to multiple factors. Indeed, strategy is used in any
situation where a number of ingredients needs to combine. The idea that
organisational arrangements designed to control and coordinate activities
are a matter of choice was first introduced by sociologists in reaction
to an earlier tradition that spoke of ‘determinism’ – often technological
determinism. Economists will always speak of choice where changing
(exogenous) technology might either enhance or restrict the opportunity
set which rational decision-takers face. We might then like to think of
technological determinism when for whatever reason, the opportunity
comprises a single option. I encourage you to think in these terms even if
you want to question the restrictive notion of rationality (see Chapter 1).
B and H introduce you to several authors from Weber and Fayol (whom
we have already encountered) to Burns and Stalker, Lawrence and Lorsch
and Child (all of whom we shall encounter in Chapters 11 and 12), who
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have debated what determines organisation structure. The intellectual
divide is between those who promote ‘one best way to manage’ as against
what is termed ‘contingency’. However, in this debate, the missing idea
(certainly from an economist’s perspective) is efficiency. The question we
should ask from a normative standpoint is: is there one or more than one
best way to manage (controlling and coordinating) resources efficiently
(i.e. in a cost-minimising manner)? Indeed, one would expect the answer
to this question to depend on contingent factors like the environmental
uncertainty, the size and the technology of the organisation which, in
turn, will impact the optimal mix of control and coordination mechanisms
and then ultimately the organisation structure (see Chapter 12). Be this
as it may, there may conceivably still be more than one ‘efficient’ way to
structure an organisation given its contingent context. If we were to view
this issue in game theoretic terms then there may be multiple equilibrium
among what one may choose. Also from a positive perspective the
appropriate question is whether or not, and perhaps why, an organisation
departs from an efficient equilibrium.
The debate about ‘strategic choice’ is thus sharpened by invoking
some economic thinking. As we have repeatedly observed there is no
inconsistency here between the economists and other social scientists’
ways of thinking.
It should be noted that Child (1984) interprets strategic choice as a
matter of managerial power. Indeed, there is no reason not to invoke the
behavioural theory of the firm (Chapter 6 again) in the context of strategic
choice. But we should, from a positive perspective, always ask, does the
power driven structuring of the organisation produce an efficient structure
or does it reflect, for instance, managerial or other preferences (see
Chapter 11)?
Activity
Now read Chapters 9 and 16 in B and H.
These chapters cover issues of strategic planning that impinge upon
organisation theory but which are more often encountered in courses
on management theory. You will benefit from reading the chapters but
a detailed analysis of strategic thinking is not central to this course.
The central idea in management theory concerns the sources of what
is termed sustained competitive advantage (SCA). Why do some
firms/organisations manage to sustain a better performance than their
competitors, while operating in the same markets? Statistics tend to
suggest that this is a common experience in many markets. Firms often
earn above-average returns (loosely rents) on their assets over relatively
extended periods of time. The assumption is that they have some
characteristics (but which?) that their competitors find it difficult to
replicate or improve upon, at least during the time in which the advantage
is sustained. From an organisational theory point of view the question to
ask is – are there ways of organising which can confer SCA? Notice that
when an organisation possesses a competitive advantage, for whatever
reason, then this implies that perfect competition is not operating. In so
far as those running organisations seek SCA, they are trying to undermine
competitive forces. The early sections of D and S’s chapter show how
game theory is an indispensable tool in studying competitive strategies. So
should SCA be derived from a clever approach to vertical contracting?
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Chapter 10: Vertical boundaries
10.3 Vertical contracting and strategic choice
Consider a transaction between B and S, as in Figure 10.4. The problem
is to design a contractual relationship to gain any possible rents. In terms
of competitive advantage this amounts to placing the transaction on the
market–organisation continuum more effectively than the competition.
Assume that there is need for relation-specific assets and a complete
contract cannot be signed because of inherent uncertainties. Suppose now
that B would like to persuade S to make the relation-specific investment.
S’s ex ante problem is that in the absence of trust and credible promises,
they anticipate that, once the investment is made, B will take advantage of
the situation. S anticipates that B will always be able, once the contract is
entered into, to find contingencies not covered by the contract. By making
the investment S, in effect, confers bargaining power upon B – who may
even use this power to renegotiate the original contract (attempt to reduce
the price of the good or service exchanged). S will then anticipate these
moral hazards and accordingly not invest; the transaction will fail and
both S and B will be less well off than they could be. Thinking in terms of
the (for the moment, one-shot) prisoner’s dilemma, S and B find a Nash
equilibrium rather than the Pareto-efficient outcome. So what can be done
to achieve the Pareto superior outcome?
S B
Figure 10.4
Some possibilities (neither exclusive nor exhaustive) are:
• B makes the relation-specific investment (but then B confers bargaining
power to S)
• B and S make a joint investment – an alliance or joint venture
• S continues to make the investment but enters into a long-term
contract with B (note that relation-specific investments tend to imply
long-term relationships in the first place)
• forward or backward integration (here non-market incentives/
monitoring/authority/power/culture achieve the move from the Nash
equilibrium to the Pareto outcome).
But let us continue to assume that B wants to find a non-integration
solution and still to encourage S to make the costly upfront relationspecific investment. They might do this in the recognition that S, as an
independent organisation, may be relatively small, flexible and focused.
Furthermore, S may be driven by a more entrepreneurial spirit than if it
were to be a division or department in B’s ‘bureaucracy’. An independent
S may be more innovative. Also small organisations tend to have lower
labour costs (production costs). If so, then both S and B can benefit. The
strategic problem is whether or not the transaction costs (ex ante and
ex post) can be kept down while reaping these potential advantages. To
offset S’s anticipated moral hazard problems, B needs to search for ways
of reducing their own and increasing S’s relative bargaining power. To the
degree that this proves possible, the strategy will offset S’s anticipated
moral hazards. B needs to make themself more dependent upon S
before the contract is signed. One notable way they can secure this is
to decentralise some design and innovation responsibilities to S. B now
becomes partially dependent upon S. Furthermore, B can commit not
only to a long-term contract but also to relatively unconditional contract
renewal. These strategies do of course put B at some risk. But since we are
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thinking in terms of incentives to transact, you should by now recognise
that risk-sharing is another aspect of the possible contracts between S and
B that can be subjected to strategic reasoning.
Not unreasonably, I think, assume that S is risk-averse and B is risk-neutral.
So, S will accept a reduction in rent in order to reduce their risk and,
relatively speaking, B will be prepared to shoulder more risk. So, a risksharing, long-term contract can conceivably lead to a Pareto improvement:
think in this respect in terms of post-contractual price negotiation. With
a fixed-cost contract any increase in S’s costs will be borne by S. S will be
reluctant to sign such a contract. With a cost-plus contract, on the other
hand, B will bear all the risks of S’s cost increases. Furthermore, S will
have no incentives to hold costs down nor, perhaps more importantly,
to innovate in order to reduce costs. Clearly, B wants S both to innovate
and, where possible, to hold down costs. It is not in B’s interests to take
the risk from S and undermine these incentives. How can they provide
appropriate incentives while reducing S’s risks and in so doing make the
contract interesting to S? What B needs to do is to accept those risks of
cost increases which S cannot control while making S responsible for those
they can control – a tricky business. B needs to know the nature of S’s cost
structure (an information problem – no problem with full information
but with information asymmetry it is another story) before they can
achieve this. Of course, integration might dispel this problem but then we
encounter the bureaucratic losses mentioned above. What can B do?
Go back to your principal–agent model (see Chapter 4). We can regard B
as a principal and S as an agent. P (B) can acquire information by having
more than one agent (S) operating in the same environment (in practice
this is not easy). This is called multiple sourcing. It could be achieved
by either multiple external sourcing or having an in-house comparator
(tapered sourcing). But, of course, one needs to ask whether B’s
sourcing requirements are of sufficient magnitude to reap any economies
of scale across the multiple sources. If not, would it be sensible – from an
information leakage point of view – to allow the sourcing organisation
to sell to other organisations on the open market? If B has decentralised
design to S then this might prove hazardous.
As we have observed, long-term relationships (see Chapter 8) can invoke
trust and reputation effects. Traditionally it was assumed that one of the
advantages of integration into an organisation derives from the repeated
interaction effects. B and S being in the same organisation, they repeatedly
interact and, indeed, they will assume that there is a high enough
probability that they will once again interact in the future. Thus prudent
calculation can overcome the moral hazards in incomplete contracting. In
game-theoretic terms B and S may play TFT (the folk theorem). B may also
wish to protect her/his reputation for fair play. In short, an organisation can
control and coordinate vertical relations by cultural means.
However, long-term contracts with a continuation clause also produce
repeated interaction (the Japanese were largely responsible, in the 1980s,
for recognising this) and, thus, reputation and trust can be generated at
other points on the market–organisation continuum. Cultural mechanisms
can operate outside formal organisations. If B and S can trust each other
not to behave opportunistically, then the advantages of S’s independence
and reduced transaction costs can be realised.
Finally, reverting to an extended value chain where S’s suppliers are also
brought into the picture, we obtain the situation as in Figure 10.5.
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Chapter 10: Vertical boundaries
R
S
B
Price and market
R
S
Long-term contracts
B
R
S
B
Organisation span
of coordination = 3
Figure 10.5
Should the whole chain be coordinated by integration (span of
coordination) or perhaps coordinated by long-term contracts, etc.? If the
latter, should B contract with S and R or should B contract with S and
S with R? In either case we have examples of network organisation and
even virtual organisation if the relationships are mediated by modern
information technology. The strategic complexion of these sorts of
organisations is little understood. Why don’t you have a go!
Reading B and H (Chapter 17) will give you a slightly different, more
descriptive, take on the issues of vertical integration and outsourcing.
The chapter in B and H also covers some aspects of the next chapter in
this guide – horizontal boundaries. The authors’ categories are, however,
entirely consistent with our above analysis. ‘Hollow organisations’ are
those which outsource all but their core activities, though it is sometimes
difficult to decide what these are.
‘Modular organistions’ rest upon a technology whereby the product can
largely be assembled from prefabricated components. These may be
fabricated in either internal divisions or external organisations (suppliers).
The latter may, however, be located anywhere on the market–organisation
continuum depending upon the strategic calculations outlined above.
‘Virtual organisations’ is a rather vague term used to describe the currently
evolving possibilities afforded by information technology, enabling quasiindependent organisations to coordinate their activities, usually involving
long-term contracts of one sort or another. The emergence in recent years
of virtual organisations has prompted the observation that the simple
equation of markets with competition and organisations with cooperation
is an over-simplification. Groups of semi-autonomous organisations can be
partially competitive with each other and partly collaborative (sometimes
called coopetition).
I hope that this section has given you some appreciation of how to analyse
organisation choices from a genuinely strategic point of view. Much of the
above reasoning can be underpinned from a game-theoretic standpoint.
This further supports my earlier contention that modern organisation
theory often requires a knowledge of strategic thinking and game theory.
A reminder of your learning outcomes
Having completed this chapter and the Essential reading and activities,
you should be able to define and explain the following terms and
concepts:
• transaction cost economics
• strategic calculation.
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Sample examination question
1. Explain why a transaction should be placed in a market or an
organisation.
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Chapter 11: Horizontal boundaries
Chapter 11: Horizontal boundaries
Aim of the chapter
To understand the factors which lead an organisation to adopt a
multidivisional structure.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to define and explain the following terms
and concepts:
• related diversification, unrelated diversification and locational
diversification
• evolution of the multidivisional firm.
Essential reading
Detailed section references are provided throughout the chapter.
Buchanan, D. and A. Huczynski Organizational behaviour: an introductory text.
(London: Prentice Hall, 2010).
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008).
Further reading
Burns, T. and G.M. Stalker The management of innovation. (Oxford: Oxford
Unversity Press, 1994).
Chandler, A. Strategy and structure. (Cambridge, MA: MIT Press, 1962).
Lawrence, P.R. and J.W. Lorsch Organization and environment. (Boston: Division
of Research, Harvard University, 1967).
Teece, D. ‘Towards an economic theory of the multiproduct firm’, Journal of
Economic Behaviour and Organisation 3(1) 1982, pp.39–63.
11.1 Introduction
We now turn to an analysis of the control and coordination of horizontal
activities, to the so-called horizontal boundaries of the firm. Activities
are described as horizontal when organisations/firms produce products/
services for more than one output market. We can still pose the question
as to whether two or more activities should be (normative question)
or in practice are (positive question) left to the market or brought into
a closer relationship. Conglomerates comprising a number of divisions
often operating in diverse markets are the prototypical case of horizontal
integration. They are described as diversified.
Activity
Now read once again the section on diversification in Chapter 9 of D and S.
11.2 Diversification
It is useful to distinguish between:
• related diversification
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MN3127 Organisation theory: an interdisciplinary approach
• unrelated diversification
• locational diversification (D and S refer to ‘multinationalisation’).
Diversification
A production process exhibits economies of scale if the average cost of a
unit of output decreases as the total output increases. The average cost
curve usually initially declines with volume of output and then either goes
flat or increases. Firms/organisations like to operate at a volume of output
which minimises average unit costs.
A production process exhibits economies of scope, across two or more
products, if the total cost of producing them in a single firm/organisation
(or by some hybrid position on the market–organisation continuum)
is lower than if they were each produced separately by a single firm/
organisation. Such economies usually arise from spreading indivisible
fixed costs across an increasing volume of total output. You can, therefore,
see straightaway that economies of scope may provide a rationale for some
form of integration. But we still need to know how scope economies can
arise in the first place. As D and S show, they can always be traced to a
common production input and are, therefore, really based upon vertical
relationships of one sort or another.
So economies of scope can originate at any position in a production
process or, if you prefer, on a value chain – indeed, given Figure 10.1,
it might be better to say at any point on the value tree. And remember
that these structures (di-graphs) can be depicted at different levels of
aggregation. The origin of economies of scope can conveniently be thought
of in terms of linking value trees which terminate in two (or more) distinct
products (markets), as in Figure 11.1. Note also that the marketing
‘function’ in this figure could also be combined to reap any economies of
scope in marketing.
Unique
input
Joint
input
Unique
input


Marketing product 1

Marketing product 2



Figure 11.1
Economies of scale and thus, potentially, of scope may be found in
production or certain disaggregated aspects of production; or research
and development; or marketing; or purchasing, and so on. A given vertical
chain/tree (generated by the division of labour) with certain activities
which cannot achieve economies of scale is a potential candidate for
linking to another chain/tree (perhaps at multiple points) and, thus,
for related diversification. Potential economies of scope are sometimes
referred to as synergies.
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Chapter 11: Horizontal boundaries
Since related diversification is always a disguised form of vertical
integration, some of the motives noted in the previous chapter can affect
the situation. One should still ask the question, where synergies exist,
why the activity that is to be shared across different products should lead
to horizontal integration rather than to some other arrangement on the
market–organisation continuum. Again, one should think, as in Chapter
10, in terms of minimising the sum of transaction and production costs.
Those activities which produce outputs which are difficult to trade in
markets or quasi-markets are clear candidates for internalisation and
related diversification. D and S emphasise specialised indivisible physical
assets, technological and organisational know-how and brand names (this is
sometimes called umbrella branding).
Activity
You might like to read Teece (1982), p.3.
Unrelated diversification
Many diversified companies appear to integrate activities where it is difficult
to identify any economies of scope. This can arise for two principal reasons.
First, as D and S argue, diversified companies may be able to allocate
financial resources among different activities more effectively than a capital
market. This, once again, is a form of vertical integration finding economies
of scope/synergy in financial provision. Second, it may be that diversification
is driven by managerial objectives rather than maximising shareholder value.
For instance, managers’ returns are often related to the size of the company
they run (see Section 11.4).
Locational diversification
D and S use the term ‘horizontal multinationalisation’. Here the firm
produces the same product in different parts of the world. It has
geographically distributed divisions. What is the advantage of these divisions
being part of the same firm?
The obvious answer is in terms of the product they market, but again a
licencing arrangement is also a possibility.
The important thing to recognise about horizontal integration is that the
combination of two or more activities into the same organisation does not
arise because there is a direct transaction between them, but rather because
there are transactions elsewhere in the vertical chains/trees in which they
are embedded. Indeed, many modern organisations are best viewed as
complex networks of transactions, which are placed at differing points on
the market–organisation continuum.
11.3 Sociological and psychological approaches
Sociologists and psychologists have taken a rather different but
complementary approach to understanding diversified organisation
structures.
Activity
Now read Chapter 16 in B and H.
Like all of the chapters in B and H, this one contains a lot of detail, and it
strays into the subject matter of our next chapter. Despite the detail it tells
a story of how thinking about large complex organisations (read ‘vertically
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integrated and diversified’) has developed from the early work of Max
Weber. We have already encountered Weber’s concept of a bureaucracy
and the central role he ascribed to rules (or contracts). A summary
follows.
How Weber’s concept of a bureaucracy has developed
• Weber thought that bureaucratic structures, as he defined them,
provided the most efficient way of organising. They were based on
formalised rules/contracts and rational bureaucratic authority (Chapter
6). In proposing this to be the case, he lay the foundations for the idea
that there is ‘one best way of organising’ (I don’t think he actually used
this phrase). Note that the idea that there is one route to success is
quite consistent with the economists’ common assumption of a unique
equilibrium (see Chapter 10).
• Following Weber, early management theorists like Fayol also tended to
look for universal organisational principles that would be optimal in
all situations. Fayol’s six principles (forcasting, planning, organising,
commanding, coordinating and controlling), can clearly be seen as
ingredients of control and coordination as we have developed them
in the previous chapters. However, they have a strong ‘top-down’
flavour, characteristic of the time that they were penned, which fails
to recognise the complexity of the various control and coordination
mechanisms we have identified.
• However, despite the continued importance of bureaucratic structures
even to this day, it became recognised that they can be dysfunctional/
inefficient (read ‘bureaucratic costs’ in D and S). Thus bureaucratic/
classical management procedures may not always provide optimal
control and coordination. In addition, the behavioural theory of the
firm (Chapter 6) cautions us to recognise that a simple assumption
of top-down directives may not reflect the political realities of an
organisation. Questions of when this is so and what are the alternatives
naturally arise. However, some scholars, such as Robins and Leavitt,
have drawn attention to the persistence of underlying bureaucratic
procedures, despite the overwhelming advocacy of flexible,
decentralised and participatory structures among many theorists. It
may be that large organisations tend to be more bureacratic (though
recently the average size of organistions has declined), and also
modern information technology can be used to bolster centralised
bureaucratic control and coordination. Scholars are rather divided in
this latter respect, some seeing information technology as facilitating
decentralisation. Perhaps it is a matter of power as to how it is used?
Furthermore, with the emergence of networks of organisations
coordinated along the market–organisation continuum, simple sizemeasurement calculations have to be treated with caution.
• Studies by researchers like Woodward, Thompson and Perrow1
suggested that rather than there being one best way to organise, the
arrangements depended upon the production technology. Optimal
organisation is thus described as contingent upon the production
technology. In particular, Thompson pointed to the interdependence
between stages in the production process as a ‘determining’ factor.
You should link this to vertical integration and economies of scale
and scope. Unfortunately, these early researchers were not as explicit
as they might have been in specifying that it is in organisations that
are optimally organised that the fit between the contingent factor
and the type of organisation structure will be found. We will examine
116
1
These are referred to in
your Essential reading;
please see the list of
references in B and H.
Chapter 11: Horizontal boundaries
alternative organisational structures (hierarchical boundaries) in
Chapter 12.
• If the production technology partly constrains the choice by successful
organisations of their organisation structures, then perhaps there are
other factors playing a parallel role. B and H suggest environment,
size, diversification and internationalisation (for which read ‘locational
diversification’).
• Environmental dynamism (many other terms are used, like
‘turbulence’) is seen as a contingent factor which renders bureaucratic
structures inappropriate. However, I encourage you, for the sake of
conceptual parsimony, to use the standard term uncertainty. In
Chapter 1 (Figures 1.7 and 1.8), we noted that as uncertainty increases
then rules/contracts become incomplete and discretion increases. Nonbureaucratic structures become appropriate as discretion increases.
As we shall see in Chapter 12, organisations (and other positions on
the market–organisation continuum), are as much discretion-handling
mechanisms as they are rule-bound bureaucracies.
• High complexity transactions (recall the use of this term in transaction
cost economics in Chapter 10) and uncertainty together tend to favour
‘organic’ non-bureaucratic as opposed to ‘mechanistic’/bureaucratic
structures. Again I encourage you not to use any new words (Burns and
Stalker, 1994). It is sometimes said that we may distinguish between
bureaucratic and non-bureaucratic cultures. If indeed we can, then one
would expect less bureaucratic structures to emphasise commitment
and trust mechanisms perhaps alongside participation in designing the
optimal mix of control and coordination mechanisms.
• However, if entire organisations need to adapt to their uncertain and
complex operating environments, why not take the story one stage
further and recognise that different departments/divisions/functions of
any organisation may each separately face environments with differing
levels of complexity/uncertainty; for example, production and research
and development departments? So some departments will optimally
need to be more non-bureaucratic or bureaucratic than others. These
departments/divisions will nevertheless need to integrate into a
coherent organisation and may encounter difficulties (transaction
costs) in so doing (Lawrence and Lorsch (1967)).
I suggest that you make a serious effort to synthesise the economic with
the sociological and psychological perspectives introduced in this chapter.
As you will have appreciated in reading Chapter 16 in B and H, various
scholars have provided a plethora of descriptive concepts, all of which
have some face-value and probably fit your intuitions about organisations.
However, you should not, as with other chapters in this textbook, believe it
is important to commit all these to memory.
11.4 The development of diversified companies
The evolution of multiproduct horizontally integrated firms from earlier
multifunctional firms is beautifully recounted in Chandler (1962).
Although you can pick up the threads of this story in the two textbooks
for this course, I would encourage you to read Chandler’s book. The
centrepiece is the evolution, in the middle of the twentieth century, of the
large conglomerates with many divisions (either product or regional),
each organised functionally (buying, production, marketing, etc.). At
their height, in the 1960s, some of the giant conglomerates had scores
of divisions and vertical spans of over 20 layers. Up to that period most
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of the advanced industrial economies shared a pattern of increasing
concentration (for instance, GNP/firm increased). After about 1975,
however, GNP/firm began to decline in most OECD economies, as
conglomerates began to ‘focus’ on a more limited range of products and to
vertically ‘contract out’ rather than integrate. Joint ventures and alliances
also became much more common.
Interestingly, the research on conglomerates, even that conducted in the
1960s and 1970s, tended to suggest that they were by no means efficient.
Research compared the performance of divisions of conglomerates with
independent firms in the same line of business. So it remains a puzzle
as to why conglomerates gained the prominence they did. It appears
that the justification used by those who promoted conglomeration was
that they could allocate resources and spread risk across divisions. In
particular, they could switch resources from divisions/markets with a poor
growth potential into those with better prospects (the Boston Consulting
Group matrix – see B and H – played a significant role in this thinking).
Subsequently, however, the line of thinking has been called into question
and it is now generally held that the capital market is a better allocator
and risk-bearer than the ‘internal capital allocation’ procedure of large
multidivision firms. Hence the concept of focus and the current relative
predominance of related diversification where ‘non-financial synergies can
be found’.
Managerial returns (salaries, bonuses, share options) greatly increase
with the size of firms, controlling for profitability. Some analysts have,
therefore, seen the drive to large multidivisional firms (e.g. through
takeovers and acquisitions) as part of ‘managerial capitalism’ representing
the interests of management as opposed to shareholders. Yet others
have suggested, in a contrary spirit, that managerial skill is scarce and
‘outstanding’ managers can more effectively spread their impact across
a number of integrated divisions rather than separate firms (sometimes
called ‘dominant managerial logic’).
A reminder of your learning outcomes
Having completed this chapter and the Essential reading and activities,
you should be able to define and explain the following terms and
concepts:
• related diversification, unrelated diversification and locational
diversification
• evolution of the multidivisional firm.
Sample examination question
1. What justification can there be for horizontally integrated firms?
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Chapter 12: Hierarchical boundaries
Chapter 12: Hierarchical boundaries
Aim of the chapter
To understand why most organisations adopt a hierarchical structure.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to explain the:
• nature of hierarchy
• factors that determine the shape of hierarchies.
Essential reading
Detailed section references are provided throughout the chapter.
Buchanan, D. and A. Huczynski Organizational behaviour. (London: Prentice
Hall, 2010).
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008).
Further reading
Alchian, A.A. and H. Demsetz ‘Production, information costs and economic
organization’, American Economic Review 62(5) 1972, pp.777–95.
Blau, P.M. and R.A. Schoenherr The structure of organizations. (New York: Basic
Books, 1971).
Chandler, A. Strategy and structure. (Cambridge, MA: MIT Press, 1962).
Williamson, O.E. ‘The economics of organization: the transaction cost
approach’, American Journal of Sociology 87(3) 1981, pp.548–77.
12.1 Hierarchies
Although the control and coordination of activities within organisations is
sometimes achieved by non-hierarchical mechanisms, most organisations
– even democratic ones – adopt some sort of hierarchy for these purposes.
The answer to the question as to why this should be the case might
seem obvious to you, but it is nevertheless worth asking. We might
reasonably assume that whatever mechanism is adopted, it should
minimise administrative costs (agency costs) while maintaining control
and coordination of its constituent activities. But before we consider these
issues, it is useful to have an understanding of the nature of a hierarchy
itself. A very simple one is pictured in Figure 12.1. Notice that hierarchies
are naturally depicted as graphs (see Appendix 1.2 of this guide).
Activity
You might like to re-read Section 3.3 in D and S at this stage; also read Chapters 15 and
17 in B and H.
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MN3127 Organisation theory: an interdisciplinary approach
Figure 12.1
The quantities defined in Appendix 12.1 are:
• the overall size (N)
• the spans of control (S)
• the depth (sometimes called the vertical span but this can be confusing
as the word ‘vertical’ is also used to refer to vertical integration) (L)
• the administrative component (A) (see Appendix 12.2 of this guide)
• the size of the bottom hierarchical level (n).
So in Figure 12.1, N = 8; S = 2 (twice) and 3; L = 3; A = 3; and n = 5.
Appendix 12.1 gives an elementary introduction to the mathematical
interrelationship of these concepts. Each link (arc) in a hierarchy
represents a relationship between a superordinate and a subordinate. The
number of the latter to the former is a span of control. It is worth recalling
that these relationships are complex amalgams of:
• incentives
• monitoring
• power (directives)
• culture
• participation.
As we have seen, they are sometimes described as providing channels
where information flows up and commands flow down. In this respect, the
links have directed features and are accordingly depicted as di-graphs.
12.2 Some properties of hierarchies
Hierarchies have some useful properties which help to explain their
frequent occurrence.
First, they always contain (N – 1) links (arcs). Check this for yourself.
Second, a hierarchy is connected. That is, there is always a path of arcs
between every pair of nodes in any hierarchy. Notice in Figure 12.1 that
the far right node is connected to the far left node by a path of four
arcs running through the top node. It would seem to be a requirement
of an organisational hierarchy that it be connected. If any node were
disconnected, then how could it be regarded as part of the organisation?
Third, a hierarchy achieves connection using a minimum number of (N –
1) symmetric arcs. In fact, on N nodes there are N(N – 1)/2 possible arcs
(see Appendix 1.2 of this guide). Such a complete structure, where every
node is connected by a single arc to every other node, is also obviously
connected. You will have read in both B and H and D and S that ‘small’
organisations often have a ‘peer group’ structure where everybody is in
a face-to-face relationship with everybody else and there is a minimum
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Chapter 12: Hierarchical boundaries
of hierarchical structuring. Perhaps you should think in terms of an
evolutionary process as N increases – see Figure 12.2.
Number
of Arcs
(Relationships)
N(N-1)/2
Peer group
N-1
Hierarchy
N Size
Figure 12.2
When N is below about 10, then a peer group with very little hierarchical
structure is possible and probable. Since there is often likely to be a leader
or entrepreneur, we could think in terms of a simple two-level organisation
with a span of control of N – 1 and where all these ‘subordinates’ are
in symmetric relationships. As the number of relations (arcs) in a peer
group increases with N squared, then above about N = 10, hierarchy
becomes attractive, maintaining connectivity with only (N – 1) hierarchical
relations. As Figure 12.2 indicates, the ‘saving’ in relationships by
substituting a hierarchy for a peer group becomes progressively more
dramatic as N increases. If you regard relationships designed to control
and coordinate activities as costly to maintain (agency costs), then a
hierarchy (ceteris paribus) is a cost-minimising structure.
It is useful to refer to a hierarchy as the formal structure but, of course,
relationships develop between nodes outside the formal hierarchy. You
should often regard these as comprising the informal structure, though
extra-hierarchical relations can be used in a formal command sense (see
below). The relationships may be very varied but extra-hierarchical
‘communication’ is particularly important.
Across-span relationships
Within-span relationships
Across-level relationship
Diagonal relationships
Figure 12.3
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Such relationships may be categorised as in Figure 12.3:
• within-span horizontal relationships (these are the source spans of
coordination: with a span of s there are a potential s(s–1)/2 symmetric
relationships (s(s–1) directed relationships). The span of coordination
is the number of actual relationships. So, for instance, a production line
will normally have a span of coordination of (s–1)
• across-span horizontal relationships: Note that these relationships have
at least a common superior at a second level in the hierarchy above the
level of the relationship. This procedure in practice often amounts to
the coordination of departments (Figure 2.4 below). For instance, in
Figure 12.4(b) the ‘second line supervisor’ controls and coordinates two
‘departments’
• across-level hierarchical relationships: Although hierarchies are
usually depicted without across-level links appearing, in practice, if
A is B’s formal superordinate and B is C’s then we naturally assume
that transitivity holds and A is also a superordinate of C (Chapter 6).
Thus, when thinking of organisations as controlled and coordinated
by power and authority, across-level hierarchical relationships are
usually assumed, indeed, running from the top of the hierarchy to
its bottom. Needless to say such across-level relationships can prove
to be extremely problematic in the politics of organisations. For an
organisation to be controlled and coordinated effectively it is probably
important that not only is power transitive, but also authority.
• across-level diagonal relationships.
One would, of course, expect fairly dense (indeed complete) within-span
relationships in most organisations.
Hierarchies are non-cyclic and each pair of nodes at any level has a least
common superior. The absence of cycles prevents ‘commands’ going
around in cycles and a least common superior designates a formal superior
point at which conflicts among subordinates may be resolved.
You should draw a number of simple hierarchies and convince yourself
that they always possess the properties I have described. Begin to think
of an organisation as a hierarchy of formal command-and-control
relationships upon which various other (informal) relationships might
develop, some of which may be essential in maintaining functional control
and coordination of the activities within the organisation. The phrase
‘informal structure’, you should be warned, is used in many different
ways. You might like to think in terms of the degree of bureaucracy or
hierarchy of an organisation that would be measured by the proportion of
functional relationships (i.e. those that maintain control and coordination)
which follow the formal hierarchy in an organisation. Organic or nonbureaucratic organisations introduced in Chapter 11 would no doubt
evidence a relatively low level of hierarchy as measured.
12.3 Constructing a hierarchy
The way you might think about constructing an organisational hierarchy is
as follows:
• Assume that the division of labour has generated a vertical chain
(value chain) of size n (e.g. the number of workers in a production
line) and this is to be located within an organisation or on the market–
organisation continuum).
• Assume that the organisation is to be controlled and coordinated
hierarchically.
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Chapter 12: Hierarchical boundaries
• One possibility then is to construct an organisation of two levels and a
span of control of n (Figure 12.4(a)).
• An alternative would be three levels with spans of control of n/2 and 2
(Figure 12.4(b)).
• Our intuition is that, other things being equal, the former arrangement
would involve fewer agency costs (a smaller administrative structure).
But would it control and coordinate activities as effectively?
• Note that hierarchies are built from spans of control/coordination;
they are the basic building blocks. Thus, what determines spans of
control is of central interest to us. But remember that this is not going
to be an easy question to answer since spans provide the locus for the
interplay of control and coordination by incentives, monitoring, power,
participation and culture.
• Notice also that, given n, the smaller the spans (s), the deeper the
organisation (i.e. the greater L) and the higher is N and, thus, the
administrative component A = N – n. Conversely, increasing spans
will reduce the number of levels, the size of the organisation and the
administrative component.
(a)
(b)
n
n/2
n/2
Figure 12.4
These simple observations provide a clue to a fundamental problem in
organisation design. The way (neoclassical) economists would express it is
as follows:
Decrease the span of control to the point where the marginal
gains in control and coordination equal the marginal costs in so
doing.
A concise statement but difficult to compute. It is essential to realise that
as spans come down, suggesting closer monitoring – which might further
suggest greater control and coordination – then depth (levels) goes up.
But as depth goes up, the risk of control loss goes up. Let us look at this
more closely.
Consider Figure 12.5, which depicts a ‘line’ of depth three in a hierarchy.
Attach probability numbers to each arc indicating the proportion of the
activities of the subordinates which contribute to the superordinate’s
objectives (we take a top-down view). Assuming that these probabilities
are independent of each other, their product will indicate the proportion
of the lowest member’s activity which will contribute to the uppermost
member’s objectives. If both proportions are unity then there will be no
control loss. But assume now that both are 0.9 – then only 81 per cent of
the activities will contribute. The control loss is 19 per cent. Add another
layer; then the figure (still assuming that the probabilities are all 0.9) is 72
per cent, with a control loss of 28 per cent.
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P1
P2
Figure 12.5
So, in building an organisational hierarchy one has to balance the gains in
control and coordination (attributable to intensity of monitoring resulting
from small spans of control) with any potential losses resulting from
control loss resulting from the consequential increased depth (L). Add to
this the possibility that people might react differently and display different
cultural attitudes towards intensity of monitoring, and you begin to
appreciate the difficulties of designing an optimal organisational hierarchy.
Chapter 15 of B and H provides an extensive list of factors, which they
claim determine spans of control. It is worth looking at these and relating
them to the way we are, and shall be, analysing the determinants of
spans. Remember how important this issue is, as hierarchies are ultimately
constructed from spans (‘who reports directly to whom’). The following
reasoning will apply (ceteris paribus) to each factor impacting spans in the
direction suggested.
• Similarities of tasks: clearly, if the tasks (jobs) of subordinates are
rather homogeneous then one would expect, other things equal, that
the optimal span can increase. This will be attributable to a reduction
in the time/effort/attention needed to monitor the activity of each
subordinate.
• Geographic proximity: again the monitoring costs (time/effort/
attention) will increase with distance and spans will reduce, but
modern information technology may be offsetting this problem.
• Subordinate characteristics: B and H interpret the characteristics as
competence and assume (implicitly) that subordinates can, without
impairment of control and coordination, take on decentralised
responsibilities. Thus, monitoring costs (time/effort/attention) can
drop and favour increased spans. But to draw this conclusion one
must assume that control-loss is not exacerbated by decentralisation of
responsibilities to skilled subordinates (Chapter 8).
• Interaction requirements: This refers to what we have termed
‘span of coordination.’ One might expect the greater the number of
relationships/transactions that have to be coordinated, the lower the
optimal span. However, this is not quite correct. It is the interaction of
the complexity of the structure of interaction links and uncertainty that
impacts upon span. If the transactions can be routinised/standardised
(i.e. with low uncertainty and relatively complete contracts/rules) then
the impact on spans should be small.
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Chapter 12: Hierarchical boundaries
• Standardised procedures: a typical example here is the standardisation
incorporated in Taylorism which we have already encountered.
Standardisation increases the optimal span (Chapter 2).
• New problems: this is best conceived as entailing uncertainty and, thus,
discretion (Chapter 1). Thus as uncertainty and discretion increase
the optimal span will drop unless control and coordination can be
maintained by decentralisation/participation.
• Knowledge gap: here once again the time/effort/attention needed
to monitor will increase with the magnitude of the gap between the
superordinate and subordinate and the optimal span will drop.
• Task complexity: the complexity of the subordinate’s task will increase
the time/effort/attention in monitoring and thus reduce the span.
• Manager’s job: the more time/effort/attention a superordinate spends
upon activities other than monitoring lower the optimal span.
• Planning and coordination; this is covered by span of coordination.
I have rather belaboured B and H’s list of factors to try and demonstrate to
you how systematic social science will attempt to transcend the descriptive
detail proposed by these authors by coining a small set of concepts to
cover the detail. The key concepts and their interrelationships will be
developed below.
12.4 Empirical relationships
We have already reviewed (Chapter 11) the evolution of large complex
organisations, which is best analysed by Chandler in his Strategy and
structure (1962). Chandler provides a story of the interplay between
economies of scale and scope and the quest for synergies (unrealised
economies of scope). The market for corporate control has in many
countries supported this quest though it may have be driven, particularly
in the period when conglomerates were much in evidence, by managerial
interests in running large organisations. Though now, under the impetus of
ideas about shareholder value, the emphasis is on focused organisations.
Organisation theorists have also studied the connection between the
overall size of organisations (usually the number of employees) and
various aspects of their internal structure. The most general finding is that
as size increases, bureaucratic features increase but at a declining rate.
The Aston studies were instrumental in establishing these sorts of results.
Furthermore, many other internal features display a rather similar
pattern with size. Blau and Schoenherr (1971) is the seminal text. They
found empirically that the differentiation of organisations into sub-units
(departments, divisions, etc.) increases at a declining rate with size. Others
have found that L (the number of levels) is similarly related to N (and n).
Figure 12.6 depicts some results from several studies. Note that this result
implies that the average span must increase with size. (In Appendix 12.3,
I show why these results are found.)
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Number of levels in the hierarchy
MN3127 Organisation theory: an interdisciplinary approach
1,000
2,000
3,000
Total number of employees
Figure 12.6: Variation in number of levels with size of organisation: trends from
three samples. (Studies by D.S. Pugh and colleagues, 46 Midlands organisations
of different types, data collected 1962–4; Alfred Kleser, 51 West German manufacturing companies, data collected 1970–1; John Child, 82 British manufacturing
and service companies, data collected 1967–9.)
Activity
Now re-read Chapter 16 in B and H; and Appendix 12.3 in this guide.
This basic relationship between size and various organisation
characteristics is now so well established that any theory must be
capable of explaining why. As we noted in Chapter 11, many of the
studies unfortunately failed to incorporate efficiency into the picture.
It is not clear whether or not poorly performing and better performing
organisations exhibit different patterns of relationships.
12.5 Designing organisations
The time has come to try to pull together our reasoning about the design
of organisations. We started this subject guide with a definition of
organisations as follows:
Organisations are constructed mechanisms for controlling
and coordinating human activities and symbolic and physical
resources in order to achieve certain objectives.
Although our studies might persuade us to modify some of the key
ingredients of this definition, it has guided us well throughout the
preceding pages. I have attempted to draw the threads together in Figure
12.7. I published a version of this many years ago but it still seems to me
to serve well. Note that it is an example of the sort of diagram I encourage
you to make use of in Appendix 1.1. Such diagrams are, I believe, useful
when there are multiple theories about a complex reality which are
currently difficult to combine into a grand integrating theory.
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Chapter 12: Hierarchical boundaries
Figure 12.7
Our starting point, in the company of D and S, is the exogenously
given division of labour. Lacking this, there is little need for exchanges/
transactions and, thus, markets or organisations of any sort. The division
of labour (within limits; see Chapter 2 of the subject guide) increases
specialisation and productivity, which, in turn, liberates possible
economies of scale. It does seem sensible to take the division of labour as
given (exogenous), though organisations could conceivably be designed to
generate a particular division of labour (i.e. making the division of labour
endogenous, see Chapter 2).
Let us assume that the division of labour and economies of scale determine
the optimal size of the ‘labour force’ – or n, as we have designated it.
So we pose the question – how should the organisation be constructed
to coordinate and control the activities and the physical and symbolic
resources of these n ‘actors’? Our reasoning at this juncture could be
applied to a situation where the n actors are individuals (e.g. a vertically
integrated production line), or n vertically related production stages, or n
horizontally related divisions. If we are going to find a general perspective
(or eventually a general theory), then it should operate in this way. I shall
use the phrase ‘n activities’ to cover the various possibilities.
We assume that the organisation operates in an uncertain environment
and, therefore, inevitably enters into incomplete contracts with its various
stakeholders. Again, uncertainty is central. In its absence, the choice
between market and organisation is indeterminate. Note, however, that in
Figure 12.7 the uncertainty variable is not exogenous; there is a negative
feedback link running from the size of the organisation to uncertainty. This
captures the idea whereby larger organisations are able to reduce, though
not eliminate, the uncertainties in their operating environments. There is
good empirical evidence for this.
Uncertainty generates discretion – the control and coordination of
activities that are not explicitly covered by enforceable contracts/rules.
Discretion raises issues of pre-contractual and post-contractual hazards
– adverse selection and moral hazard. I shall use the terminology of PA
theory (see Chapter 4), though the ideas go well beyond the current
achievements of the theory.
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MN3127 Organisation theory: an interdisciplinary approach
The division of labour generates what I have generically called
interdependence. This term covers:
• relation-specific assets (Williamson, Chapter 10)
• economies of scope (synergies) (Williamson, Chapter 10)
• team production externalities (Alchian and Demsetz, Chapter 10).
Interdependence is best interpreted as an asymmetric relationship even
though the work flow might be directed (Thompson).
It is the interaction of discretion, generated by uncertainty, and
interdependence which drives organisation design. As discretion and
interdependence increase, the use of complete contracts/rules declines.
Rules are associated with formalisation and standardisation, namely,
routinisation; the classical Weberian bureaucracy (Taylorism/Fordism).
So, by derivation, as discretion increases, bureaucracy declines (organic
organisations become effective (Burns and Stalker, 1994)).
Organisations are thus mechanisms both for allocating and monitoring
discretionary activities, and setting and monitoring contracts/rules. The
degree to which discretionary activities are determined by the n agents is
indicative of decentralisation. The degree to which discretionary activities
are determined is directed by a Principal (P) then the organisation is
relatively centralised. For the moment, we consider a two-level (L = 2)
organisation.
The level of decentralisation of discretion is determined by three main
variables, as depicted in Figure 12.7. First, the risk of control loss:
if discretion is decentralised then there is always a risk that the agent’s
activities will not contribute to the objectives of the principal. To use
Williamson’s term, there will be an ever-present danger of sub-goal
pursuit. Thus, other things being equal, the risk of control loss will induce
principals to centralise discretion.
Decentralising discretion in the context of interdependence is particularly
risky. Consider the situations depicted in Figure 12.8.
(a)
P
μ
μ
(b)
P
μ
inventory
μ = uncertainty
Figure 12.8
In Figure 12.8(a) we have a case of unrelated horizontal integration. The
uncertainty in supply for each agent is separate (independent) and the
risks of control loss to P, on decentralisation, are independent. Contrast
situation (b): here, if decentralisation at the left agent leads to control
loss, this can be transmitted to the other agent. The risks are accordingly
multiplied. If an inventory between the agents can be established then the
risks are reduced, though inventories designed to hedge against hold-up
are expensive.
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Chapter 12: Hierarchical boundaries
The second variable affecting the level of decentralisation is what I have
termed ‘value of local information’: if the risk of control loss suggests
centralisation then local knowledge possessed by agents – particularly
implicit/tacit knowledge – suggests the reverse. To make optimal use of
local knowledge, P will need to decentralise discretion to his/her agents.
Think of an operating division geographically remote from a headquarters
which has a detailed understanding of local market conditions. There is
thus a tension between the risk of control loss and local knowledge.
The third variable is time to process at P. Assume P decides to
centralise all the extra-contractual discretion generated in their span of
control; then P may encounter another problem. The more discretionary
issues are passed up the line to P, the slower they may be in processing
the information and passing down a solution/directive. This suggests
decentralisation which will lead to increased monitoring. The problem can,
however, be partially obviated to the degree that P can build ‘staff’ support
to enhance their information-processing capacity; though P might in turn
encounter control loss problems in respect of the staff function. Note that
the ‘staff at P’ cycle in Figure 12.7 provides a stabilising negative feedback
cycle (see Appendix 1.1 of this guide).
As decentralisation of discretion increases while maintaining control
and coordination, we would expect spans of control to increase. It is,
however, extremely difficult to predict spans of control. They seem to vary
across organisations which otherwise look rather similar. So far we have
examined organisations as mechanisms for allocating extra-contractual
discretion and procuring effective monitoring such that the activities of
agents should contribute to the principal’s objectives. In earlier chapters,
however, we saw how incentives, bargaining power and culture are also
ingredients in coordinating and controlling activities. It is these factors
which make for the variability in spans. Unfortunately we have no theories
which integrate all of these considerations.
If incentives could be devised to guarantee that decentralised discretion
would be used to contribute to the principal’s objectives, then spans could
be large and organisations flat. Indeed, as we saw, franchising, which
might be regarded as an extreme form of decentralisation, and, ultimately,
competitive markets do provide these incentives.
Spans can also provide a location for (bargaining) power relations. If
P and the agents in P’s span – either immediate span or cascaded span
down the line – have resources to bargain about the nature of contracts
and the disposition of discretion, this can have a profound impact upon
organisation design. Agents may, for instance, resist close monitoring and
curtailment of discretion. The consequences of bargaining processes are
extremely difficult to anticipate. Devolved power may or may not be used
to promote the principal’s objectives. The behavioural theory of the firm
becomes an appropriate analytical framework.
Finally, what I have generically termed ‘culture’, which covers a number
of mechanisms, can impact on spans. If, for instance, a principal can trust
both the ability and motivation of agents to utilise decentralised discretion
to the principal’s benefit, then spans can be expanded. If norms either
external to or generated within an organisation affect agents’ activities,
then this can either be supportive of the principal’s objectives or not, with
consequent implications for the intensity of monitoring. Altruism and
commitment can have similar effects.
The basic building blocks of hierarchies, spans of control, cascaded
spans and spans of coordination are subject to a bewildering number of
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conflicting constraints. But returning finally to Figure 12.7, whatever
it is that shapes spans, they and the optimal size of the lowest level in
the hierarchy (n) jointly determine the value of L – the number of levels
(this is a mathematical relationship), the administrative component (A)
and the size (N) of the organisation. Note that as L increases, we expect
control loss to be exacerbated. The negative feedback running from size to
uncertainty also delivers (with suitable parameters) the major empirical
finding that differentiation or depth increases with size but at a declining
rate (see Figure 12.6).
A reminder of your learning outcomes
Having completed this chapter and the Essential reading and activities,
you should be able to explain:
• the nature of hierarchy
• the factors which determine the shape of hierarchies.
Sample examination questions
1. What factors influence the spans of control and coordination in an
organisation?
2. Under what circumstances would you expect a ‘bureaucratic structure’
to prove effective? Explain why.
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Chapter 13: Is there one best way to organise?
Chapter 13: Is there one best way to
organise?
Aim of the chapter
To understand whether one can conceive of a general theory of
organisation.
Learning outcomes
By the end of this chapter and having completed the Essential reading and
activities, you should be able to explain:
• the role of efficiency/effectiveness in organisation theory
• the significance of differing business systems.
Essential reading
Douma, S. and H. Schreuder Economic approaches to organizations. (London:
Prentice Hall, 2008) Chapter 11.
Further reading
Campbell, J.L., J.R. Hollingsworth and L.N. Lindberg Governance of the
American economy. (Cambridge: Cambridge University Press, 1991).
Roberts, J. The modern firm. (Oxford: Oxford University Press, 2007).
Whitley, R. and P. Kristensen (eds) The changing European firm. (London:
Routledge, 1996).
13.1 Introduction
As we have seen at various points in our studies, organisation theorists see
their intellectual quest as one of delivering prescriptions about the best
way to organise – some would even say the ‘one’ best way. Organisation
theorists are often asked to provide an answer to the question, ‘How
should activities be controlled and coordinated?’ with the expectation
that the answer will centre upon the best/optimal arrangement.
At the outset, we should recognise that the optimal way to organise
will be dependent upon the organisational socio-cultural-political and
technological environment. Optimal arrangements (if they can be found –
see below) will depend, in various ways, upon the values and knowledge
that people bring to organisations. Therefore, we should reformulate the
opening question as: in a given (exogenous) environment, is there one
best way to organise? Furthermore, particularly in the modern world,
environments may themselves be rapidly changing.
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13.2 Efficiency and effectiveness
Most economists have a clear way of reasoning about optimal
arrangements – efficiency. Organisational resources, they aver, are used
efficiently if they are allocated between and within organisations, i.e. on
the market–organisation continuum, so that they are put to their most
productive use (a given amount of production/output is achieved using a
minimum of resources/inputs). If, furthermore, these inputs and outputs
can be translated into monetary units, this amounts to finding the leastcost arrangement.
Economists also assume that the performance function relating
performance to the choice of input in an environment is concave. This
almost guarantees that there is a unique maximum, and when the choice
is not at the maximum, then any improving moves will always take the
organisation in the direction of the maximum. If, however, the assumption
does not hold (increasing returns, etc.), then the search for the maximum
will not be as straightforward.
We have noticed that it is important to distinguish between the normative
and positive use of the efficiency criterion. This enables us, in principle,
to answer questions about how organisations should be arranged and
are, in practice, actually arranged. I say ‘in principle’ for in practice it is
often not easy to describe the optimal (i.e. first-best) arrangement within
organisations. Although not usually as explicit as (neoclassical) economists
about issues of efficiency, Weber, the early management theorists,
Taylor and the disciples of scientific management were all engaged in
finding productive ways of organising. Economists (with some notable
exceptions) also evoke the competitive forces surrounding organisations
as an (ultimate) selection mechanism, driving out less efficient and
selecting cost-minimising arrangements. There is, however, plenty of
room within this framework for organisations to exhibit significant
levels of inertia, particularly in highly complex, uncertain and rapidly
changing environments. Institutional environments may also apply a
brake to the evolution towards efficient arrangements. Furthermore,
even if competitive conditions are entirely absent, the quest for efficient
arrangements does not disappear.
There is, thus, significant common ground amongst the various
approaches to ‘organisation theory’, enabling us to interpret the disciplines
as a normative and positive search for efficient ways of controlling and
coordinating activities with symbolic and physical resources. There are
organisations where efficiency constraints do not play a central role
– churches, recreation clubs, certain often democratically organised
voluntary organisations – but even these usually have a side where costs
are central to organising their administration. Many people-processing
organisations (churches, hospitals, prisons) may not at first sight appear
to invite ideas about efficient (cost-minimising) use of resources. But at
a deeper level they do. In effect, the product and consumer are one and
the same. So, the organisation (e.g. a hospital) needs to be efficiently
organised in order to provide a given level of service/treatment to its
patients. Similarly, for a church, mosque, etc., the allocation of pastoral
care and other experiences is central in allocating the priest’s time, etc.
In my view (and I have to express a personal view here, as in the final
analysis, many would disagree with me), the efficient use of resources
should be at the centre of organisation theory. Some sociologists, in
the recognition that narrow views of economic efficiency ignore some
‘resources’ which cannot be given uncontroversial monetary values, have
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Chapter 13: Is there one best way to organise?
urged that effectiveness be distinguished from efficiency. This seems
sensible to me. However, as we have noted at a number of points in the
preceding chapters, it is important to acknowledge that when transactions
are brought within the boundaries of the firm, it does not follow that
such an arrangement is necessarily ‘first-best’ efficient; rather only that
the costs are less than those associated with market transactions. It is not
at all clear that the competition between organisations procures a firstbest solution. It is relatively easy to specify the market conditions which
enhance efficiency but when it comes to the complexity of organisational
structures the story is very different. Perhaps all we can say about interorganisational competitive forces is that they will select ‘more efficient’
forms, not necessarily the most efficient – not even ‘ultimately’, whatever
that might imply. This makes room for factors other than efficiency
in determining organisational arrangements (the mix of control and
coordination mechanisms). We will return to these issues below.
Activity
Now read Chapter 11 in D and S.
13.3 Comparison of models
Figure 11.3 in D and S cross-classifies the various economic theories of
organisation. You might like to add some of the sociological theories you
have encountered. The classification raises an important issue about the
nature of differing ways of studying organisations and how they might
impinge upon the quest for the best way to organise.
Until quite recently, most models of organisation were static in nature.
The difference, however, between economics and other disciplines was
that economic models were formulated so that factors under study were
conceived as being in a steady state or equilibrium. Sociological models,
on the other hand, were not so constrained. Consider, for example, the
relationship between an organisation’s size (see Chapter 12) and its
internal differentiation into units of one sort or another (Figure 12.6).
These studies were conducted by sociologists and appear to find an
interesting non-linear generalisation which is robust across samples and
countries. But two questions arise. First, does the relationship only hold
for organisations that are, in some sense, at an efficient equilibrium
(profit-maximising, cost-minimising)? Appendix 12.3 of this guide adopts
this perspective. Second, does the internal differentiation adapt to size
instantaneously? If so, no problem will arise with static cross-sectional
studies as long as we record the performance of the organisations and seek
the connection between the variables among equilibrated organisations
only. This might sound rather trivial, but we find authors arguing (see
below) against the proposition that there is a best way to organise on
the basis of empirical diversity. But the diversity may represent variables
that have not equilibrated or where some organisations are (temporarily)
not operating at efficient levels. This seems to me to provide a further
justification, as we attempt to construct an interdisciplinary approach, for
giving efficient/effective use of resources a pivotal position in our thinking.
I want you to think hard about this.
The recognition that competitive forces appear not to have driven
organisations to a homogenous pattern of control and coordination has led
some researchers to look for different national or even regional ‘business
systems’.
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Activity
You might like to read some of the following: Campbell et al. (1991); Whitley and
Kristensen (1996).
In your earlier reading, you will have encountered descriptions of the
Anglo-Saxon, the Japanese, the Italian industrial districts, and so on. Some
authors have used rather abstract-sounding terms, but the usual point is
that a number of characteristics of these seem to go together, notably:
• different types of ownership (banks, equity, states, cooperatives, etc.)
• collaboration between firms or lack of it
• the role of organised labour (degree of trade union penetration)
• the regulation of markets (particularly capital and labour)
• production processes (Fordism/post-Fordism/flexible specialisation)
• varying labour skills (human capital)
• institutional environments.
Two important questions arise:
• Are the different systems converging, particularly with the advent of
globalisation, or will diverse systems persist?
• Are certain systems likely to disappear altogether?
We would expect more efficient systems to eventually triumph even
if inertia and received institutional environments inhibit the process.
However, different systems may be nearer to optimal in differing socialpolitical-institutional environments, which may not change quickly.
We do not really understand these issues and with rapid technological
innovation the future is not predictable in any case. Even if we cannot
envisage the future, we can adopt ways of thinking about it which are
intellectually productive. The sorts of lists that those who describe
‘business systems’ may hold because the various factors complement
each other in delivering levels of performance in a particular cultural/
institutional environment. The idea that successful organisations are
bundles of complementary assets (human, physical and symbolic) which
are controlled and coordinated should be at the centre of your thinking.
I conclude with two alternative production systems (see Figures 13.1
and 13.2) adapted from Roberts (2007), which may well show complex
patterns of complementarity.
Activity
Try to work out how you think the various aspects of organisations depicted in Figures
13.1 and 13.2 complement each other (i.e. the presence of one enhances the productivity
of another).
Specialised machinery
Long production runs
Infrequent product changes
Narrow product line
Mass marketing
Low worker skill requirements
Specialised skill jobs
Central expertise and coordination
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Chapter 13: Is there one best way to organise?
Hierarchic planning and control
Vertical internal communication
Sequential product development
Static optimisation
Accent on volume
High inventories
Supply management
Make to stock, limited communication with customers
Market dealings with employees and suppliers
Vertical integration
Figure 13.1: Characteristic features of mass production.
Flexible machines, low set-up costs
Short production runs
Frequent product improvement
Broad product lines
Targeted markets
Highly skilled, cross-trained workers
Worker initiative
Local information and self-regulation
Horizontal communication
Cross-functional development teams
Continuous improvement
Accent on cost and quality
Low inventories
Demand management
Make to order, extensive communications with customers
Long-term, trust-based relationships
Reliance on outside suppliers
Figure 13.2: Characteristic features of modern manufacturing.
A reminder of your learning outcomes
Having completed this chapter and the Essential reading and activities,
you should be able to explain:
• the role of efficiency/effectiveness in organisation theory
• the significance of differing business systems.
Sample examination question
1. Will globalisation lead to a single best way of organising?
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Notes
136
Appendix 1.1: Qualitative causal diagrams
Appendix 1.1: Qualitative causal
diagrams
You should learn some conventions about diagrams like the one depicted
in Figure 1.1 in Chapter 1. They are often useful in summarising the
relationships between a number of concepts (variables).
In Figure 1.1 there is no arrow coming into the division of labour – which
is therefore described as exogenous. We do not ask (at least at this
stage of our enquiries, though we may later) how the division of labour
is caused/determined – it is given. It is always important in developing
theories to be explicit about what is taken as given (i.e. exogenous).
Economists are better at observing this injunction than sociologists.
The variables ‘specialisation’ and ‘productivity’ are, on the other hand,
described as endogenous because we do (if the diagram is correct), at
least in part, have an explanation of what determines them.
The (+) sign on the arrow between the boxes (variables) means that
as the first variable increases (decreases) in value, the value of the
second variable increases (decreases). Unless it is otherwise stated, the
relationship is assumed to be linear. A (–) sign (there is no such sign
in Figure 1.1) implies that as the value of the first variable increases
(decreases), the value of the second variable decreases (increases). Note
that D and S do not place signs on their diagrams but they are assumed to
be positive (+). A (+/–) sign indicates a non-linear relationship initially
positive then negative. A (–/+) sign depicts a non-linear relationship first
decreasing then increasing, A =/0 depicts a non-linear relationship first
positive then a plateau (maximum).
You should satisfy yourself that in a chain of arrows the overall
relationship (i.e. between the first and last variable) is positive (+) if,
either, all the constituent arrows are positive (+) or there is an even
number of negative (–) arrows. It is negative otherwise.
Whereas much economics is expressed in mathematical equations where
it is easy to trace chains of reasoning, you will find that much sociology
and psychology is not so expressed. Then it is often useful to construct
diagrams depicting the signs and patterns of hypothesised relationships.
In complex diagrams it is possible to have more than one path of arrows
between a pair of variables. We shall also encounter such diagrams.
The diagrams might have cycles (see Appendix 1.2) which are feedback
(positive or negative) processes.
These sorts of diagram are used in system dynamics and causal path
models. Figure 12.7 is a good example of a causal diagram.
Further reading
If you are interested, you might like to read Richardson (1991).
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Notes
138
Appendix 1.2: Network analysis – an introduction
Appendix 1.2: Network analysis – an
introduction
Network theory and graph theory are equivalent terms.
Definition of a graph:
G = {N; R}
Where
N = a set of points (nodes) usually finite
R = a set of pairs of points (N  N).
An example: lines below are sometimes called arcs.
b
a
d
e
c
So, N = {a, b, c, d, e}
R = {aRb, aRc, bRd, cRd, dRe}
• Note that here the relations (R) are always symmetric; (for example, if
aRb then bRa).
• An example would be ‘who interacts with whom’ on a set of individuals.
Notice that not all the points interact (for example, e and b).
• Note that the position on the page of the nodes has no significance, but
the way a graph is presented may well be visually important.
• A graph can always be depicted as a matrix. The above graph would
have an (associated) matrix as follows:
a
a
b
1
c
1
d
e
b
c
d
e
1
1
0
0
0
1
0
1
0
0
1
1
1
1
where 1 indicates the presence of a relation and 0 its absence.
Note that the matrix is symmetric about the main diagonal. This follows
from the relationships (for example, interaction) being symmetric.
• We can add direction to relations – then we define a di-graph, as in
the following examples.
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Di-graphs
• The left-hand di-graph is in the form of a hierarchy and the arc/
relations may represent ‘has formal authority over’.
• The right-hand di-graph might depict who sent a message to whom.
• Di-graphs can also be depicted as matrices but, in general, they will not
be symmetric.
• We could add ‘loops’ to both graphs and di-graphs. That is ‘selfrelationship’. They would appear down the diagonal in the associated
matrix.
• The above graphs and di-graphs only register the presence or absence
of a relationship between a pair of nodes. However, ‘interaction’ or
‘sending a message’ may lend themselves to measures, for example,
intensity, duration, frequency, etc. We would then attach the measure
to the arc and place it in the appropriate cell in the associated matrix.
These are then called valued graphs (or valued di-graphs).
Some properties of graphs and di-graphs
Further reading
All the following properties can be defined precisely and formally. If you want to study
these definitions then see Wasserman and Faust (1994).
Completion
A graph (or di-graph) is complete if all the possible arcs are present.
On a graph of N points there will be N(N – 1)/2 symmetric relations. The
degree of completion is the proportion of the possible arcs present.
Connectivity
• A graph is connected if there exists a path of arcs between all pairs
or nodes. A path is a sequence of arcs.
• A complete graph is connected but a connected graph is not necessarily
complete. Connection is important for flows of information.
• A di-graph is strongly connected if there exists a directed path (i.e.
following the arrows) in both directions between all pairs of nodes.
• A di-graph is weakly connected if there exists a directed path in at
least one direction between all pairs of nodes.
In-degree/Out-degree
In-degree in a di-graph is the number of arcs coming into a node. The
out-degree is the number of arcs going from a node. Nodes in a graph
have the same in- and out-degree.
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Appendix 4.1: A simple principal–agent model
Appendix 4.1: A simple principal–agent
model
Consider a principal–agent relation.
P wants an optimal incentive contract. What should s/he do? A simple way
of thinking about the problem is as follows.
• Assume P and A are profit/income/utility maximisers,
• Assume A’s input is effort (e)
• Assume A has an available alternative to contracting with P (outside
option/opportunity cost etc), A0
So we are talking of ‘voluntary contracting’.
• Assume both P and A are risk-neutral (make sure you know what
this means).
The agent A’s production function is given by: Q = e + 
where
Q is output
e is effort (unobservable by P)
 is a random variable with expectation of zero.
•
You may imagine  as representing all those factors beyond both
A’s and P’s control which impact (sometimes positively, sometimes
negatively, on the average zero) upon A’s output.
So E(Q) = e
(1)
• Assume the agent A finds exerting effort as costly to him. Further, that
increasing effort is increasingly costly. (Note: some psychologists/
sociologists don’t like this assumption at least for low levels of effort –
people ‘like’ exerting effort in certain circumstances.)
• Assume (rather unrigorously) that A’s cost function has the following
form:
CA = e2
(2)
(e measured in income equivalents)
• P will attempt to motivate through:
• a fixed (time) wage rate (W)
• a variable commission on output (Q) (presumably with a quality
constraint).
But what is the optimal combination from P’s and A’s point of view?
• Assume P offers a ‘linear contract’ whence:
A = W + Q – CA
(3)
A = W + Q – e
2
(4)
So, from (1), A’s expected profit:
E(A) = W + e – e2
(5)
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A’s optimal effort level e is then given by:
dE (ΠΑ )
= β - 2αe≠ = 0
de
(6)
so, e = /2
(7)
A sets effort level independently of W. (So why W?)
A’s effort is proportional to  (PBR). But what value of ?
P wants optimal effort from A by adjusting W and .
The total ‘profit’ (revenue) from the contract (assuming price of Q = 1) is:
R = Q – e2
(8)
P’s profit p is given by:
p = Q – e2 A0
E(p) = e – e2 A0
(9)
(10)
(from equation (1)).
P will maximise E(p) with respect to A’s effort:
dE (Πp )
= 1-2 αe = 0
de
(11)
The effort level which P wants (eP) is:
1
ep = 2
So, eP = e when = 1
(12)
(by comparing (12) with (7))
This may be regarded as rather surprising. Optimally P has to give the full
residual profit to A.
So how will P make a return in this abstract setting?
• P will seek a fixed payment for ‘franchising’ the job to A.
• P will choose (-W) to make
W – e – e2 = A0
when  = 1
1
and e = 2
Compare this result with those in D and S. In this framework ‘wage rates’
(W) will arise when A is relatively risk-averse and would prefer a fixed
wage rather than a variable return.
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Appendix 5.1: Introduction to decision theory and game theory
Appendix 5.1: Introduction to decision
theory and game theory
Decision theory
Decision theory is one way of analysing decision situations. Game
theory extends the idea of decision theory to situations where two or
more decision-makers interact.
Decision theory usually involves a single decision-maker facing a series of
options (actions) each of which leads to outcomes with attached payoffs
with certain (subjective) probabilities. We start by analysing a simple
decision.
The basic idea is to:
1. construct a decision tree
2. attach some value (payoff) to the ‘outcomes’ indicated by
decision tree
on the
3. estimate the best (expected) outcome.
A decision tree is best introduced by an elementary example, as shown in
Figure 1.
Payoffs of
outcomes
0.25
7.0
0.50
10
5
0.25
8
7.0
2.0
0.25
10
0.25
4
0.25
0.25
-2
-4
Figure 1: Decision tree.
The decision-maker must choose between Action 1 and Action 2.
Some conventions
This shape is called a decision (or action) node:
This shape is called a probability node:
Lines (arcs) from action nodes are actions available at that node.
Lines (arcs) from probability nodes are beliefs by the decision-maker about
the probability of the outcomes. The probabilities sum to unity at each
node. Outcomes are exclusive.
Payoffs are the monetary values of the outcomes to the decision-maker.
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The probability nodes are labelled with the respective expected payoffs
(see below).
Note: The payoffs are those which the decision-maker attaches. Another
decision-maker may have different payoffs. In more advanced theory
payoffs are often measured in terms of utility.
The probabilities may be objective or the subjective estimates of the
particular decision-maker.
The question that now arises is this: which action, 1 or 2:
1. Should the decision-maker choose (normative theory)?
2. Will the decision-maker choose (positive theory)?
If the decision-maker is rational, 1 and 2 should be the same.
Use expected value theory as follows:
• Expected value of Action 1
= (0.25)(10) + (0.50)(5) + (0.25)(8) = 7.0
• Expected value of Action 2
= (0.25)(10) + (0.25)(4) – (0.25)(2) – (0.25)(4) = 2.0
The decision-maker will/should choose Action 1: that is, it maximises
expected payoff.
Notes:
1. Could have many actions at the decision node.
2. Two or more actions may have equal expected value (then indifferent
between them).
3. The probabilities might be subjective estimates; then maximise
subjective payoff.
Game theory
Game theory extends decision theory to situations where decision-making
(by a number of decision-makers) is strategically interdependent.
By strategically interdependent we mean:
• the outcomes of one player’s decisions are dependent upon the
decisions of the other player and vice versa
• therefore, players need to take account of others’ decisions in making
their own decisions if they have an interest in the outcomes and are to
influence them accordingly.
The basic elements of a game are:
• players (individual/collective), at least two
• moves
• strategies
• outcomes
• payoffs.
These will become clear as we proceed.
Some basic distinctions in game theory
Non-cooperative and cooperative theory:
• cooperative theory assumes that communication and binding
(enforceable) agreements (contracts) can be secured between players.
• non-cooperative theory makes no such assumptions.
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Appendix 5.1: Introduction to decision theory and game theory
It is usually accepted that non-cooperative theory is fundamental
since cooperative games can be reduced to non-cooperative games (by
modelling the establishment of binding agreements).
One-shot and repeated games:
• in the one-shot situation a game is played once
• repeated games are played more than once – perhaps an indefinite
number of times.
We shall, in this introduction, only consider one-shot situations, though
repeated games are central to organisation theory.
Assumptions of rationality
Game theory usually starts by assuming rationality. By this is meant:
• players maximise expected return (utility)
• players assume that others playing are also rational
• players assume that others assume they are rational, and so on.
There are two alternative ways of depicting the structure of a game:
• games in extensive form
• games in normal (or strategic) form.
Extensive-form games
We start by introducing the basic idea of games in extensive form. They
are best introduced by elementary examples. Consider first a situation
where two players, P and A, decide upon a joint venture. Each has two
possible actions (moves):
1. to cooperate (involving costs)(c)
2. to slack (reducing costs)(s).
We can model an interdependent decision tree, as shown in Figure 2 below.
Outcome
c
c
Both cooperate
A
s
P
s
P cooperates
A slacks
c
A cooperates
P slacks
s
Both slack
A
Figure 2: Interdependent decision tree.
The tree is almost self-explanatory. P is described as the first mover and
A as the second mover. Games could be much more complicated with
repeated moves and, indeed, more than two players. In this simple model
both P and A have two moves (s and c each). It should be clear to you that
players could have any number of moves and, indeed, different sorts of
moves.
The tree gives, as it were, the logically possible combinations of moves and
the outcomes are described here in an obvious manner; they derive from
tracing the ‘path’ through the tree. As the model stands, however, we can
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MN3127 Organisation theory: an interdisciplinary approach
make no predictions without some idea of the preferences of P and A over
outcomes.
So we now assume, not unreasonably, that the outcomes are valued as in
Figure 3 (payoffs).
c
c
P
A
3
3
1
4
4
1
2
2
A
s
P
c
s
A
4>3>2>1
s
Figure 3: Game 1.
This is the same situation as above except that the ranking of the outcomes
for both P and A are now included. So, for instance, P’s best outcome
(scored 4) is to slack and for A to cooperate. This is known as a non-zero
sum (or variable sum) game because the payoffs for any outcome are
not such that what one player gains, the other loses (we assume for this
idea that the numbers not only rank the outcomes but can be added and
subtracted).
The question now is, what will happen in this simple situation? The basic
idea is to think forwards and reason backwards, although this does not
always work.
Now A will choose s whichever node he or she is at. This is because s is
known as a dominant strategy for A, being the choice at both nodes.
P will then choose s because 2 > 1.
ss is what is termed the Nash equilibrium. It is the prediction of what
rational decision-makers will choose. P can think ahead and note that A
will choose s, and will thus also choose s.
A Nash equilibrium is a combination of strategies (one for each player)
which has the property that no player has an incentive to choose another
strategy if the other players also choose their Nash strategies. This
game has one unique Nash equilibrium (both slack). Note that the cc
combination could make both players ‘better off’. Both would acquire 3
rather than 2 units of value. cc is the Pareto equilibrium, though ss is
the Nash equilibrium. Much of organisation theory is concerned with how
to move interactions from the Nash to the Pareto equilibrium.
This game has a number of noteworthy characteristics.
1. It is a game of complete information. Roughly speaking, this means
that both players know the structure of the game (the tree) and each
other’s payoffs. Imagine what might happen if the players did not know
each other’s payoffs.
2. It is a game of perfect information. This means that the players
know what choices have been taken in the past (the history of the
game). So A knows whether P has chosen c or s. Note that if P (by
mistake, shall we say) chose c, then A would still choose s (and receive
4 units of value).
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Appendix 5.1: Introduction to decision theory and game theory
3. You should satisfy yourself that the same outcome (Nash equilibrium)
will result if A is the first mover rather than P. There is no first-mover
advantage.
Now consider what might happen if the ranking of the outcomes changed
as shown in Figure 4.
P
A
c
c
3
3
2
4
4
2
1
1
A
s
P
c
s
A
s
4>3>2>1
Figure 4: Game 2.
What will happen now? You should think forwards, reason backwards.
A will choose s at the upper node and c at the lower node.
P will anticipate this and choose s.
(s,c) is the Nash equilibrium.
If A moved first, s/he would get the 2,4 result (a Nash equilibrium).
There is first-mover advantage.
Again, this is a game of:
• complete information
• perfect information.
We will now consider games with imperfect information. Consider Figure 5.
c
c
P
A
3
3
1
4
4
1
2
2
A
s
P
c
s
A
s
Figure 5: Revert to Game 1 (Game 1a).
You should now note the dashed line (called an information set). This
is a convention which indicates that A does not know the history of the
game (whether P has chosen c or s). Alternatively, A and P may decide at
the same time.
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MN3127 Organisation theory: an interdisciplinary approach
What will happen now?
• A will still choose s.
• P will still choose s.
We obtain the same result as before (the ss Nash equilibrium).
Games in strategic form
We now turn to the definition of games in normal or strategic form.
Consider Game 1a. Both P and A have two strategies, c and s.
The normal form is a matrix as follows:
A
P
c
s
c
3,3
1,4
s
4,1
2,2
Here the rows represent the strategies of P and the columns those of A. In
each cell of the matrix the first number (by convention) is the payoff of the
row player and the second that of the column player. You should be able to
see how to move from the extensive form of Game 1a to the normal form.
We know, of course, that the Nash equilibrium is at ss (the bottom righthand corner of the matrix).
You can find the Nash equilibrium in the normal form as follows:
if A chooses c, then P will choose s (4 > 3)
if A chooses s, then P will choose s (2 > 1).
Now:
• if P chooses c, then A will choose s (4 > 3)
• if P chooses s, then A will choose s (2 > 1).
Then ss is the Nash equilibrium.
Now consider Game 1 again (perfect information). A strategy in a game
for a given player is a complete specification of what he or she may do
under all possible circumstances.
In Game 1, P has two strategies, c and s respectively. A, however, has four
strategies:
• c if P does c and c if P does s, cc
• s if P does c and c if P does s, sc
• c if P does c and s if P does s, cs
• s if P does c and s if P does s, ss.
The game in normal form is given by:
A
P
cc
sc
cs
ss
c
33
14
33
14
s
41
41
22
22
You should be clear using the above procedure that s, ss is the unique Nash
equilibrium.
148
Appendix 5.2: Levels of analysis
Appendix 5.2: Levels of analysis
Organisational analysis is sometimes pursued by taking organisations as
the unit of analysis; at other times, the units are individuals, groups/teams
or departments within an organisation. It is useful to have an analytical
framework which enables us to think about the connections between these
alternative ‘levels’. The following type of diagram (sometimes attributed to
James Coleman (1990))1 is helpful: it considers the relationships between
corporate culture and performance.
1
Coleman, J.S.
Foundations of social
theory. (Cambridge,
MA: Harvard University
Press, 1990) [ISBN
0674312252].
Figure 5.2
Imagine that each arrow depicts a causal mechanism. Then 4’ is a causal
relationship at the macro/corporate/organisation level. It would be
studied by inspecting relationships (correlations) where organisations
are the units of analysis. 3’ and 3 are across-level relationships: how
organisations impact on groups and then the latter impact on individuals.
These are sometimes called ‘macro-micro’ relations – causal mechanisms,
which can be decomposed into macro-meso and meso-micro.
2’ and 2 depict mechanisms operating respectively at the group and
individual levels. 1 and 1’ are the mechanisms which translate individual
performance to group and ultimately to organisation performance –
sometimes called ‘micro-macro’. We may wish to suppress the group
level and just consider two levels – the organisation (macro) and the
individual (micro). A methodological individualist will maintain that
no mechanisms ‘exist’ at levels 4’ and 2’ that are not the conjunction of
mechanisms that operate at the lower levels. So, to explain the impact of
corporate culture upon corporate performance one would have to reduce
the explanation to statements about individual norms and performance
and how those produce (perhaps aggregate to) corporate performance.
Further reading
If you are interested in these issues you might like to read Abell (1992).
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Notes
150
Appendix 6.1: A simple model of sequential bargaining
Appendix 6.1: A simple model of
sequential bargaining
Consider a sequential alternating offer ‘game’ between M and L. M and L
are bargaining over the division of a unit value. (In a ‘proper’ model, one
would make explicit assumptions about M and L’s utility functions, but I
abstract from this.)
Initially M (first mover) makes an ‘opening offer’ X to L and (1 – X) to self
(0 < X < 1).
L can either:
• accept, or
• make a counter-proposal.
If L does not accept, the unit value is diminished by a factor (0 <  < 1).
So the value of the unit declines at some rate (equal for both M and L).
(One could easily make it different for M and L.)
 captures the idea of bargaining costs.
If L does not accept M’s opening offer, L makes a counter-offer about how
to divide .1.
Say L offers  X to M and (1 – X) to self.
Assume the bargaining can go on indefinitely.
So, M (by backward induction) needs to fix the opening offer so that L is
indifferent between X and (1 – X)
So X =
ς
1+ς
M gets 1 –
L gets
ς
1+ς
ς
1+ς
Then the opening offer is accepted.
If  = 1 then 50/50 divide.
As   0 first mover advantage.
Notes:
1. Not realistic – bargaining protracted – why?
2. Irrational?
3. Model too simple?
4. Perhaps information asymmetry?
5. M and L don’t know each other’s .
This model leads to games of incomplete information involving haggling,
learning and bargaining. See Muthoo (1999).
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MN3127 Organisation theory: an interdisciplinary approach
Notes
152
Appendix 6.2: Bargaining failure
Appendix 6.2: Bargaining failure
Could bilateral/multilateral bargaining (Appendix 6.1) provide an
efficient way of controlling and coordinating activities? If so, could it be
an alternative to both markets and organisations? Coase (1960)1 argues
that with no bargaining costs and clear property rights, the answer is yes.
But the distribution of the bargained outcome will depend upon the prior
property rights. In practice, however, if the distribution of the bargained
outcome is not deemed legitimate, then players will tend to bargain over
the initial property rights.
1
See pp.1–44.
But, also, if because of asymmetric information bargaining costs (haggling)
increase, then the efficiency of bargaining will decline. It is especially
likely that bargaining costs will be high in multilateral bargaining.
If asymmetric information about players’ preferences (L(min), M(max))
is the problem, then is it in the interests of bargainers to reveal their
preferences? General answer – no. Information revealing has the form
of a prisoner’s dilemma (PD) – n-person for multilateral and 2-person
for bilateral. Each player/bargainer’s preference is to conceal their own
preference at a sub-optimal Nash equilibrium. With multilateral bargaining
there will be a tendency to free-ride on the bargaining ‘group’ (see Section
5.5 in D and S).
The solution to this PD would be to find incentives which would induce
each bargainer to reveal their preferences. This is a so-called incentive
compatible system.
The general conclusion is that a ‘third party’ with ‘coercive powers’, which
the bargainers can ‘voluntarily’ subject themselves to, is required. Thus,
bargaining without organisation fails as an alternative to the market.
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MN3127 Organisation theory: an interdisciplinary approach
Notes
154
Appendix 9.1: Introduction to evolutionary game theory
Appendix 9.1: Introduction to
evolutionary game theory
Consider a population of players (N) where randomly chosen pairs play
the game:
C
D
C
XX
YZ
D
ZY
TT
where C and D are the strategies available to the players.
Let the probability of playing D in the population be h.
Then the probability of playing C in the population is (1 – h).
In repeated random interactions:
• the payoff to playing D is
• PD = (1 – h)Z + hT
• The payoff to playing C,
• PD = (1 – h)X + hY
Thus
PD = h(T – Z) + Z
PC = h(Y – X) + X
If Z > X > Y > T (chicken payoff?)
Z>X
(T – Z) < 0
(Y – X) < 0
We may plot as follows:
This shows that at equilibrium we have h≠N playing D and (1 – h≠)N
playing C.
But how would an off-equilibrium system evolve?
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MN3127 Organisation theory: an interdisciplinary approach
Assume that strategies evolve in proportion to their relative success
(payoff). In a fixed population players change strategy in this manner.
Thus, when C players do better than D players, the latter will switch from
D to C (the right-hand part of the above plot); when D does better than C
then the switch will be to D.
So the system will evolve to h≠. The equilibrium is stable.
Now consider the rankings of the prisoner’s dilemma:
Z > X > T > Y.
Now
Z>X
(T – Z ) < 0
(Y – Z ) < 0
T>Y
Plotting once again, we have:
Now there is no mixed equilibrium. A system will evolve to h = 1 (the
Payoff
D
C
z
T
x
0
Nash equilibrium).
Finally, assume:
X > Z > T > Y.
Now
X>Z
(T – Z) < 0
(Y – Z) < 0
T>Y
156
h
1
Y
Appendix 9.1: Introduction to evolutionary game theory
Plotting:
Payoff
D
x
C
z
0
h=/
h
Y
1
The system will evolve to h = 0 if it starts to the left of h≠; and to h = 1 if
it starts to the right. h≠ is an unstable equilibrium and the system path is
dependent.
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MN3127 Organisation theory: an interdisciplinary approach
Notes
158
Appendix 9.2: Logistic growth – an introduction
Appendix 9.2: Logistic growth – an
introduction
N = number of organisations
t = time
dN
=B–D
dt
(1)
where B is the births per unit time, D is the deaths per unit time.
B and D will in general depend upon N.
Assume B = bN and D = dN
where b = the average birth rate per organisation per unit time,
So,
d = the average death rate per organisation per unit time
dN
(2)
= (b – d) N
dt
If b > d, then the population will grow at an increasing rate indefinitely
(exponential growth) as follows:
Number of
organisations
t
Exponential growth also assumes that b and d are fixed and
independent of N (no density dependence).
We can regard equation (2) as the basic demographic equation. In the text
we noted that Carroll and Hannan assume that both b and d depend on N
in a non-linear fashion. Here we assume that the dependence is linear.
b = b0 – kbN
(3)
d = d0 + kdN
(4)
where b0 and d0 are the values of b and d when N tends to zero.
Note that b declines with N and d increases. These are rather standard
assumptions in elementary demographic models.
So, substituting (3) and (4) in (2),
dN
dt
= ((b0 – kbN) – (d0 – kdN)) N
When dN/dt = 0 (that is, when the birth and death rates are equal)
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MN3127 Organisation theory: an interdisciplinary approach
N≠ = b0 – d0/kb + kd
Let r = b0 – d0
Then substituting we have:
≠
dN
= rN ( N –≠ N )
N
dt
This is the slope of the logistic curve, which takes the form:
N≠
Number of
organisations
t
Notice that the growth of N is proportional to its departure from
equilibrium (where the death and birth rates are equal).
N≠ is often designated as K in the literature. You might like to put nonlinear relations between N, b and d into equation (2) and show that the
population can decline from N≠.
Further reading
For further reading, see Carroll and Hannan (2004).
160
Appendix 10.1: Transaction cost analysis (Williamson’s analysis)
Appendix 10.1: Transaction cost analysis
(Williamson’s analysis)
Transaction cost economics implies that a transaction should be placed
either in a market or in an organisation so that costs are minimised. The
relevant costs are production costs and transaction costs. Both of
these costs vary with the asset specificity and uncertainty involved in
the transaction.
Consider the impact of asset specificity upon costs, for a relevant level of
uncertainty and transaction. Production costs will vary as follows:
Production
costs
Or
ga
nis
ati
on
ket
Mar
0
Specificity
(Cost of
org.
Cost of
market)
0
Specificity
As specificity increases, the market becomes more expensive as outside
opportunities decline. At low levels of specificity organisation is costly
because outside options offer economies of scale.
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MN3127 Organisation theory: an interdisciplinary approach
Transaction costs will vary as follows:
Transaction
costs
Market
Organisation
Specificity
(Cost of
org.
Cost of
market)
Specificity
Combining production and transaction costs:
Prod.
cost
(Cost of
org.
Cost of
market)
Prod. and
Trans. cost
x
Specificity
Trans.
costs
Market
Organisation
Thus an organisation transaction is favoured when the asset specificity
exceeds x.
162
Appendix 12.1: The nature of hierarchy
Appendix 12.1: The nature of hierarchy
Let
Size = N
Spans = S
Depth = L
Then
N = 1 + S + S2 + .... + SL–1,
L
∑S
N=
i–1
i=1
.
The size of the bottom layer n,
n = SL–1 .
The administrative component A,
A = 1 + S + S2 + .... + SL-2
L–1
=
∑S
i–1
i –1
.
Since
n = SL–1 ,
log n = (L – 1)logS
=
log n
+1
log s
.
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MN3127 Organisation theory: an interdisciplinary approach
Notes
164
Appendix 12.2: Administrative costs
Appendix 12.2: Administrative costs
Empirically established relationship.
C = CEO income
N = size of organisation
log C = a log N – k
where a, k are constants.
Why?
Assume n members at bottom
S (average) span of control
Income at bottom = 1 per person
Assume ratio of income in consecutive layers in constant =  (empirical
results support this).
Number at each level
n + n + n2
S
S
....
+ nL–1
S
Total income
2
n + n β + n2 β .... + nL–1 β L–1
S
S
S
Thus
C = nL–1 β L–1
S
log C = log n + (L–1)[logβ − logS]
n
n 2
n
l–1
Administrative costs = s β + s2 β .... sl–1 β
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MN3127 Organisation theory: an interdisciplinary approach
Notes
166
Appendix 12.3: Horizontal differentiation and size
Appendix 12.3: Horizontal differentiation
and size
Organisation size = N
n1 units (span of CEO?)
Each unit has n2 members
∴ N =n1n2
C1 = transaction costs of maintaining inter-unit dependencies
Total cost between units = C1n1(n1 – 1)
C2 transaction costs of maintaining intra-unit dependencies
Total costs inside units = C2n2(n2-1)n1
Total transaction costs TC = C1n1(n1 – 1) + C2n2(n2-1)n1
Choose n1 and n2 to minimise TC
Subject to: N – n1n2 = 0
Form a Lagrangian
L = TC + (N – n1n2)
= C1n1(n1 – 1) + C2n2(n2 – 1)n1 + (N – n1n2)
Taking partial derivatives and setting to zero,
∂L
= C1 (2n1–1) + C2n2(n2–1) +λ n2 = 0
Sn1
SL
= C2 n1(2n2–1) − λ n1 = 0
δ n2
SL
= N – n 1n2 = 0
Sλ
Cost minimising value of n1:
≠3
≠2
2n1– n1 = [C2 /C1] N2
We need to determine the signs of:
≠
δ n 1/ δ N
and
≠
δ 2 n1/δ N 2
Thus
≠
2
≠
≠
≠
6n1 (δ n1/δ N ) – 2 n1 ( δ n1/δ N )
= 2[C2 / C1]N
and
≠
≠2
≠
δ n1/δ N =[C2 /C1] N/3n1– n1
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MN3127 Organisation theory: an interdisciplinary approach
So for
≠
n1> 1/3
≠
δ n/δ N > 0
Similarly,
≠
S2 n1/δ N2 > 0
So the regularity discovered by Blau and Schoenherr is proven.1
Differentiation increases at a declining marginal rate with N (= size).
Transaction cost considerations inside the firm explain a major regularity.
168
1
See Blau and
Schoenherr (1971).
Appendix 13: Sample examination paper
Appendix 13: Sample examination paper
Important note: This Sample examination paper reflects the
examination and assessment arrangements for this course in the academic
year 2013–2014. The format and structure of the examination may have
changed since the publication of this subject guide. You can find the most
recent examination papers on the VLE where all changes to the format of
the examination are posted.
Time allowed: three hours.
Candidates should answer four of the following twelve questions. All
questions carry equal marks.
1. Discuss the proposition that firms (organisations with an economic
objective) only exist because of incomplete information.
2. How does the division of labour influence the design of organisations?
3. Weber analysed organisations as heavily dependent upon ‘rules’.
Economists emphasise the role of ‘incomplete contracts’. Are these
concepts compatible? Explain your answer.
4. An organisation is coordinated by a risk-neutral principal (P) who can
only observe an agent’s output. The agents are also risk-neutral. What
is the optimal contract from P’s point of view? What do you consider to
be the advantages and disadvantages of analysing organisations from
this standpoint?
5. ‘Corporate culture can be conceptualised as a mechanism whereby
inter-personal trust and reciprocity are established.’ Discuss.
6. What do you understand by the term ‘team production’? Show how
you would expect team production to influence the spans of control in
an organisation.
7. Explain how ‘free-riding’ might arise in a ‘peer group’. What
mechanisms could, in your view, overcome the problem?
8. The employment contract does not involve the exertion of ‘power’ of
one actor over another. Do you agree? If so, why? If not, why not?
9. ‘Psychologists have demonstrated that it is rarely, if ever, possible to
analyse organisations according to the precepts of rational, selfinterested behaviour.’ Discuss.
10. ‘There are many ways of locating a transaction in neither a market
nor a hierarchical organisation.’ Outline some of the alternatives and
explain what factors might determine their choice.
11. What contribution can evolutionary models make towards an
understanding of organisation structures?
12. ‘Organisations are complex strategic systems, which implies that
game theory should be at the centre of any attempt to analyse them.’
Discuss.
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MN3127 Organisation theory: an interdisciplinary approach
Notes
170