Organizations, Management Behavior and Economics

Sunday, July 02, 2006

Jodi's Demsetz Summary

Demsetz argues that Coaseā€™s theory of the firm is still incomplete, and that more attention needs to be given to information costs. (Information costs are one presumably important component of transaction costs.)

In order to have a cogent theory of the firm, we need to take away the traditional assumption of costless information.

Moral Hazard, Shirking and Opportunism:

Demsetz points out that another issue involved with organizations is that of aligning incentives. In section, we briefly discussed the issue of post-contractual opportunistic behavior, or "holdup". The general model assumes a buyer and a seller that make a contract in some state of uncertainty, so that they don't know perfectly what the world is going to be like when it comes time for work to be done. When the true state of the world is revealed, the buyer and seller tend to renegotiate, even though they already had a contract. This is because there are certain items that cannot be contracted on, and contracts are not perfectly enforceable. This renegotiation is costly from a logistical perspective, and could also be costly for the party that doesn't have a lot of bargaining power. The theory is that these holdup problems can be mitigated with internal organization (according to Klein Crawford Alchian).

Given these problems, why do we have markets? Demsetz argues that markets offer high-powered incentives that cannot always be recreated within a firm.

(Obviously preliminary, again stay tuned!)


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