1. A STRATEGIC THEORY OF THE FIRM AS A NEXUS OF INCOMPLETE CONTRACTS: A PROPERTY RIGHTS APPROACH Authors: Kim, Jongwook and Joseph T. Mahoney Presenter: Cheng (Orange) Wang

2. Paper Structure / Presentation Presentation Structure Research Question Definitions of Terms Paper Discussion 1 1 2 2 3 3 4 4

3. The paper reviews existing literature and suggests a strategic theory of the firm: the contracting process is a form of the entrepreneurial discovery enabling firms to sense and seize new economic opportunities. This paper:  Applies property rights theory in defining resources and capabilities as bundles of property rights.  Suggests that developing, deploying, and renewing resources and dynamic capabilities is a process of bundling and re-bundling resource combinations.  Suggests that bundling resources is a contracting process that generates more information, increases efficiency and discovers new opportunities.  Firm is a nexus of incomplete contracts rather than complete contracts. Research Question

4.  Firm boundary choice: Informed by transaction costs theory and the firm resources and capabilities, like productivity, complementary capabilities and non-deployable capabilities. (Dynamic interaction between a firm’s capability development and its boundary choice can occur in a variety of ways, such as possible constraint by a firm’s prior capability development on its current choice set of boundaries (Argyres and Liebeskind, 1999), possible real options value embedded in a certain boundary choice (Kang, Tan and Mahoney, 2009), and potential capability development facilitated by a chosen governance structure (Wang and Barney, 2006) ---- From Lihong Qian’s dissertation)  Bundles of Property Rights: a common way to explain the complexities of property ownership. It is strongly rooted in common law to explain how a property can simultaneously be "owned" by multiple parties. It implies rules of specifying, proscribing, or authorizing actions on the part of the owner. (E.g,. the rights to pick apple but not the right to cut the tree. Also a solution to both common and anti-commons tragedies)  Internalize externality: The act of making a change in a company's private costs or benefits in order to make them equal to the company's social costs or benefits.  The Austrian View: 1, the society is a combination of people; 2, marginal utility theory of value, i.e. the value depends on utility and scarcity; 3, subjective opportunity set  Sanctioned behavior: Property rights are sanctioned behavioral relations among decision makers in the use of potentially valuable resources. In law, the word sanction can mean “a provision of a law enacting a penalty for disobedience or a reward for obedience.” Definitions of Terms

5.  Economic/ Resource rent: a surplus value after all costs and normal returns have been accounted for, i.e., the difference between the price at which an output from a resource can be sold and its respective extraction and production costs, including normal return.  Ricardian rents: Loosely, it is a return or profit from a differential advantage for production, as in case of income or earnings due to rare natural gifts creating a natural monopoly. In Peteraf 1993, The conventional resource-based logic indicates that economic profits that accrue from scarce resources (which are more efficient) are Ricardian rents.  Entrepreneurial rents: also called quasi-rent, can accrue due to entrepreneurial skills or managerial investments. Definitions of Terms

6.  Introduction: Background and Literature Review  Establishing Property Rights: - Contributions of Property Rights Theory - Resources as Bundles of Property Rights  Property Rights and Dynamic Capabilities - Firm Boundaries - Generating Economic Rents - Dynamic Capabilities and Property Rights - Toward a More Systemic View  A Nexus of Incomplete Contracts: A synthesis  Conclusions Paper Structure

7. Introduction: Background and Literature Review RBV Dynamic Capability Property Rights Valuable, Rare, Inimitable, Non-substitutable Sustainable competitive advantage In a equilibrium view and assume no change Process Oriented; Path-dependency Relate to RBV Process is based on the VRIN condition Provides a contractual process-oriented approach for how dynamic capabilities are developed, sustained, and rejuvenated and in so doing intertwines firm boundary issues with the capabilities dimension of a strategic theory of the firm. Dynamic Capabilities Resource Based View Property Rights Theory Why this paper? To link specific organizational processes that are the foundations of dynamic capabilities to how the firm might realize or capture economic rents, we must track contractual processes of bringing resource combinations together.

8.  Establishing Property Rights:  Contributions of Property Rights Theory  Resources as Bundles of Property Rights Establishing Property Rights:

9. TCERBV Dynamic Capabilities 1.TCE and PR see entrepreneurial and innovative economic actors as opportunism 2.Opportunism vs Opportunity 3.Internalize externalities 4.Well defined PR and economic value creation 1.Oil field case 2.PR and free riding 3.markets, hierarchies, or some hybrid governance structure at the firm level are not enough to attain efficiency Establishing Property Rights: Contributions of Property Rights Theory 1. the processes whereby entrepreneurs internalize certain aspects of externalities through innovations in property rights Classical Property Rights Theory (who get the residual claimant) provide foundations for TCE, RBV and Dynamic Capabilities

10. TCERBV Dynamic Capabilities 1.Economic transactions are exchanges of bundles of PR. 2. the right to appropriate economic returns from a resource (in team labor production the right to receive the residual income) --- Alchian & Demsetz (1972) 1. the PR to use a resource may be held separately from the PR to buy or sell that same resource 2. the right to use and change the form of the resource (in the case of labor the right to terminate or revise membership) --- Alchian & Demsetz (1972) Establishing Property Rights: Resources as Bundles of Property Rights 1.Help to consider firm boundaries; and to consider how to create and how to capture the value creation 2.Cospecialized resources; difficult to imitate via MKT mechanism. 3. the right to transfer the above-mentioned rights (i.e., alienability) --- Alchian & Demsetz (1972) Bundles of Property Rights: Property Rights can be Partitioned Define resources and capabilities as partitioned PR can -Help to clearly define what are resources and capabilities -Help to tell how to confer economic rents to the firm as a result of developing and utilizing those resources and capabilities

11. Establishing Property Rights:

12.  Property Rights and Dynamic Capabilities  Firm Boundaries  Generating Economic Rents  Dynamic Capabilities and Property Rights - Toward a More Systemic View Property Rights and Dynamic Capabilities

13. -Firm to reduce transaction costs -TC aspects determine the decisions of organization forms or governance such as make or buy -A broader view than Penrosean -Concern about contracting difficulties in coordinating economic activities across firm boundaries How do they view Firm Boundaries Pros and Cons Pros and Cons -Differences in capabilities can partially explain firm boundaries -RBV, not directly deal with boundaries -Penrose: firms as administrative; managerial attention and training affect growth -Consider market failure and growth opportunities -Consider physical and human capital -But how does it affect administration? Contractual/TCE RBV and Dynamic Capabilities Property Rights and Dynamic Capabilities: Firm Boundaries

14. -Economizing on governance costs (i.e., ex ante incentive provisions and ex post attenuation of opportunism) Economic Profit from: -Economizing on the costs of transacting across firm boundaries -Capturing at least a part of the quasi-rents -Competitive market, we need identify trade parters ect -The entrepreneurial discovery needs knowledge of value -PR theory brings a contractual approach to the Austrian idea of entrepreneurial discovery -The Dynamic capabilities view entrepreneurial rent seeking as a discovery process -Market incompleteness --- opportunism --- firms try to capture PR, ect Rent Generating How does Property Rights Theory relate to them? -Production-side efficiencies and dynamic capabilities Economic Profit from -Ricardian Rent from scarce resources -Entrepreneurial rent through Penrose Resource view. TCE Dynamic RBV Property Rights and Dynamic Capabilities: Generating Economic Rents

15. -While dynamic capabilities approach emphasizes economic value creation, transaction cost economics emphasizes capturing economic value (distribution). Economic Value How does Property Rights Theory relate to them? -Firms’ capabilities to sense opportunities and utilize them through organizational process such as learning, integration, etc. -Difficult to predict ex ante; “Flaw” -Sense new opportunities requires access to information and the ability to recognize and shape opportunities TCE Dynamic Capabilities Property Rights and Dynamic Capabilities Toward a More Systematic View -Process of establishing property rights is also generating relevant infor. about bundles of PR and about transactions, whether those rights are realized or remain unrealized. -Bundles of PR is shaped through Dynamic contractual process -process is crucial for uncovering new infor. about the MKT and possible economic value creation -Complementary: more valuable, more incentive to make PR precise and more valuable Contracting processes: heart of creating and capturing value rejuvenating economic value over time. -How certain resource combinations might be implemented; -How such combinations might be kept within the organization. PR theory is complemen- tary with both TCE and dynamic capabilities PR theory can fit in both value creation and value distribution

16. Property Rights and Dynamic Capabilities Toward a More Systemic View

17. A Nexus of Incomplete Contracts: A synthesis Dynamic Capabilities Property Rights Firm Nature of the firm: - Increasing the economic value of the firm’s resource portfolio Enables an institutional analysis of the competitive process brought up by DC Combining the previous two, we define the firm as Incomplete Contract  The coordination of resources and capabilities, within or across firm boundaries, is done through various (price and non-price) mechanisms. So economic activities (within or across firm boundaries) can be understood as being coordinated by multiple mechanisms.  Incomplete contracts run the risk of various exchange hazards (from asymmetric information and opportunism); Solutions require adaptive responses such as vertical integration or mutual credible commitments.  A nexus of incomplete contracts implies that the firm has many different providers of resources and capabilities contributing to the value-creation process but with varying degrees of overlap in commitment and alignment of incentives.

18. Conclusions How to build it? How to maintain it VRIN Maintain stability; exploration Create/ exploit MKT opportunities Integration, reconfiguration, learning, transformation Sustainable Competitive Advantage PR: Dynamic Capabilities: concerning the nature of organizational processes and resource positions RBV and TCE and DC: PR and legal framework is a institution; deal with ex post governance issues (TCE) acquire and/or develop VRIN resources and capabilities (RBV and DC) Strategic Management Question: Sustainable competitive advantage Dynamic Capabilities RBV

19.  Contributions: This paper joins different theories and suggests a more comprehensive way to look at firms and firms’ behavior. As is suggested by Van de Ven (2007), we need “triangulation” to better understand the world. This paper provides theoretical triangulation.  Limitations: -while this paper suggests we need to combine different theories together, we need to keep in mind that we also face the constraints of “Boundaries”, i.e. we need to know the “map size” we need and find a niche. -the paper talks about Austrian Economics but does not explain why Austrian Economics ideas will fit in the paper or the strategy field. -There is a “changing word” problem in this paper. E.g. “dynamic RBV” and “dynamic capabilities” are interchangeable which is kind of confusing.  Future Research: triangulation and empirical Discussions