1. The Choice of Organizational Form
Joshua Downs
8/31/2015
Anand RV
9/05/2017
The Choice of Organizational Form
Vertical financial ownership versus other methods of vertical integration
Mahoney, SMJ

2. Main Points Why ownership may be unnecessary?
Presents a generalized theory for predicting organizational form
Integrates and extends previous work done under both the strategy and industrial organization paradigms
Key reasons for vertical integration
Strategic considerations, input and output price related, uncertainty in costs or prices
Why ownership may be unnecessary?
Other organizational forms may provide similar efficiencies
Advantages and disadvantages of financial ownership
Predicting the organizational form
Integrating agency and TCE
Motives cannot predict form; form cannot predict motives

3. Why Vertically Integrate?
Strategic motives (role of regulatory environment?)
Increase entry and exit barriers
Price squeezing
Output and/or input price advantages
VI can help evade monopoly prices charged upstream
Addresses risk of arbitrage between sets of downstream firms with heterogeneous price sensitivities when price discrimination is practiced
Uncertainty
Asymmetric information between upstream and downstream stage participants, risk of supply failure or overproduction respectively
Integration improves forecasting for pricing and capital investment
Inconsistent findings on whether vertical integration reduces demand and technological uncertainty
Discrepancy between VI and risk/uncertainty reduction claims (Williamson and Harrigan)
Reconciled by discussion of dynamic or static levels of asset specificity
Measurement and quality uncertainty (and other types of uncertainty)
Key input quality and point of sale service
Disagreement regarding technological uncertainty and likelihood of VI (key: asset specificity)

4. Are contracts equivalent to ownership?
Contracting can address concerns that financial ownership also does
What are the advantages of doing so?
Equivalency proposition of Coase theorem
“The initial assignment of property rights does not matter”
Extend arguments for ownership to vertical integration and apply to long-term contracts

6. What Determines Organizational Form?
Transaction costs concerning attributes of the transaction
Ex ante costs: Search and information, Drafting, bargaining, and decision, Agreement safeguarding
Ex post costs: Monitoring and Enforcement, Adaptation and haggling, Bonding, Maladaptation
Agency costs concerning incentives and measurement problems of the individual
Monitoring by principal, bonding expenditures by agent, loss of residuals
2 Branches
Mathematical Principal Agent Models
Unboundedly Rational, Firm as nexus of contracts, Alignment of ex ante incentives sufficient to achieve vertical financial ownership outcomes through contracting
Positive Agency Theory
Emphasizes information asymmetry issues, reward based on output or behavior
Nonseparability of effort to output
Low task programmability reduces effectiveness of monitoring
Measurement costs and transaction costs should be considered simultaneously for the purpose of predicting organizational form
Emphasis on Measurement problems fills Transaction Costs Gap (571)

7. Advantages of financial ownership
Profit
Costs related to preemptive claims on profit by separate firms eliminated
Coordination and Control
Authority derived inducements to reduce opportunistic behavior
Resolution of conflict more efficiently achieved internally than through 3rd party (litigation)
Audit and Resource Allocation
Internal divisions can be audited, superior information on which to base allocations so as to eliminate opportunistic behavior
Motivation
Inculcation of solidarity (organizational identity) converges interests to reduce behavioral uncertainty
Communication: Internally coded communication more efficient than external communication
Even frequent interactions feature opportunism concerns

8. Disadvantages of financial ownership
Bureaucratic Costs
Difficult to anticipate, synergies overestimated
Additional tasks may require additional skills
Increasing superior/subordinate spans obviates communication advantages
Lack of market incentives leads to increased slack, norms of reciprocity form
Strategic Costs
Reduced access to knowledge of from severing ties to outside partners
Specialized assets (Indivisible?) leading to excess capacity
Reduced flexibility, increased exit barriers, psychological commitments and divestment related administrative difficulties
Flexibility/Stability tradeoffs
Production Costs
Internal Inputs must be sufficiently utilized to achieve sufficient scale compared to market sourced inputs of competitors
Capital drain concerns for small firms (Williamson, 1975)
Capacity imbalances (among stages of production)

9. What Should the Organizational Form Decision be Based Upon?
Framework for Predicting Organizational Form
Transactions dimensionalized according to frequency, uncertainty, and asset specificity
Uncertainty (Demand and technological) and asset specificity (Human, Physical, Site)
Frequency only influences structure choice in intermediate asset specificity, not considered
Agency perspective emphasizes information asymmetry/measurment issues
Nonseparability (measurement of output)
Task Programmability (measurement of input; effort)
Integration of theories
Task programmability, nonseparability, demand uncertainty, technological uncertainty, and asset specificity are five determinants of organizational form
Demand and technological uncertainty are theoretically indeterminate, thus model focuses on interactions of remaining 3 dichotomous variables as determinants of organizational form

11. Discussion questions
How much does industry matter in accurately predicting organizational form?
When search and information costs and monitoring and enforcement costs have decreased presumably due to the ease with which information can now be accessed and evaluated, will we see a decrease or an increase in vertical financial ownership?
A large literature suggests that vertical contracting can address some of the concerns that financial ownership can address (Table-1, Mahoney(1992)). Given that financial ownership has disadvantages : bureaucratic costs, strategic costs and production costs, to what extent are these costs also associated with vertical contracts. In other words, when are vertical contracts more appropriate than ownership?