Market frictions as building blocks of an organization economics approach to strategic

managementMahoney and Qian, 2013 SMJ

Slides by Minjae Lee, BADM 545 Fall 2013

Overview

A wider recognition of the role of market frictions is useful to

Identify an evolving market-frictions paradigm in strategic management

Show how two primary questions in strategy and three primary strategic goals can be better joined and evaluated Why firms exist and why some firms outperform others Cost minimization, value creation, and value capture

Generate new research questions and advance theory development in the strategic management field

Overview

An evolving market-frictions logic can serve as a common language

Three strategic goals are often intertwined and a framework that simultaneously consider these three goals is likely to be more relevant for management practice and to be more fruitful for richer theory development

Pairwise joining of these theories suggests the presence of logical coherence, but does not fully reveal the fundamental commonalities among all these theories.

Develops the market-friction logic Identifying the concept of market-frictions

through first fundamental welfare theorem of economics

Taking a Stock: Market-frictions logic

Taking a Stock: Market-frictions logic

Economic consequences of a particular combination of market frictions

Organizational economics approach to cost minimization

Transaction costs theory

Opportunism, Asset specificity Uncertainty

Taking a Stock: Market-frictions logic

Organizational economics approach to value creation

Resource-based approach (Value creation) Valuable: luck and/or asymmetric information Rare: asymmetric information about the economic value

of those resources / resources that are created by a firm (spillover)

Heterogeneity: asymmetric information, causal ambiguity, and asset specificity/uniqueness

Complementarity: positive inter-project spillovers, such as economies of scope & positive inte-temporal spillovers, such as asset accumulation or interconnectedness over time

Taking a Stock: Market-frictions logic

Organizational economics approach to value creation Resource-based approach (Value Sustainability)

Low transferability: information asymmetry between sellers and buyers, tacitness and intangibility, difficulties in partitioning, isolating mechanisms such as patent and trademark enforcement

Inimitability: interfirm externalities, intra-firm spillovers, and asymmetric information

Non-substitutability:

Real options theory uncertainty in investment decisions, the (in)flexibility in

strategic choice, and the inter-project as well as inter-temporal spillovers

Taking a Stock: Market-frictions logic

Taking a Stock: Market-frictions logic

Organizational economics approach to value capture

Resource-based approach Complementarity: asset specificity Embeddedness: interconnectedness of resources

Property rights theory Poorly or undefined property rights Imperfection in residual control assignments can

lead to poor resource allocation

Building on the same fundamental logic, each theory branches out by emphasizing different but overlapping combinations of market frictions to address its canonical problem.

Taking a Stock: Market-frictions logic

Recent developments in organization economics approach

Considering more than one strategic goal has already enabled greater theory development

Cost minimization coupled with value creation. Intra-firm spillovers and governance inseparability

=> Transaction cost theory => Dual role of governance structure and Interaction between goals

Intra-firm spillovers and economies of scale/scope when economies of scope or technical complementarity

are combined with intra-firm spillovers and market frictions

Recent developments in organization economics approach

Cost minimization coupled with value capture

Property rights theory

Asset specificity and negative inter-firm externalities

Asset specificity and loss of positive intra-firm spillovers

Recent developments in organization economics approach

Value creation coupled with value creation.

Poorly or undefined property rights and capabilities with value creation potential

Asset specificity and positive intra-firm spillovers

Focusing on the concept of market friction as the key unit of analysis may prove useful in explaining the two primary questions

Generalized market-frictions approach

One example Alchian and Demsetz (1972)

Due to nonseparability problem, ex ante free-riding (shirking) and ex post haggling can occur. Hierarchical monitoring is suggested as a solution to this problem

Rajan and Zingales (1998) build upon the nonseparability of team production and join

it with the market friction of asset specificity Contrary to the recommendations by property rights

theory, assigning ownership to that team member may reduce incentives in firm-specific investment by all team members, including the one that is assigned ownership

use the property rights mechanism of restricted access to critical assets, instead of ownership

Market-frictions logic enables us to explore the intertwined relationships between the economic rents question and the organizational boundary decision, instead of treating these two questions in isolation

Organization boundary decision can be further examined through a value creation and value capture lens via learning, dynamic capabilities, and knowledge spill-in Kang et al.(2009)

Generalized market-frictions approach

Using the market-frictions logic First approach is to start with the research gap

identified within the existing literature

Second approach is to start with the strategic phenomenon of interest