1. 1 Institutional Economics and Economic organisation Theory (IE&EOT) Chapter 8 Coordination mechanisms and organisational modes

2. 2 Overview Coordination, motivation and the way of organising matters Four groups of coordination mechanisms Why deserves relationship between governance structures (GSs) and coordination mechanisms (CMs) attention? A continuum of governance structures Five organisational modes

3. 3 Differences between CMs and GSs Coordination is more based on –Nature of coordination mechanisms Price, mutual adjustment, contract rules, direct order Governance structures or organisational modes consist of –coordination mechanism –Motivation mechanism –formal rules concerning legal ownership, corporate status and tax regimes, if it is a firm Between coordination mechanisms and governance structures exists a mutual relationship: →nature of coordination mechanism determines for a large part the type of a governance structure.

4. 4 Coordination Coordination includes what needs to be coordinated, for example, –the right producers should produce the right quantity and quality at the right place and the right time; how co-ordination is achieved in spot markets, in organizations and in hybrids (such as contracts), which alternatives there are for achieving co-ordination between organizational units and how each part of a system fits together. the alignments of activities within a firm and between firms adaptive ability of the price as coordination mechanism (book p.102)

5. 5 Motivation (1) This includes –what and who needs to be motivated, –which incentives are needed, –what alternative kinds of incentive mechanisms are there, –and what needs to be done to make incentive mechanisms effective and efficient? Each governance structure contains motivation-elements –For example, many contracts have a steering mechanism which defines performance criteria and the means to measure the performance. Motivation is also often included in specification of the reward- structure → which marks the level of payment if a minimum level of performance is attained.

6. 6 Motivation (2) Two types of motivation mechanisms can be distinguished: 1.intrinsic motives –Intrinsic motives refer to the desire to do your work well, trustworthiness, having or building a good reputation and altruism. 2.extrinsic motives. –Motivation can also be driven by extrinsic motives, such as monetary incentives and direct order (as in hierarchical governance structure) Between both can consist a trade-off → extrinsic motivation can crowd out intrinsic motivation

7. 7 Way of organising transactions matter 1.nature of coordination mechanism characterises for a large part type of governance structure. 2.transaction costs theory: governance structures are a response to various transactional considerations. –Transaction cost economics (TCE) tries to explain which institutional arrangement has a comparative advantage in carrying out transactions. 3.governance structures often consist of more than just a coordination mechanism. –E.g., if the governance structure is a contract, it should also specify contract agreements, if the governance structure is a firm, it also includes legal formal rules concerning legal ownership, corporate status and tax regimes for the firm.

8. 8 Why deserves relationship between GS and CM attention? 1.There is not always a one-to-one correspondence between the two. A given governance structure may, under specific circumstances, uses a mix of elements of the four groups of coordination mechanisms. 2.A clear distinction between governance structures and coordination mechanisms is key to understand –the different governance structures and –the potential possibilities of combining coordination mechanisms into governance structures 3.Coordination is a central issue in a governance structure → it includes what need to be coordinated and how coordination is achieved in GSs

9. 9 Four groups of coordination mechanisms (1) Handshake: Mutual adjustment Common values and norms Visible Hand: Authority Direct Supervision Invisible Hand: Price Handbook: Rules Directives Safeguards Coordination

10. 10 Four groups of coordination mechanisms (2) 1.invisible hand → market as GS –Price is coordination mechanism 2.handshake → club, peer groups as GS –coordination mechanism consists of mutual adjustment, common values and norms 3.Handbook → contract as GS –coordination mechanism consists of rules, directives and safeguards 4.visible hand → firm as hierarchy as GS –coordination mechanism consists of authority, fiat and direct supervision

11. 11 Some propositions for relationship between GSs and CMs There is not always a one-to one correspondence The two extreme GSs use different CMs –Spot markets use price as coordination mechanism –Firms as hierarchy use direct order as coordination mechanism Combination of prices, rules, direct supervision and mutual adjustment as coordination mechanisms defines a wide variety of governance structures A wide range of hybrids is found in the real world: peer groups, cooperatives, contracting, networks, franchising and collective trademarks.

12. 12 Figure 8.1: Coordination mechanisms and continuum of governance structures

13. 13 Key elements for characterising GS 1.co-ordination mechanisms 2.motivation mechanisms 3.identity of partners (personal relationship or not) 4.ex-ante restrictions on a choice of a partner 5.duration 6.enforcement mechanisms 7.financial participation (in the form of equity) 8. degree of vertical (or horizontal) integration.

14. 14 Table 8.1 Typology of governance structures Governance structures Spot market Classical contract Neoclassical Contract Relational contract Equity based alliance Vertical integration Main coordination mechanism invisible hand invisible hand/handbook Invisible hand/handbook handshake/handb ook handbook/visible hand/handshake visible hand Motivation  Intrinsic  Extrinsic extrinsic extrinsic/intrinsi c Intrinsic/extrinsicextrinsic/intrinsic Impersonal relation Yes No Ex-ante restrictions on choice of a partner No Yes DurationShort ModerateLong EnforcementCourtRules/court Reputation/courtCourtAuthority Equity participation No Yes Vertical integration No PartlyFull

15. 15 Networks and clubs and intermediaries Vertical integration –means creation of one organization –it is also called in-house production –make versus buy decision →it is the making by yourself solution –it is also called unified ownership or do-it-yourself option. –it could involve bringing two or more separate organizations under an unified direction Networks, clubs based on self-organisations and more formal clubs are horizontal relationships –handshake is an important coordination mechanism.

16. 16 Intermediaries Intermediaries have greater incentives than an individual contract taker to invest in reputation capital –They have more transactions and –The probability of re-transacting with a buyer is greater than the probability of re-contracting between a contract giver and a contract taker In general, the value of reputation is related to –the frequency of similar transactions, –the time horizon over which similar transactions are expected to occur, and the profitability of the transactions. → the incentives to build and maintain a reputation are larger –These arguments hold for especially for intermediaries, because of the frequency of the transactions; clubs with overlapping generations members, because of the long time horizon.

17. 17 Criteria for typifying organisational forms of firms ownership (including the separation of ownership and management), corporate status, Liability (including risk sharing) fiscal aspects transaction costs and costs of capital.

18. 18 Table 8.2. Summary of five organisational modes Single ownerPartnershipPartnership firmLimited partnershipPrivate limited company OwnershipOne farm headCo-ownership; more farm heads; organisation mode for succession Co-ownership; more farm heads Difference between silent and active partners Separation of ownership and management; shares not traded publicly Corporate status Non-legal entity Legal entity LiabilityFarm head personally liable Farm heads personally liable for their share All farm heads personally liable for their entire estate Silent partners for their brought-in capital. Active partners for their entire estate Shareholders only liable for their brought-in capital Fiscal aspects Profit taxed by income tax Profit taxed by income tax or corporation tax Profits taxed by corporation tax Dividends also taxed Transaction costs Relatively lowIncrease with more members Sharing partnership’s profits by active partners limits agency cost Incentive problems if ownership and management separated Cost of capital for the farm Relatively high Relatively high, but partly lower because of silent partners Lower; risk- bearing costs are lower

19. 19 From single owner to (private) limited company separation of ownership and management will increase co-ownership offers possibilities of building up reputation; who has residual control rights and who is able to capture residual income becomes less clear; transaction costs increase because of –(1) hidden information and hidden actions –(2) giving incentives for workers and managers; more possibilities of sharing risk. –An important difference between a private limited company and e.g. single owner, is reduced liability and therefore risk, which in turn implies a lower cost of capital and more possibilities for larger scale activities; more possibilities for specialisation of work and management; more possibilities to spreading fixed costs over more transactions; the governance structure becomes more complex and more robust.