1. Resource-Based and Property Rights Perspectives
on Value Creation: The Case of Oil Filed Unitization
Session 4: Property Rights Theory
Jongwook Kim
Joseph T. Mahoney
Managerial and Decision Economics (2002)
by Eunkwang Seo

2. AGENDA Research Objective
To expand the scope of resource-based theory to a business context where there are struggles in establishing property rights that will enhance the economic value of resources.
Specifically, property rights theory complements an apparent shortcoming of resource-based theory by relaxing the implicit assumption that ownership of certain resources automatically leads to generation of economic value.

3. RESOURCE-BASED THEORY
The Source of Sustainable Competitive Advantages
Possessing those resources leads to sustainable competitive advantages.

4. RESOURCE-BASED THEORY
Possession is Sufficient? (1)
The case of oil unitization
Oil field satisfies the four criteria as a source of potential economic rents (geographical heterogeneity, inimitability and non-substitutability as a natural resource, ex-ante uncertainty, and imperfect mobility).
Adopting the view of resource-based theory, therefore, oil field is expected to generate sustainable economic rents.
In reality, HOWEVER, the potential value is NOT being realized.

5. Oil Field
An oilfield is an area of rock under the ground that is full of oil or gas or both. Oilfields are typically km (6-12 miles) wide.
Oil is created in a source rock, along with water and gas. Over millions of years, the oil and gas float upwards above the water along a migration path. Oil and gas often rises all the way to the surface of the earth. In other cases, it collects in a reservoir; a rock that has spaces where oil can collect. Sandstone is a good example, in which oil collects in the spaces (pores) between the sand grains. There must also be a trap - a rock structure that forms a seal above and around the reservoir rock. A seal is impermeable - that is, fluids such as oil cannot flow through it. Clay and shale are impermeable and make good seals.
Source:

6. RESOURCE-BASED THEORY
Possession is Sufficient? (2)
A serious common-pool problem
Both imperfect information about valuation of individual leases and potential for strategic hold-out behavior lead to economic incentives to drill competitively.
Since oil firms in an oil reservoir are drawing from a common resource pool that is exhaustible, competitive drilling generates negative externalities for neighboring oil firms.
In Slaughter oil field in Texas, cost for setting up injection wells preventing oil migration to an adjacent tract of land amounted to about $156 million dollars.
Property Rights Matter!! ?
Potential Value
Realized Value

7. PROPERTY RIGHTS THEORY
Property Rights Theory and Strategic Management
What are property rights?
Property rights refer to sanctioned behavioral relations among decision makers in the use of potentially valuable resources.
Types of property rights (Libecap, 1986, 1989)
The right to exclude non-owners from access
The right to appropriate the stream of economic rents from use of and investments in the resource
The right to sell or transfer the resource to others
Implications
By assigning ownership to valuable resources and by designing who bears economic rewards and costs of resource-use decisions, property rights institutions structure incentives for economic behavior within society.
An economic party with the most to gain or lose from performance of a particular resource, the owner is aligned with maximizing economic performance of that resource.

8. PROPERTY RIGHTS THEORY
Application to the Case of Oil Field
Oil Field Unitization --- to “internalize the externalities” (and solve the Prisoners’ dilemma problem)
Unitization refers to a private contractual arrangement to reduce economic losses associated with common-pool extraction.
Under oil field unitization, drilling is delegated to a single operator who is a residual claimant to profits from the reservoir.
This shifts the strategic intent from maximization of economic value of an individual lease to that of the unit (Libecap, 1989).
The oil field unitization, thus, is the most straightforward economic solution to a serious common-pool problem in oil and gas production.
The problem of competitive drilling in oil field can be attributed to
poorly defined property rights to the common resources.

9. PROPERTY RIGHTS THEORY
Optimistic Views to Property Rights
The perspective of “Pareto Efficiency”
If there is a chance to enhance economic wealth of some parties without sacrificing others’ wealth, new institutional arrangements on property rights will take place.
Coase Theorem
Given zero transaction costs, the economic system will move toward an efficient system of property rights that internalize externalities.
Demsetz’s argument (1967)
even in a world of positive transaction costs, as long as the cost-benefit calculus indicates potential economic gains to be expected, we will observe a change in the system of property rights that leads to potential economic gains being realized.
However, we observe empirically a surprisingly low rate of oil field unitization.
( As late as 1975, only 38% of Oklahoma production and 20% of Texas production came from field-wide units.)

10. PROPERTY RIGHTS THEORY
Impediments to Contracting (1)
Asymmetric Information
In the case of oil field, each contracting party conducts calculation by doing tests based on their own land, thus leading to greatly diverging valuations of each party’s share.
Such asymmetry prevents from converging on contractual agreements.
Number and Heterogeneity of Exchange Parties;
Strategic Behavior (e.g., strategic holdout)
Because reservoirs are not uniform, certain tracts of land have inherent structural advantages that allow more efficient production than others.
Leaseholders of such advantageous positions would have little economic incentive to participate in oil field unitization unless sufficiently compensated.

11. PROPERTY RIGHTS THEORY
Impediments to Contracting (2)
Biased third-party enforcement
Property rights institutions are determined basically through the political process, involving either negotiations among immediate group members of the lobbying activities that take place at a higher levels of government.
For instance, the Railroad Commission of Texas, the primary regulatory body in oil production in Texas, are systemically biased toward protecting smaller, higher cost producers.
Therefore, it is hard to expect that a Pareto-improving change resolving the problems of property rights naturally occurs in the market.
In sum, in order to realize the potential value of strategic resources, firms must pay attention to designing the property rights among the resource holders.

12. Complementarity between RBV and PR
“The more valuable the resources, the more incentives there are to make property rights of resources more precise.”
“The more precisely delineated the property rights of resources, the more valuable resources become.” PR
RBV

13. Contribution to Resource-Based Theory
CONCLUSION
Contribution to Resource-Based Theory
Potential value is not automatically realized.
As seen in the case of oil field, possessing strategic resources is not often sufficient to generating full economic values.
Property rights matter!!
The expected distribution of wealth among resource providers ex post has important implications for value creation activities ex ante.
Thus, examining their property rights gives a powerful framework to expect the process of realizing the potential value of the given resources.
Therefore, property rights theory must come to the foreground in an analysis of economic value creation.

14. Conclusions A full resource-based analysis must consider:
not only whether resources are valuable, rare, inimitable and non-substitutable,
but must also consider the role of property rights in (realized) value creation.
“The property rights theory (along with transaction costs and agency theories) will become increasingly prominent in the next generation of resource-based research in strategic management.”
Conclusions
Agency
Theory
Transaction
Costs
Theory
Property
Rights
Theory