Resource-Based and Property Rights Perspectives on Value Creation: The Case of Oil Field Unitization Kim and Mahoney (2002) Presented by Xia Cao

Why is property rights theory important？ The Resource Based View (RBV) suggests that resources that are valuable, rare, inimitable, and non-substitutable (VRIN) increase the likelihood of value creation Property rights theory (PRT) complements the resource-based view by relaxing the implicit assumption that resources are secure.

Potential value creation Realized value creation Frictions in establishing property rights Potential value creation Realized value creation PRT RBV This paper examines frictions through the example of oil field unitization.

Property Rights Theory Property rights are social institutions Coase (1960) suggests that a resource should be seen as a “bundle of rights” Alchian (1969) then clarifies this bundle The right to appropriate The right to use and change form The right to transfer

Limitations of RBV RBV makes a simplifying assumption that property rights are secure There are transaction costs (searching, bargaining and enforcement) There are agency costs

Why PRT works? Property rights theory is in many ways more fundamental -The “right” determines the extent of the transaction costs and the agency problems -It defines the rights of stakeholders clearly Thus property rights help in predicting the potential for value creation

Origins of PRT Coase (1960) introduced property rights into mainstream economics. Coase Theorem: given zero transaction costs, governance choice between different modes of resource allocation will not matter for economic efficiency. It suggested that property rights are the reason why firms work The difficulty in establishing property rights leads to the need for laws which subsequently have an impact on transaction costs

The Case of Oil Field Unitization Oil field unitization is where a single firm is designated as the unit operator to develop/drill the oil reservoir as a whole.

The Case of Oil Field Unitization Important variables for efficient extraction the rate of production the location of the wells Individual competitive drilling goes against finding optimal location maintaining efficient extraction rate Therefore, oil field unitization is the most complete solution. But why is this solution not realized?

Impediments of Contracting The length of the contract, the feature of a once-and-for-all contract, the requirement of site-specific investments with little economic salvage value, substantial uncertainty about behavior of contracting parties, and inherent risk involved in drilling for oil The presence of negative externalities, information asymmetry, and distributional conflicts, leads to suboptimal economic results (a prisoners’ dilemma situation)

RBV and Oil field unitization The oil field satisfies the four criteria as a source of potential economic rents (Peteraf, 1993) resource heterogeneity ex post limits to competition ex ante limits imperfect resource mobility But RBV is not sufficient because Who appropriates matters Expectations change depending on feedback So rent appropriation should be plausible from an RBV perspective. So (well defined) property rights matter in the case of oil field unitization

RBV in Terms of PRT The bundles of property rights promise potential economic rents: Clearly defined property rights are specific in delineating what utilization are possible with a particular resource. In the essence, the process of making property rights more precis can be another way of looking at value creation process Unitization appears to be a valid solution Yet we see very little of it Asymmetric information and the likelihood of hold outs Not only are property rights important but are also challenging to implement

Conclusion 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.