This is the second part of the review of the Economic Foundations of Strategic Management. Part 1 here.
This week, I spent my time reviewing theories used in strategic management that were derived from economics or grounded in economic concepts.
In one of my classes, we were encouraged to summarize theories by looking at the assumptions they make, how they are similar to other theories, the unit of analysis, and the predictions that can be made.
Transaction cost theory focuses on an organization’s transactions. The central idea is that when organizations make decisions about their key operations, they either incur transaction costs or production costs. The transaction costs include costs and difficulties associated with the searching for the best supplier, as well as the creation implementation, and monitoring of a contract. Production costs, on the other hand, involve costs associated with the coordination of the people and processes inside a firm. The selection of one set of costs over the other is called the “make or buy” decision. Two factors associated with the choice to buy or make a key component of production is the level of uncertainty and the asset specificity. Both of these concepts are related to risk and the role it plays on a firm’s decisions.
Agency Theory emerged as a response to managerial theory (Jensen & Meckling, 1976). The core idea is the relationship between stockholders (owners, principals) and managers (agents). This is often described as the principal-agent relationship. This theory assumes that managers (agents) may pursue goals that are not always aligned with those of their principles (stockholders). As a result, there is a loss in efficiency. In order to avoid misalignment of principal-agent interests, governance mechanisms have evolved to limit managerial discretions. These include:
The managerial theories of firm growth are concerned with the role of management in the productivity and performance of the firm.