Organizational theories

Question 2

Organization theorists have long been concerned with two related questions: (1) why do firms exist? and (2) what determines the boundaries of the firm?

a. Describe why the answers to these questions are important for academic research. (half single-spaced page)

b. Summarize two theories that answer both questions. (half single-spaced page)

c. Explain how the underlying assumptions or tenets of each theory overlap or contradict one another. (half single-spaced page)

d. Take stock of the practical significance of this body of knowledge. To what extent do managers benefit? (half single-spaced page)

References and instructions in how to answer:

QUESTION 1A: Answer writing about the following theories

Psychological:

P1: Organizational learning - Uses this content and references as source of inspiration:

This one must be in the answer: Levitt & March, 1988 – Review on Organizational Learning. Much started with Cyert & March, 1963 and Nelson & Winter, 1982. Learning from experience and from others, developing frameworks for interpreting the experience. Routine-based, path-dependent, and target-oriented. Lockout and competency trap.

Argote & Epple, 1990 – Learning Curves. As organizations produce more of a product, the unit cost of production typically decreases at a decreasing rate. Variation on the rate that organizations learn may be due to organizational “forgetting”, employee turnover, transfer of knowledge, and the failure to control for other factors, such as economies of scale, when estimating learning curves.

March, 1991 – Exploration and Exploitation. Balance is important.

Cohen & Levinthal, 1991 – Absorptive Capacity. The ability of a firm to recognize the value of new, external information, assimilate it, and apply it to commercial ends. Path dependent (lock out). Your path locks you out of things you have not experienced.

Zahra & George, 2002 – Absorptive Capacity. Potential vs realized.

Szulanski, 1996 – Knowledge transfer of best practices internally. The major barriers to internal knowledge transfer are knowledge-related factors such as the recipient's lack of absorptive capacity, causal ambiguity, and an arduous relationship between the source and the recipient.

Vermeulen & Barkema, 2001 – Learning through Acquisitions (M&As). Exploitation of a firm's knowledge base through greenfields eventually makes a firm simple and inert. In contrast, acquisitions may broaden a firm's knowledge base and decrease inertia, enhancing the viability of its later ventures. Over time, firms strike a balance between the use of greenfields and acquisitions.

Levinthal & Rerup, 2006 – Bridging Mindful and Less-Mindful Perspectives on Organizational Learning. The role of established action repertories that facilitate the response to novel stimuli and how routines and established role structures enable mindfulness to be sustained across time and the span of the organization.

Lavie & Rosenkopf, 2006 – Exploration & Exploitation in Alliance Formation. Absorptive capacity and organizational inertia impose conflicting pressures for exploration and exploitation with respect to the value chain function of alliances, the attributes of partners, and partners' network positions. Although path dependencies reinforce either exploration or exploitation within each of these domains, firms balance their tendencies to explore and exploit over time and across domains.

Barkema & Schijven, 2008 – Learning to Acquire (M&As). Three more recent streams of research—negative experience transfer, deliberate learning mechanisms, and learning from others.

Yang et al., 2010 – Knowledge Spillovers. When an originating firm's spillovers are recombined with complementary knowledge by recipient firms, a spillover knowledge pool is formed, containing opportunities for the originator to learn vicariously from recipients.

Bingham & Davis, 2012 – Learning sequences. *Process research generally focuses on understanding the temporal dynamics of organizational phenomena such as learning (Van de Ven, 1992; Langley, 2007). For example, as noted earlier, research on trial-and-error learning describes how firms engage in an action and then the consequences of that action influence subsequent action (Van de Ven & Polley, 1992).

Bingham et al., 2015 – Concurrent Learning. Process theory. Concurrent learning of dynamic capabilities is aided by three activities: initiating structure (i.e. dedicated corporate group that begins knowledge codification), generalizing structure (leveraging initial structure for one process into multiple processes concurrently), and backward-chaining structure (codification of phases in reverse chronological order).

Reus et al., 2015 – Dark Side of Knowledge Transfer (M&As). One of the first to empirically test knowledge transfer.

Puranam et al., 2015 – Modelling Bounded Rationality in Organizations. Various models of organizational learning.

P2: Prospect theory - Uses this content and references as source of inspiration:

FEW IDEAS ON IT (NOT FLUID AND NOT PLAGIARISM FREE:

Attempts to explain individual choice under uncertainty. Individuals judge outcomes relative to a reference point. The theory assigns values to the difference between the outcome and the reference point. The function for values differs for outcomes above and below the reference point. The value function is concave for outcomes above the reference point (risk averse), convex for outcomes below the reference point (risk seeking), and has a substantially steeper slope for negative than positive outcomes. Choice depends on a sum of these values weighted by a function that depends on the probabilities of the outcomes. The weighing function generally under weights outcomes with mid-range probabilities but over weights extremely low probabilities, and may assign zero weight to very low probabilities (Kahneman & Tversky, 1979).

▪ As with much of BDT, prospect theory attempts to explain how individuals differ from the predictions of expected utility maximization (see Schoemaker, 1982 for a review of expected utility model).

1. Prospect theory proposes that people derive utility from gains and losses relative to a reference point, while utility theory assumes that people derive utility from total wealth or consumption.

2. Prospect theory’s value function differs in the domain of gains from the domain of losses, but, since utility functions only consider final outcomes, utility functions do not differ with reference point.

3. Near the reference point, in prospect theory, a unit change for outcomes framed as losses influences value much more than a unit change for outcomes framed as gains.

▪ Three main contributions:

1. Loss aversion.

2. Diminishing sensibility.

3. Decision weights.

▪ Diminishing sensitivity—the further from the reference point, the less perception of difference for small amounts. Not only money but also time, positive vs negative, temperature, weight, distance, etc. this is maybe a natural cognitive behavior because one does not confront things far from one’s reference point frequently.

▪ Expected value: probability times outcome. Utility theory—what matters is the utility of the outcome, not the outcome itself vs Prospect theory—the weight of the probability; reference point is the status quo. Far from the reference point—underweighted; close to the reference point—over weighted (Holmes et al., 2011).

▪ The pain of losses is much higher than the pleasure of gains (about 2.25 times).

▪ If the probability is close to the midpoint, the choice is usually based on the outcome. If the probability is close to the endpoint, the choice is usually based on the probability.

▪ Prospect theory differs from BToF particularly in relation to choices near the reference point. Firms with performance near the reference point should face even more mixed gambles than firms further from the reference point. In contrast, the BToF predicts relatively little risk-taking for firms near the reference point.

▪ Risk-taking behavior is affected by prior gain and losses. The presentation format of the alternatives also matters. Hence, generalizing about risk-taking preferences is difficult. General tendencies can be reversed by a simple reframing of options. Challenges the isolation effect. Silver-lining principle—we experience gain separately from loss and prefer to segregate gains (Thaler & Johnson, 1990; Wong & Kwong, 2005 when analyzing performance valuations).

▪ One wants information to be framed in a positive way, with small numbers in things one is good at and large numbers in things one is weak at (Wong & Kwong, 2005).

▪ Prospect theory predicts behavior for inexperienced consumers. Consumers with high market experience, however, behave largely in accordance with expected utility predictions. Via previous market interaction and arbitrage opportunities, they learn to treat goods leaving their endowment (i.e. reference point; from where one frames gains and/or losses) as an opportunity cost rather than a loss. Willingness to accept is higher than to pay. Loss aversion creates endowment (i.e. status quo; omission) (List, 2004).

Issues and Directions for Future Research:

▪ Comes from experimental results where a particular reference point is imposed. Therefore, it does not offer a sophisticated explanation for the determination of the reference point. A diversity of factors determine the reference point (Tversky & Kahneman, 1981).

▪ Almost all strategy interpretations of prospect theory only consider the value function without addressing the other components of the theory.

▪ Predictions of prospect theory depend strongly on a variety of assumptions that the management literature has ignored (Bromiley, 2008).

▪ Whether corporate behavior patterns actually reflect organizational rather than psychological effects remains an open issue.

▪ Four areas of concern regarding the use of prospect theory (Holmes et al., 2011):

1. Most of the studies use only a couple of constructs proposed by the theory instead of using the whole theory.

2. Predictions made by these studies are inconsistent with the theory.

3. Since the use of the theory is not coherent, it is difficult to compare results across studies.

4. Studies use the theory to explain high-level phenomena, while it is an individual-level theory.

The main suggestions for future research are threefold:

1. Studies should derive the hypotheses directly from the two central components of the theory (value function and probability weighting function).

2. Studies should have clearly identified the aspects of the theory being analyzed.

3. There should be more valid and consistent measurement of the constructs.

▪ Other theories should be incorporated into organizational aspirations research, such as legitimacy theory, psychological goal-setting theory, institutional theory, and research on competitive dynamics. Also, there should be proper measurement of aspirations (or goals), considering different levels of analysis (Shinkle, 2012).

Sociology:

S1: Institutional theory - Uses this content and references as source of inspiration:

DiMaggio, P. & Powell, W. 1983. The iron cage revisited: institutionalized isomorphism and collective rationality in organizational fields. ASR, 48: 147-160.

Meyer, J. & Rowan, B. 1977. Institutionalized organizations: formal structure as myth and ceremony. AJS, 83: 340-363.

North. 1990. Institutions, institutional change and economic performance. Ch 1. (more latter)

Maguire & Hardy. 2009. Discourse and deinstitutionalization: The decline of DDT. AMJ, 52: 148-178.

Jonsson, S., Greve, H. & Fujiwara-Greve, T. 2009. Undeserved loss: The spread of legitimacy loss to innocent organizations in response to reported corporate deviance. ASQ, 54: 195-228.

Suddaby, R., Elsbach, K., Greenwood, R., Meyer, J. & Zilber, T. 2010. Organizations and their institutional environments – bringing meanings, values, and culture back in: Introduction to the special research forum. AMJ, 53: 1234-1240.

Delmestri, G. & Greenwood, R. 2016. How Cinderella became a queen: Theorizing radical status change. ASQ, 61: 507-550.

Dalpiaz, Rindova & Ravasi. 2016. Combing logics to transform organizational agency: Blending industry and art at Alessi. ASQ, 61: 347-392.

Yan, S., Ferraro, F. & Almoandoz, J. 2019. The rise of socially responsible investment funds: The paradoxical role of the financial logic. ASQ, 64: 466-501.

Durand, R., Hawn, O. & Ioannou, I. 2019. Willing and able: a general model of organizational responses to normative pressures. AMR, 44: 299-320.

S2: Power and Resource Dependence - Uses this content and references as source of inspiration:

Pfeffer, J. 1981. Power in organizations: Ch 1, 4 & 9. – Overview, clasic

Emerson, R. 1962. Power-dependence relations. ASR, 27: 31-41.

French & Raven. 1968. The bases of social power. In Cartwright & Zander Group Dynamics. New York: Harper & Row. – two classics on power dependence, deals with power and interdependence on

Pfeffer & Salancik 1978. The external control of organizations. Ch 1, 3-5 & 10

Casciaro, T., & Piskorski, M.J. (2005). Power imbalance, mutual dependence, and constraint,

absorption: A close look at resource dependence theory. Administrative Science Quarterly, 50(2), 167–199. – only ones that extended, and took them all the way to the 2005, summarize kucal,d and haudreitchs

Oliver, C. & Holzinger, I. 2008. The effectiveness of strategic political management: A dynamic capabilities framework. AMR, 33: 496-520. – a little bit a good bit of including clarificing the political monubering

Wry. T., Cobb, J., Aldrich, H. 2013. More than a metaphor. Academy of Management Annals, 7: 441-488. –

Sutton, T., Devine, R., Lamont, B. & Holmes, R.M. Resource dependence, uncertainty, and the allocation of corporate political contributions across multiple jurisdictions. Working paper under 4th review at AMJ. - extend resource depended theory

Economics:

E1: Agency theory – Uses this essay and references as source of inspiration:

Fama, Jensen, Jensen & Meckling 1976

Fama 1980

Fama & Jensen 1983

Demsetz 1983

Eisenhardt 1989

Davis et al. 1997

Hitt, Arregle and Holmes, 2021 – agency theory will use stakeholder theory as critical complement due to multifaceted principal (many stakeholders)

Barney (2018) and Hitt, Arregle and Holmes, 2021, consider the shareholder as the only residual claimant is inconsistent and does not work on the current situation of the world. Generate value to other stakeholders is necessary to create firm’s value and profits for shareholders. Stakeholder theory became critical complement on agency theory. All stakeholders can be considered principals in different ways and with different claimants.

An agency relationship mainly involves two actors, the principal, and the agent. The two engage mostly to achieve some service, including transferring some authority in making decisions to the agent. One of the notable agency relations is the one that exists between an employer and an employee. Agency theory in management attempts to explain this relationship between the principal and the agent. It also tries to explain the delegation of control and prevent misalignments of goals between the agent and the principal. The theory explains how to establish a relationship where one party regulates the activities of the other, and another party completes and styles the required decisions on the principal's behalf (Jensen and Meckling, 1976). Agency has been noted as a universal principle and not just a theory belonging to the firm. It focuses on the main model of making the agent produce maximum gains for the principal and not for itself.

According to the theory, there arise three main issues that give a chance to a concern. The issues include the problems encountered by the principal, the agent, by policing procedures and initiatives (Jensen & Meckling, 1976). The principal's problem is concerned with inspiring the agent to perform to accomplish the principal's goals. The principal uses motivational tools that agree with his goals. The agent faces the problem of deciding to perform in the interest of the principal, his interest, or concuss between the two in case do not concur. Besides, monitoring the agent's actions is seen as a source of agency cost. With the costs come other costs, including bonding costs borne by the agent and wealth loss borne by the agent's actions. Jensen and Meckling (1976) identify that both parties resolve the issues found in corporate welfare. The administration of the organization may also affect the director's monitoring behavior.

On the other hand, agency theory recommends that outside authority mechanisms can dissuade managers from acting resourcefully. With the assistance of cognitive evaluation theory, the argument comes in that powerful expectations imposed by external authorities can influence the feelings of the top manager. The impingement may lead to the autonomy of the manager's feelings. It may also lead to an effect on the intrinsic motivation of the crowd. The autonomy eventually leads to financial fraud committed by the manager (Shi, Connelly, & Hoskisson, 2017). External pressures forced on managers further decrease the likelihood of ethical dangers. Besides, the theory outlines the concept where the manager takes for himself possible risks. This results in potential outcomes and extreme loss (Sanders & Hambrick, 2007). The main financial options of the manager may lead to high levels of investment or extreme corporate performance, which includes big gains and big losses for the organization.

In addition, Nyberg, Fulmer, Gerhart, & Carpenter (2010) point out that agency theory suggests that the manager's damage may happen in case of a divergence between the interests of owners and managers. They establish the importance of agent compensation and equity ownership as possible solutions to the problem. On theorizing executive compensation for agents, micro-foundations are mainly used as behavioral agency theory. The microfoundations focus on the agent performance and notes that the welfares of shareholders and their agents are expected to be affiliated if directors are driven to achieve to the best of their capabilities (Pepper & Gore, 2015). With this arises the incentive alignment mechanism as a way to monitor and control agency costs.

However, the agency theory contains some shortfalls. The agency's model's unsophisticated conceptualization of the struggle with interest inherent in the relationship between employer and employee proves insufficient to handle the complications and inconsistencies surrounding the uses of accountancy data. They are mainly experienced in assessing and regulating employee accomplishment (Ogden, 1993). Besides, the ownership arrangements found in the venture capitalist-entrepreneur relationships appear to be important (Arthurs & Busenitz, 2003). Agency theory does not clearly explain the behavior of individuals in the relationship. The theory uses assumptions of agents being self-centered, boundedly rational, and diverse from leaders in their ideas and taking risks; thus, it is narrow in its assumptions. Agency theory focuses on self-interested and opportunistic human behavior. Thus, the theory tends to ignore a broader range of human motives further to explain their behaviors and the outcome of those behaviors.

Besides, the theory may be used in the future in some ways. According to Bosse & Phillips, 2016), the theory draws attention to various behaviors of managers and authorities that create losses for the community. This may, in turn, initiate a problem between the principal and the agent that happens when the welfares of the principal and the agent conflict. However, when agency theory is utilized to the maximum, it may result in corporate governance, which restores the policies that guide the agent and the principal's interests. It helps in understanding the associations between agents and principals. Agency theory helps the agent represent the principal in various organizational activities with the principal's best interest without regard for self-interest. In the organization's structure, this may be helpful as it leads to obedience, respect, and quality operations. The theory can also be used to resolve issues in the relationship. The most common relationship is found between the shareholders as principals and executives in an organization as agent.

E2: Transaction costs economics

5. Transaction Cost Economics (TCE)

Argote, L. (2015). A Behavioral Theory of the Firm. Journal of Management Inquiry, 24(3), 321–321. https://doi.org/10.1177/1056492615572538

Argyres, N. S., & Zenger, T. R. (2012). Capabilities, transaction costs, and firm boundaries. Organization Science, 23(6), 1643–1657. https://doi.org/10.1287/orsc.1110.0736

Asmussen, C. G., Foss, K., Foss, N. J., & Klein, P. G. (2021). Economizing and strategizing: How coalitions and transaction costs shape value creation and appropriation. Strategic Management Journal, 42(2), 413–434. https://doi.org/10.1002/smj.3227

Coase, R. H. (1937). The Nature of the Firm. Economica, 4(16), 386–405. https://doi.org/10.1111/j.1468-0335.1937.tb00002.x

Cuypers, I. R. P., Hennart, J. F., Silverman, B. S., & Ertug, G. (2021). Transaction cost theory: Past progress, current challenges, and suggestions for the future. Academy of Management Annals, 15(1), 111–150. https://doi.org/10.5465/annals.2019.0051

David, R. J., & Han, S.-K. (2004). A systematic assessment of the empirical support for transaction cost economics. Strategic Management Journal, 25(1), 39–58. https://doi.org/10.1002/smj.359

Geyskens, I., Steenkamp, J. B. E. M., & Kumar, N. (2006). Make, buy, or ally: A transaction cost theory meta-analysis. Academy of Management Journal, 49(3), 519–543. https://doi.org/10.5465/AMJ.2006.21794670

Greve, H. R., & Argote, L. (2015). Behavioral Theories of Organization. International Encyclopedia of the Social & Behavioral Sciences, 481–486. https://doi.org/10.1016/B978-0-08-097086-8.73121-7

Sestu, M. C., & Majocchi, A. (2020). Family Firms and the Choice Between Wholly Owned Subsidiaries and Joint Ventures: A Transaction Costs Perspective. Entrepreneurship Theory and Practice, 44(2), 211–232. https://doi.org/10.1177/1042258718797925

Weber, L., & Mayer, K. (2014). Transaction cost economics and the cognitive perspective: Investigating the sources and governance of interpretive uncertainty. Academy of Management Review, 39(3), 344–363. https://doi.org/10.5465/amr.2011.0463

Williamson, O. E. (1975). Markets and Hierarchies: Analysis and Antitrust Implications: A Study in the Economics of Internal Organization. Free Press.

Williamson, O. E. (1981). The Economics of Organization: The Transaction Cost Approach on JSTOR. American Journal of Sociology, 87(3), 548–577. https://www.jstor.org/stable/2778934?seq=24#metadata_info_tab_contents

Williamson, O. E. (1985). The Economic Institutions of Capitalism. Free Press. https://papers.ssrn.com/abstract=1496720

Williamson, O. E. (1991). Comparative Economic Organization: The Analysis of Discrete Structural Alternatives. Administrative Science Quarterly, 36(2), 269. https://doi.org/10.2307/2393356

Zenger, T. R., Felin, T., & Bigelow, L. (2011). Theories of the Firm–Market Boundary. Academy of Management Annals, 5(1), 89–133. https://doi.org/10.5465/19416520.2011.590301

QUESTION 1B

Use these three studies: