Cambridge University Press 978-1-107-13440-9 — Adaptation, Specialization, and the Theory of the Firm Birger Wernerfelt Frontmatter More Information Adaptation, Specialization, and the Theory of the Firm This invaluable book provides the foundations for a new theory of the firm, drawing on Birger Wernerfelt’s landmark work on economic theory and the resource-based view of the firm It addresses a vigorous and long-standing academic debate over what exactly a “firm” is, both in the field of management and economics Wernerfelt revisits his classic articles, including an extensively revised “A Resource-Based View of the Firm” (1984), which have been updated and synthesized to provide precise and accessible concepts and predictions By offering future directions for research and practice, this book will be of interest to students and scholars of management and economics alike birger wernerfelt is the J C Penney Professor of Management at the MIT Sloan School of Management www.cambridge.org Cambridge University Press 978-1-107-13440-9 — Adaptation, Specialization, and the Theory of the Firm Birger Wernerfelt Frontmatter More Information Adaptation, Specialization, and the Theory of the Firm Foundations of the Resource-Based View Birger Wernerfelt MIT Sloan School of Management www.cambridge.org Cambridge University Press 978-1-107-13440-9 — Adaptation, Specialization, and the Theory of the Firm Birger Wernerfelt Frontmatter More Information University Printing House, Cambridge CB2 8BS, United Kingdom One Liberty Plaza, 20th Floor, New York, NY 10006, USA 477 Williamstown Road, Port Melbourne, VIC 3207, Australia 4843/24, 2nd Floor, Ansari Road, Daryaganj, Delhi – 110002, India 79 Anson Road, #06–04/06, Singapore 079906 Cambridge University Press is part of the University of Cambridge It furthers the University’s mission by disseminating knowledge in the pursuit of education, learning and research at the highest international levels of excellence www.cambridge.org Information on this title: www.cambridge.org/9781107595781 DOI: 10.1017/9781316466872 © Birger Wernerfelt 2016 This publication is in copyright Subject to statutory exception and to the provisions of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press First published 2016 Printed in the United Kingdom by Clays, St Ives plc A catalogue record for this publication is available from the British Library Library of Congress Cataloging-in-Publication Data Names: Wernerfelt, Birger, author Title: Adaptation, specialization, and the theory of the firm : foundations of the resource-based view / by Birger Wernerfelt, J C Penney Professor of Management, MIT Sloan School of Management Description: Cambridge, United Kingdom : Cambridge University Press, [2016] | Includes index Identifiers: LCCN 2016017702| ISBN 9781107134409 (Hardback) | ISBN 9781107595781 (Paperback) Subjects: LCSH: Industrial organization (Economic theory) | Economic specialization | Diversification in industry Classification: LCC HD2326 W467 2016 | DDC 338.5–dc23 LC record available at https://lccn.loc.gov/2016017702 ISBN 978-1-107-13440-9 Hardback ISBN 978-1-107-59578-1 Paperback Cambridge University Press has no responsibility for the persistence or accuracy of URLs for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate www.cambridge.org Cambridge University Press 978-1-107-13440-9 — Adaptation, Specialization, and the Theory of the Firm Birger Wernerfelt Frontmatter More Information For Bjoern www.cambridge.org Cambridge University Press 978-1-107-13440-9 — Adaptation, Specialization, and the Theory of the Firm Birger Wernerfelt Frontmatter More Information Contents List of Figures List of Tables Preface Part I Agenda Introduction Preview: Small Forces, High Frequencies, and Large Firms Part II The Main Argument page ix x xiii 10 31 Adaptation Costs in One Dimension: Firms, Contracts, and Price Lists 33 Adaptation Costs in Three Dimensions: Firms, Markets, and Contracts 58 All Adaptations Are Not the Same: The Scope of Firms and the Size of Markets 83 Resources and the Scope of the Firm Part III Implications 101 113 The Allocation of Asset Ownership 115 Communication within and between Firms 128 The Power of Incentives within and between Firms 150 10 Decision-Making in Large Organizations 161 vii www.cambridge.org Cambridge University Press 978-1-107-13440-9 — Adaptation, Specialization, and the Theory of the Firm Birger Wernerfelt Frontmatter More Information viii Contents Part IV Empirical Tests 179 11 Bargaining Costs: Existence and Sub-Additivity 181 12 Adaptation Frequency and the Boundary of the Firm 201 13 Asset Ownership and Externalities 229 Part V 251 Foundations 14 Endogenously Incomplete Contracts 253 15 Multiple Equilibria and Firm Heterogeneity 272 16 On the Endogenous Amplification of Small Differences 284 Part VI 299 Postscript 17 Summary and Final Reflections Index 301 303 www.cambridge.org Cambridge University Press 978-1-107-13440-9 — Adaptation, Specialization, and the Theory of the Firm Birger Wernerfelt Frontmatter More Information Figures 2.1 2.2 2.3 3.1 4.1 4.2 4.3 5.1 6.1 6.2 6.3 6.4 7.1 8.1 8.2 8.3 11.1 11.A-1 14.1 15.1 Most efficient mechanisms and changing needs page 18 Most efficient mechanisms and changing needs 19 Most efficient mechanisms and changing needs 20 Most efficient mechanisms 41 Most efficient mechanisms by frequency of change and switching costs 72 Most efficient mechanisms by frequency of change and gains from service specialization 72 Most efficient mechanisms by frequency of change and number of needs 75 A two business–two service economy 90 Resource–product matrix 103 Sequential entry 107 Exploit and develop 109 Stepping stone 110 The value–depreciation frontier 117 Conditional posterior density of cl if the seller did not find the new design (F = U) 136 Conditional posterior densities of cl if seller found, but did not offer, new design (F = U) 137 Conditional posterior densities of ch if seller offered the new design (F = U) 139 Schematic screen-shot of the bargaining environment for the buyer 185 Frequency of settling times by experimental treatment 200 {k, r │The buyer will cede decision d to the seller} 265 Possible linear codes when V = 276 ix www.cambridge.org Cambridge University Press 978-1-107-13440-9 — Adaptation, Specialization, and the Theory of the Firm Birger Wernerfelt Frontmatter More Information Tables 3.1 3.2 3.3 4.A-1 7.1 11.1 11.2 11.3 11.4 11.5 12.1 12.2 12.3 12.4 12.5 12.6 12.7 12.A-1 12.A-2 12.A-3 12.A-4 Kendall rank correlations Correlation coefficients t-Values from regressions Components of efficiency and performance of mechanisms Questionnaire The tendency to pool for increasing costs of pooling The tendency to pool for different costs and benefits of pooling The role of time-savings in the tendency to pool The role of anonymity in the tendency to pool Number of offers in one period negotiations and pooling prices List of parts Descriptive statistics by production system Probability of pair-wise co-production by adaptation frequency Sum of internalized adaptation frequencies by production system Models of max Σijxij(β)[βfij + eij] Sum of squared production system residuals (SSR) by alternative models Sum of squared firm residuals (SSR) by alternative models Adaptation frequencies from interviews and co-production data for production system A Descriptive statistics by production system Probability of pair-wise co-production by adaptation frequency Sum of internalized adaptation frequencies by production system page 51 52 52 79 123 187 189 189 190 191 207 208 210 212 217 219 220 224 226 226 227 x www.cambridge.org Cambridge University Press 978-1-107-13440-9 — Adaptation, Specialization, and the Theory of the Firm Birger Wernerfelt Frontmatter More Information List of Tables 12.A-5 Models of max Σijxij(β)[βfij + eij] 12.A-6 Sum of squared production system residuals (SSR) by alternative models 12.A-7 Sum of squared firm residuals (SSR) by alternative models 13.1 Summary statistics 13.2 Rank-order correlation of the measures 13.3 Multivariate analysis 13.4 Modified multivariate analysis 15.1 Number of rounds when one member uses code A and the other uses code B 15.2 Number of rounds when both members use code A 15.3 Number of rounds when both members use code B xi 227 228 228 240 245 245 248 278 278 278 www.cambridge.org Cambridge University Press 978-1-107-13440-9 — Adaptation, Specialization, and the Theory of the Firm Birger Wernerfelt Frontmatter More Information Preface This book is based on fifteen papers written over a thirty-year period Two of them, “A Resource-Based View of the Firm” (proposing what is now called the RBV) and “On the Nature and Scope of the Firm” (proposing what is here called the “Adaptation Cost,” or just AC, theory of the firm1) were written a few years apart in the 1980s While both papers aim to characterize the sets of activities that should and should not be undertaken by firms, I long considered them incompatible One was about excess capacity of certain productive assets and the other was about the costs of adapting contracts Only when writing what is now Chapter did I realize that the sub-additive bargaining costs underlying the AC theory could make productive assets de facto indivisible and capable of existing in excess capacity, thus taking me directly to the RBV The main purpose of the book is to clarify the AC–RBV relationship and this is done in two steps In “Adaptation Costs in Three Dimensions: Firms, Markets, and Contracts,” I derive the AC theory under gains from specialization, and in “All Adaptations Are Not the Same: The Scope of Firms and the Size of Markets,” I develop the resulting theory of the scope of the firm and compare it to the RBV To make the linkage as clear as possible, the four key chapters have been placed in sequence at the start of the book The remaining eleven chapters look, theoretically and empirically, at important implications and foundations of the AC/RBV Most chapters have their basis in a single stand-alone paper, some published several years ago All have been rewritten for consistency of notation and terminology and updated to reflect other literature published between their original publication date and now I not flag the parts that are most extensively rewritten, but the reader should be aware that there may be significant differences between the original In its first incarnation, the theory was, at the suggestion of a referee, labelled the “Adjustment Cost” Theory However, that term is also used in the macro literature where it denotes a different phenomenon xiii www.cambridge.org 298 On the Endogenous Amplification of Small Differences References Cohen, Wesley M., and Daniel A Levinthal, “Absorptive Capacity: A New Perspective on Learning and Innovation,” Administrative Science Quarterly, 35, no 1, 128–52, 1990 D’Aunno, Thomas, Melissa Succi, and Jeffrey A Alexander, “The Role of Institutional and Market Forces in Divergent Organizational Change,” Administrative Science Quarterly, 45, no 4, 679–703, 2000 Ghemawat, Pankaj, Commitment, New York, NY: The Free Press, 1991 Hannan, Michael T., and John Freeman, Organizational Ecology, Cambridge, MA: Harvard University Press, 1989 Helfat, Constance E (ed.), “The Evolution of Firm Capabilities,” Strategic Management Journal, 21, special issue 10–11, 2000 Lippman, Steven A., and Richard P Rumelt, “Uncertain Imitability: An Analysis of Interfirm Differences Under Competition,” Bell Journal of Economics, 13, 418–38, 1982 Monteverde, Kirk, “Technical Dialog as an Incentive for Vertical Integration in the Semiconductor Industry,” Management Science, 41, no 10, 1624–38, 1995 Nelson, Richard R., “Why Do Firms Differ and How Does it Matter?” Strategic Management Journal, 12, Winter, 61–74, 1991 Nelson, Richard R., and Sidney G Winter, An Evolutionary Theory of Economic Change, Cambridge, MA: Harvard University Press, 1982 Polanyi, Michael, Personal Knowledge: Towards a Post-critical Philosophy, New York: NY, Harper and Row, 1962 Rumelt, Richard P., Daniel Schendel, and David J Teece, “Strategic Management and Economics,” Strategic Management Journal, 12 (Winter), 5–30, 1991 Simester, Duncan I., and Marc Knez, “Direct and Indirect Bargaining Costs and the Scope of the Firm,” Journal of Business, 75, no 2, 283–304, 2002 Simon, Herbert A., Administrative Behavior, New York, NY: The Free Press, 3rd edn., 1976 Sutton, John, Sunk Costs and Market Structure, Cambridge, MA: MIT Press, 1991 Tushman, Michael L., “Technical Communication in R&D Laboratories: the Impact of Project Work Characteristic,” Academy of Management Journal, 21, no 4, 624–45, 1978 Wernerfelt, Birger, “On the Nature and Scope of the Firm: an Adjustment-Cost Theory,” Journal of Business, 70, no 4, 489–514, 1997 Wernerfelt, Birger, “Organizational Languages,” Journal of Economics and Management Strategy, 13, 461–72, 2004 Wernerfelt, Birger, “Bargaining Before or After Communication?,” Journal of Institutional and Theoretical Economics, 164, no 2, 211–29, 2008 Core terms of use, 15 Jun 2017 at 16:05:09, subject to the Cambridge 021 Part VI Postscript Core terms of use, 12 Jun 2017 at 22:08:50, subject to the Cambridge Core terms of use, 12 Jun 2017 at 22:08:50, subject to the Cambridge 17 Summary and Final Reflections The AC theory of the firm explains economic institutions, such as local markets and firms, as attempts to minimize the costs of worker adaptation This includes the bargaining costs of adapting prices and the extra production costs incurred when the worker is unable to continue specializing in a service or a business We abstracted from inefficient non-trading by appealing to repeated interactions and the folk theorem The employment mechanism is defined as one in which the worker agrees to perform, on demand, any element in a large set of services in return for a once-and-for-all negotiated standard payment Assuming that bargaining costs are subadditive, this mechanism dominates others when adaptations are sufficiently frequent and diverse We define the scope of an entrepreneur’s firm by the number of workers with whom she trades in the employment mechanism If a firm has very frequent needs for a specific service, it can hire a “doubly specialized” worker to perform the same service for the same firm in every period These are the most efficient workers and a firm may want to hire one even if it cannot use him in the specialized capacity on a full-time basis It will then be tempting for the firm to expand its scope in order to use the extra capacity The best way to this may be to enter other businesses that are similar to the original business in the sense that the worker loses little efficiency when changing from one to the other The scope of the firm is bounded because the constituent businesses eventually will become too different This observation, that the firm can benefit from expanding to leverage excess capacity of productive assets, is the core of the RBV It applies to assets that are economically inalienable for the firm in the sense that it is inefficient to have any part of their capacity used by other firms These assets are called “resources” in the RBV Because of sub-additive bargaining costs, these assets are de facto indivisible and uneconomical to trade on a small scale (which again means that the firm may have excess capacity of them) The AC theory portrays the employee as having agreed to take orders from the boss This property alone yields predictions that are consistent 301 Core terms of use, 12 Jun 2017 at 22:08:44, subject to the Cambridge 022 302 Summary and Final Reflections with the major stylized facts about firms: The boss should own most assets because she dictates how they are used (and abused), there is more communication within than between firms because the parties can speak without worrying about compromising their bargaining power, and incentives are less steep inside the firm because the boss may take the employee off task While there is a lot of empirical work claiming to be about specific theories of the firm, the tested predictions are often shared by almost all theories of the firm So there is no real discrimination We here tested three hypotheses that are more or less unique to the AC theory: that bargaining costs are sub-additive, that more frequently adapted tasks are internalized, and that assets are owned by the players whose decisions affect their rate of depreciation the most The key elements in the AC theory: sub-additive bargaining costs and advantages of specialization, are quite different from the investment and effort distortions that have played such a large role in economic theories of the firm over the last thirty years However, there is a growing feeling in the profession that the current mainstream approach cannot deliver a satisfactory theory of the firm, and as a result, the willingness to experiment with new assumptions is greater than it has been in a long time In writing this book, I hope to tap into some of this willingness and entice others to work along lines similar to those suggested by the AC theory It is certainly under-explored territory The market position of the RBV is radically different It has been enthusiastically accepted by both practicing managers and management academics and the latter group has done a tremendous amount of work on it, developing the theory and applying it in a wide variety of settings While this body of work thus has been very successful by most standards, there have been recurrent calls for a more satisfactory theoretical structure, more precisely defined concepts, and stronger predictions (e.g., Foss, 1998; Priem and Butler, 2001) The micro-foundation proposed here has the potential to help address some of these issues, although a number of further steps still would have to be taken References Priem, Richard L., and John E Butler, “Is the Resource-Based View a Useful Perspective for Strategic Management Research?” Academy of Management Review, 26, no 1, 22–40, 2001 Foss, Nicolai J., “The Resource-Based Perspective: An Assessment and Diagnosis of Problems,” Scandinavian Journal of Management, 14, no 3, March, 133–49, 1998 Core terms of use, 12 Jun 2017 at 22:08:44, subject to the Cambridge 022 Index adaptation cost (AC) theory, 3, 16–26 academic literature on, 34–37 asset ownership and, 22–24 benefits of, 54 common law test in, 76 communication within/between firms and, 24–25, 33–34, 54 contractual adaptation costs, delegation of decision rights in, 25–26 differentiation between firms and, 287 empirical tests for, 47–50, 54 employment mechanisms and, 17, 26, 33, 38–44, 146 extensions in, 41–43 motivation in, 38 static model for, 39–41 employment relationship in, 7, 46–53 between employer and employee, 301–2 incentive systems theory and, 46 legal definitions of, 46–47 PRT and, 46 evidence in, 44–53 ex ante bargaining mechanisms and, 146 firm heterogeneity and, 272 future research on, 221 incentive system theory and, 36 low-powered incentives in, 25 price lists and, 17–18, 54 productive adaptation costs, PRT and, 16, 35–36 RBV and, 21–23 sales force organization in, 47 scope of firm and, 21–23, 27 sequential contracting mechanisms and, 17 specialization of firms and, 302 sub-additive bargaining costs and, 4, 54, 302 TCE and, 16 adaptation costs, 19, 22–23, 33–34, 54, 58, 83, 85, 97, 205, 213–14 adaptation frequency in AC theory, 201–2 computational difficulties in, 202 data analysis, 205–8 economic research in, 207 integration studies, 206 Likert-type scales, 207 on production systems, 206–7, 224–25 data requirements and, 202 employment relationship and, 203–4 hypotheses for, 202–5 internalized, 212, 227 production systems and, 201–2, 204–5 cluster analysis of, 211 comparisons between, 217–19 data on, 206–7, 224–25 descriptive statistics by, 208, 226 estimation techniques for, 209–16 firm-level estimation, 217–19 optimization model for, 213–16 at pair-by-pair level, 209–11, 226 pooled models, 227 SSR by alternative models, 219–20, 228 testing of, 211–13 sequential contracting mechanisms and, 203–4 technology and, 204 time consumed during bargaining, 203–4 aspirational bargaining model, 194–96 asset ownership AC theory and, 22–24 through asset-specific human capital investments, 234–35, 246 in carpentry trade, 231 efficiency gains from, 229, 236 empirical data on, 236–48 asset-specific human capital investments, 246 efficiency gains, 245–46 employees’ incentives, 244 303 Core terms of use, 12 Jun 2017 at 22:09:14, subject to the Cambridge 304 Index asset ownership (cont.) employers’ asset deployment strategies, 245–46 rank-order correlation, 245 risk sharing, 246 robustness checks, 247–48 by employees, 45 through asset-sharing, 236, 245–46 empirical data on, 244–46 incentives for, 229, 233, 244 for multiple employees, 236 through risk sharing, 235–36 by employers deployment strategies for, 233–34, 245–46 empirical data on, 245–46 through risk sharing, 235–36 evidence variables with, 122–24 ex ante bargaining mechanisms, 24 ex post bargaining mechanisms, 24 externality argument for, 116–22, 125 depreciation variances in, 120–21 employee ownership and, 120–22 for risk-averse players, 121 incentive system and, 36–37, 115 manager surveys for, 123–24 PRT and, 36–37, 44–46, 115, 125 through risk sharing, 229, 235–36 empirical data on, 246 for employers compared to employees, 235–36 asset services, 43–44 assets economically divisible, 102 inalienability property and, 102 as resources, in RBV, 301 scope of firms and, 102 asymmetric equilibria, 272 compatibility advantages of, 273 asymmetric information, 25, 64, 150–51, 154–55, 157, 259 authority, 25, 35–37, 43, 166, 175, 269 Bain, Joe, bargaining bins, 64–65, 87–88 bargaining costs See also ex ante bargaining mechanisms; ex post bargaining mechanisms; sub-additive bargaining costs bilateral mechanisms and, 61 Coasian, 14 communication costs as, 24–25, 33–34 communication within/between firms as, 24–25, 33–34, 128–30 Core terms of use, in contracts, 254–55, 268–69 of decision-making, 165 employment mechanisms and, 62 fixed, 15 for fixed firms, 87–88 frictionless models, 14–15 frictions in, 14, 16 market mechanisms and, 61–62 pooling of, 15 pre-play information and, 61 scope of firms and, 85, 93–94 sequential contracting mechanisms and, 62 service specialization and, 60 trade and, 61 bargaining efficiency effect, 129 bargaining power effect, 131 bilateral contracts, 253 renegotiation of, 253–54 bilateral mechanisms bargaining costs and, 61 market mechanisms and, 71 service specialization and, 58–59 binding contracts, 64 boundary of the firm, 12, 110 business specialization, switching costs in, 60 carpentry trade, 230–33 client contracts in, 231 productive assets in, 230–31 ownership of, 231 projects in, 232–33 wage contracts in, 231–32 charitable organizations, decision-making in, 164 client contracts, in carpentry trade, 231 Coasian bargaining, 14 common law test, 76 Common Sequence of Events, 65, 73 communication costs, 33–34, 37–38, 53, 175, 190, 269 communication within/between firms See also language theory in AC theory, 24–25, 33–34, 54 as bargaining cost, 24–25, 33–34, 128–30 bargaining efficiency effect and, 129 bargaining power effect and, 131 in equilibrium models, 275–79 ex ante bargaining mechanisms, 129–30, 133–35 ex post bargaining mechanisms and, 129–30, 133–34, 135–40 efficiency of, 140 ex ante bargaining mechanisms compared to, 140 12 Jun 2017 at 22:09:14, subject to the Cambridge Index in heterogeneous firms, 281–82 incentive transfer effect, 129, 131–32 symmetric equilibrium models, 277–79 competition, differentiation between firms and, 284–85, 291–92 competitive advantage, 281, 294 competitive effects, in reporting rules, 288–89 complementarity theories, 44–45 Condorcet Jury Theorem, 165 contingencies See unforeseen contingencies contracting regimes robust, 150 analysis of, 154–55 defined, 154–55 dynamic extension of, 155–57 efficiency of, 151 ex interim information in, 152, 155 incentives in, 150–51 limitations of, 157–58 negotiations in, 153–55 production and payoff in, 156 renegotiation mechanisms in, 155–56 spot contracting regime as inferior to, 159 static model for, 152–55 spot, 150 analysis of, 153–54 defined, 153–54 dynamic extension of, 155–57 efficiency of, 151 ex interim information in, 152, 155 incentives in, 150–51 limitations of, 157–58 negotiations in, 153 production and payoff in, 156 renegotiation mechanisms in, 155–56 robust contracting regime as superior to, 159 static model for, 152–55 contracts bargaining costs in, 254–55, 268–69 bilateral, 253 renegotiation of, 253–54 binding, 64 in carpentry trade client contracts, 231 wage contracts, 231–32 completeness of, 253–54 decision-making for, 255–56 employment mechanisms as, 43 incomplete, 45 academic literature on, 256–58 complexity category of, 257 Core terms of use, 305 exogenous, 256–57 hold-ups for, 266–68 implicit, 257 model for, 258–68 renegotiation of, 253–54, 257, 260–68 strategic category of, 257 out-of-equilibrium cases, 255 contractual adaptation costs, contractual control, in decision-making, 173–74 control, 46, 101–2, 131, 163, 173–74 cooperative behavior, of employees, 41 cooperatives, decision-making in, 164 Core Competencies, customer loyalty, as resource, 105 data analysis of adaptation frequency, 205–8 economic research in, 207 integration studies, 206 Likert-type scales, 207 on production systems, 206–7, 224–25 on asset ownership, 236–48 asset-specific human capital investments, 246 efficiency gains, 245–46 employees’ incentives, 244 employers’ asset deployment strategies, 245–46 rank-order correlation, 245 risk sharing, 246 robustness checks, 247–48 decision rights, delegation of, 25–26 renegotiation threats and, 26 decision-making for contracts, 255–56 in large organizations abdication of, 164 academic literature on, 163–66 bargaining costs of, 165 changes in, 171–73 for charitable organizations, 164 contractual control in, 173–74 in cooperatives, 164 delegation of, 162–63 employment relationships and, 163, 175 intermember bargaining and, 167 joint payoffs and, 175 management compared to, 165–66 by managers, 162 model of, 166–70 renegotiations in, 172 repeated, 175 through threatened protest, 170–75 unchangeable decisions, 173–74 12 Jun 2017 at 22:09:14, subject to the Cambridge 306 Index decision-making (cont.) vertical division of labor as influence on, 164 delegation, 25–26, 163, 174, 254, 257, 268 descriptive statistics, by adaptation frequencies, 208, 226 Design Structure Matrix, 202 differentiation, between firms AC theory and, 287 competitive, 284–85, 291–92 in equilibrium, 292–93 informational implications for, 286–87 reporting errors, 288–89, 293–95 by specific firm, 288–89 intuitive arguments for, 286–89 local environments as factor in, 290 model philosophy, 289–90 number of employees and, 295–96 organizational change as result of, 285 organizational processes as factor in, 290–91 product, 286 in reporting rules, 288 competitive effects, 288–89 resource effects, 288–89 through specialization, 286–87 distribution of needs, 94–95 division of labor, 75, 79–80, 85, 164, 286 doubly-specialized employees, 301 dual-service businesses, 89–91 Dynamic Capabilities theory, economic theory of languages, 274 economically inalienable, 5, 12, 22, 97, 101–3, 301 economically indivisible, 102 efficiency treatment (ET) studies, 187 empirical tests for AC theory, 47–50, 54 for incentive system theory, 49–50 for PRT, 50 for sales force organization and management, 51–53 correlation coefficients in, 52 Kendall Rank correlations in, 51 t-values in, 52 employee ownership, of businesses, 120–22 employees asset ownership by, 45 through asset-sharing, 236, 245–46 empirical data on, 244–46 incentives for, 229, 233, 244 for multiple employees, 236 through risk sharing, 235–36 component fit mistakes by, 297 Core terms of use, cooperative behavior by, 41 differentiation between firms based on number, 295–96 doubly-specialized, 301 in everyday language, 46–47 as firm resource, 104 in incentive system theory, 36, 45 incentive transfer effect and, 147 incorrect time allocation by, 297 legal rules for, 41 level of work quality by, 297 relationship with employers, in AC theory, 301–2 reporting errors by, 285 employers asset ownership by deployment strategies for, 233–34, 245–46 empirical data on, 245–46 through risk sharing, 235–36 PRT and, 125 relationship with employees, in AC theory, 301–2 employment mechanisms, 69–70 See also sales force organization and management in AC theory, 17, 26, 33, 38–44, 146 extensions in, 41–43 motivation, 38 static model, 39–41 bargaining costs and, 62 defined, 16, 69 efficiency components of, 79 ex ante bargaining mechanism as, 145–46 for human asset services, 43–44 as an implicit contract, 43 incentive systems theory and, 42 internal coordination within firms, 44 for large entrepreneurs, 74–75 market mechanisms compared to, 71 payoffs and, 70 performance variables for, 79 price lists and, 18 proof of propositions in, 78 proof of theorem for, 78–80 PRT and, 145–46 repeated trade and, 70 sequential contracting mechanisms and, 43, 71 service specialization and, 59 for small entrepreneurs, 73–75 TCE and, 42 testable implications for, 75–76 employment relationships, 7, 46–53 adaptation frequency and, 203–4 12 Jun 2017 at 22:09:14, subject to the Cambridge Index decision-making and, 163, 175 defined, 91 incentive systems theory and, 46 independent contracting and, 182 legal definitions of, 46–47 PRT and, 46 entrepreneurs See also scope, of firms distribution of needs and, 94–95 in dual-service businesses, 89–91 in fixed firms, 86–89 bargaining costs for, 87–88 degrees of specialization for, 87 strategies for, 88–89 large, focal mechanisms for, 74–75 small, focal mechanisms for, 73–75 equilibrium models asymmetric, 272 compatibility advantages of, 273 differentiation between firms and, 292–93 global maxima and, 279–80 in labor markets, 76–77 local maxima and, 279–80 resource allocations in, between members, 275–79 symmetric, 272 communication within firms and, 277–79 compatibility advantages of, 273 estimation techniques, for adaptation frequencies, 209–16 ET studies See efficiency treatment studies ex ante bargaining mechanisms, 24 AC theory and, 146 communication within firms and, 129–30, 133, 134–35 ex post bargaining mechanisms compared to, 140 as employment contract, 145–46 incentive alignment in, 145 PRT and, 145–46 renegotiations in, 140–43 for sellers, 143 TIOLI offers, 141–43 ex interim information in robust contracting regime, 152, 155 in sequential contracting mechanisms, 25 in spot contracting regime, 152, 155 ex post bargaining mechanisms, 24 communication within firms and, 129–30, 133–34, 135–40 efficiency of, 140 ex ante bargaining mechanisms compared to, 140 price adjustments in, 144 renegotiations in, 140–43 Core terms of use, 307 for sellers, 143–44 TIOLI offers, 135–38, 140 excess capacity, 5, 12, 22, 83, 85–86, 96– 97, 103–4, 301 existence studies, for sub-additive bargaining costs, 186 exogenous incomplete contracts, 256–57 externality argument, 116–22, 125 depreciation variances in, 120–21 employee ownership and, 120–22 for risk-averse players, 121 face-to-face bargaining, 189 firms See also adaptation cost theory; communication within/between firms; resource-based view; specialization, of firms component fit, mistakes with, 297 defined, 125 expansion of, 110 exploitation and development, 109–10 fixed, 86–89 bargaining costs for, 87–88 degrees of specialization for, 87 strategies for, 88–89 heterogeneous, 26–28 AC theory and, 272 communication within/between, 281–82 intuitive arguments for, 286–89 inalienability property, 101–2 incorrect time allocation by, 297 internal coordination within, 44 level of work quality, 297 product portfolio theory and, 109 resources of, 102–5 customer loyalty, 105 defined, 102–3 efficient groups of employees, 104 exploitation and development of, 109–10 exploitation of learning curve, 106–10 management of, over time, 105–10 during mergers and acquisitions, 106 product matrix for, 103 production capacity, 104–5 production experience, 105 sequential entry of, 106–9 technological leads, 105 scope of, 93–95 AC theory and, 21–23, 27 bargaining costs and, 85 distribution of needs, 94–95 excessive productive capacity as factor in, 83–85 12 Jun 2017 at 22:09:14, subject to the Cambridge 308 Index firms (cont.) for multiproduct firms, 85–86 productive efficiency and, 85 sharing of assets and, 102 sub-additive bargaining costs of, 101–2 Five Force Analysis, 4–5 fixed bargaining costs, 15 fixed firms, 86–89 bargaining costs for, 87–88 degrees of specialization for, 87 strategies for, 88–89 focal mechanisms See employment mechanisms; market mechanisms; sequential contracting mechanisms global markets, defined, 91–92 governance, 21, 38, 75, 84 heterogeneous firms, 26–28 AC theory and, 272 communication within/between, 281–82 intuitive arguments for, 286–89 hold-up, 266–68 human capital investments, asset ownership through, 234–35 implicit contracts, 257 inalienable, 97 incentive system theory AC theory and, 36 asset ownership and, 36–37, 115 efficiency gains from, 229 risk sharing and, 229 empirical testing of, 49–50 employees in, 36, 45 employment mechanisms and, 42 employment relationship and, 46 incentive transfer effect, 129, 131–32 employees and, 147 incentives in ex ante bargaining mechanism, 145 low-powered, 25 in robust contracting regime, 150–51 in spot contracting regime, 150–51 incomplete contracts, 45 academic literature on, 256–58 complexity category of, 257 exogenous, 256–57 hold-ups for, 266–68 implicit, 257 model for, 258–68 renegotiation of, 253–54, 257, 260–68 strategic category of, 257 independent contracting, employment relationship and, 182 Core terms of use, indivisibility, 5, 22, 86, 102 Industrial Organization economics, information in Design Structure Matrix, 202 differentiation between firms and, implications for, 286–87 reporting errors, 288–89, 293–95 by specific firm, 288–89 ex interim in robust contracting regime, 152, 155 in sequential contracting mechanisms, 25 in spot contracting regime, 152, 155 pre-play, bargaining costs and, 61 reporting strategies for, to management, 288 sub-additive bargaining costs and, 184 integration, 47, 147, 206 internalized adaptation frequencies, 212, 227 intuitive arguments, for differentiation between firms, 286–89 joint payoffs, in decision-making, 175 Kendall Rank correlations, 51 labor markets, equilibrium models, 76–77 language theory, 273–74 economic, 274 organizational, 281–82 large entrepreneurs, focal mechanisms for, 74–75 large organizations, decision-making in abdication of, 164 academic literature on, 163–66 bargaining costs of, 165 changes in, 171–73 for charitable organizations, 164 contractual control in, 173–74 in cooperatives, 164 delegation of, 162–63 employment relationships and, 163, 175 intermember bargaining and, 167 joint payoffs and, 175 management compared to, 165–66 by managers, 162 model of, 166–70 renegotiations in, 172 repeated, 175 through threatened protest, 170–75 for unchangeable decisions, 173–74 vertical division of labor as influence on, 164 Likert-type scales, 207 local markets, defined, 92 12 Jun 2017 at 22:09:14, subject to the Cambridge Index low-powered incentives, in AC theory, 25 managers decision-making by, 162 information reported to, strategies for, 288 market failure, 5, 22, 85–86, 102 market mechanisms, 65–66 bargaining costs and, 61–62 bilateral mechanisms compared to, 71 efficiency components of, 79 employment mechanisms compared to, 71 for large entrepreneurs, 74–75 performance variables for, 79 proof of theorem for, 78–80 sequential contracting mechanisms compared to, 71 for small entrepreneurs, 73–75 switching costs and, 66 testable implications for, 75–76 mergers and acquisitions, firm resources during, 106 Moore-Rupello mechanisms, 6–7 multilateral mechanisms, service specialization and, 58 multiproduct firms, 85–86 negotiation-as-needed, 52 negotiations in robust contracting regime, 153–55 in spot contracting regime, 153 ontologically indivisible, 12, 86, 102 organizational change, differentiation between firms, 285 organizational language, 281–82 organizations See also large organizations charitable, 164 sales force, 47 correlation coefficients in, 52 empirical testing for, 51–53 Kendall Rank correlations for, 51 t-values in, 52 out-of-equilibrium cases, 255 ownership, 115, 120, 122–23, 239 See also asset ownership; employee ownership; employees, asset ownership by; employers, asset ownership by payoffs in decision-making, 175 employment mechanisms and, 70 in robust contracting regime, 156 Core terms of use, 309 in sequential contracting mechanisms, 67–68 in spot contracting regime, 156 pooling, of bargaining costs, 15 sub-additive studies on, 186–89, 191 Porter, Michael, 4–5 pre-play information, 61 price adjustments, in ex post bargaining mechanisms, 144 price determination, 17, 23, 58, 61, 65, 67, 69, 83, 89, 96 price list mechanisms AC theory and, 17–18, 54 employment mechanisms and, 18 service specialization and, 59 product differentiation, 286 product matrix, 103 product portfolio theory, 109 production systems, adaptation frequency and, 201–2, 204–5 cluster analysis of, 211 comparisons between systems, 217–19 data on, 206–7, 224–25 descriptive statistics by, 208, 226 estimation techniques for, 209–16 firm-level estimation, 217–19 optimization model for, 213–16 at pair-by-pair level, 209–11, 226 pooled models, 227 SSR by alternative models, 219–20, 228 testing of, 211–13 productive adaptation costs, Property Rights Theory (PRT) AC theory and, 16, 35–36 asset ownership and, 36–37, 44–46, 115 empirical testing of, 50 employee ownership and, 120–22 employer ownership, 125 employment relationship and, 46 ex ante bargaining mechanisms and, 145–46 externality argument, 116–22, 125 depreciation variances in, 120–21 employee ownership and, 120–22 for risk-averse players, 121 protests, in decision-making, 170–75 PRT See Property Rights Theory RBV See resource-based view renegotiation mechanisms for bilateral contracts, 253–54 decision rights and, 26 in decision-making, 172 in ex ante bargaining mechanisms, 140–43 12 Jun 2017 at 22:09:14, subject to the Cambridge 310 Index renegotiation mechanisms (cont.) in ex post bargaining mechanisms, 140–43 for incomplete contracts, 253–54, 257, 260–68 in robust contracting regime, 155–56 in spot contracting regime, 155–56 stages of, 141 repeated decision-making, 175 reporting errors by employees, 285 informational implications for, 288–89, 293–95 reporting rules, 288 competitive effects, 288–89 resource effects, 288–89 resource allocations, in equilibrium models, 275–79 resource effects, in reporting rules, 288–89 resource position barriers, 104 Resource-Advantage Theory, Resource-Based Theory, resource-based view (RBV), 3–4 AC theory and, 21–23 assets as resources in, 301 Five Force Analysis, 4–5 human-resource management in, 4–6 marketing and, 4–6 operational strategies in, 4–6 team production and, 95–97 resources assets as, in RBV, 301 defined, 12, 102–3 of firms, 102–5 customer loyalty as, 105 defined, 102–3 efficient groups of employees, 104 exploitation and development of, 109–10 exploitation of learning curve, 106–10 management of, over time, 105–10 during mergers and acquisitions, 106 position barriers, 104 product matrix for, 103 production capacity, 104–5 production experience, 105 sequential entry and, 106–9 technological leads, 105 risk sharing, asset ownership and, 229, 235– 36 empirical data on, 246 for employers compared to employees, 235–36 risk-averse players, externality argument for, 121 Core terms of use, robust contracting regime, 150 analysis of, 154–55 defined, 154–55 dynamic extension of, 155–57 efficiency of, 151 ex interim information in, 152, 155 incentives in, 150–51 limitations of, 157–58 negotiations in, 153–55 production and payoff in, 156 renegotiation mechanisms in, 155–56 spot contracting regime as inferior to, 159 static model for, 152–55 sales force organization and management, 47 empirical testing for, 51–53 correlation coefficients in, 52 Kendall Rank correlations in, 51 t-values in, 52 sequential contracting mechanisms and, 49 scope, of firms, 93–95 AC theory and, 21–23, 27 bargaining costs and, 85, 93–94 distribution of needs, 94–95 excessive productive capacity as factor in, 83–85 for multiproduct firms, 85–86 productive efficiency and, 85 sharing of assets and, 102 sellers ex ante bargaining mechanisms for, 143 ex post bargaining mechanisms for, 143–44 TIOLI offers and, 143–44 sequential contracting mechanisms, 66–69 AC theory and, 17 adaptation frequency and, 203–4 bargaining costs and, 19, 62 efficiency components of, 79 employment mechanisms and, 43, 71 ex interim information in, 25 for large entrepreneurs, 74–75 market mechanisms compared to, 71 matching workers in, 66–67 offers made in, 67 payoffs in, 67–68 performance variables for, 79 proof of propositions in, 78 proof of theorem for, 78–80 for small entrepreneurs, 73–75 testable implications for, 75–76 sequential entry, 106–9 12 Jun 2017 at 22:09:14, subject to the Cambridge Index service specialization advantages of, 63–64 bargaining costs and, 60 bilateral mechanisms and, 58–59 employment mechanisms and, 59 multilateral mechanisms and, 58 price list mechanisms and, 59 size as influence on, 59 small entrepreneurs, focal mechanisms for, 73–75 Smith, Adam, 58, 63, 75 specialization, of firms, 286–87 AC theory and, 287, 302 competitive, 284–85, 291–92 differentiation through, 286–87 in equilibrium model, 292–93 in fixed firms, 87 informational implications for, 286–87 reporting errors, 288–89, 293–95 by specific firm, 288–89 intuitive arguments for, 286–89 local environments as factor in, 290 model philosophy, 289–90 number of employees and, 295–96 organizational change as result of, 285 organizational processes as factor in, 290–91 product, 286 reporting rules and, 288 competitive effects, 288–89 resource effects, 288–89 for services advantages of, 63–64 bargaining costs and, 60 bilateral mechanisms and, 58–59 employment mechanisms and, 59 multilateral mechanisms and, 58 price list mechanisms and, 59 size of firm and, 59 switching costs in, 60 spot contracting regime, 150 analysis of, 153–54 defined, 153–54 dynamic extension of, 155–57 efficiency of, 151 ex interim information in, 152, 155 incentives in, 150–51 limitations of, 157–58 negotiations in, 153 production and payoff in, 156 renegotiation mechanisms in, 155–56 robust contracting regime as superior to, 159 static model for, 152–55 Core terms of use, 311 SSR See Sum of Squared Production system Residuals strategic bargaining, 194–96 in aspirational bargaining model, 194–96 Strengths, Weaknesses, Opportunities, and Threats (SWOT), 103 sub-additive bargaining costs, 14–16 AC theory and, 4, 54, 302 in aspirational bargaining model, 194–96 defined, 182 economics and, 6–8 exchanged offers and, 190–91 experimental design analysis of, 183–86 face-to-face bargaining, 189 of firms, 101–2 frequency of settling times, 200 information and, as investment, 184 Moore-Rupello mechanisms and, 6–7 pooling prices, 190–91 reduced form model of, 182–83 strategic bargaining and, 194–96 studies on, 186–91, 197–99 anonymity in, 189–90 ET, 187 existence, 186 with increased stakes, 187–88 number of bargains, 188 pooling costs, 186–89, 191 time savings, 188–89 Sum of Squared Production system Residuals (SSR), 219–20, 228 switching costs in business specialization, 60 market mechanisms and, 66 for workers, 65 SWOT See Strengths, Weaknesses, Opportunities, and Threats symmetric equilibria, 272 communication within firms and, 277–79 compatibility advantages of, 273 take-it-or-leave-it (TIOLI) offers, 64–65, 132 ex ante bargaining mechanisms and, 141–43 ex post bargaining mechanisms and, 135–38, 140 sellers and, 143–44 TCE See Transaction-Cost Economics team production, RBV and, 95–97 technological leads, as resource, 105 technology, adaptation frequency and, 204 12 Jun 2017 at 22:09:14, subject to the Cambridge 312 Index thought worlds, 274–75 time consumed during bargaining, 203–4 time savings studies, for sub-additive bargaining costs, 188–89 TIOLI offers See take-it-or-leave-it offers trade bargaining costs and, 61 employment mechanisms and, 70 Transaction-Cost Economics (TCE), AC theory and, 16 employment mechanisms and, 42 Core terms of use, unforeseen contingencies, 45 vertical division of labor, 164 Vikings, decision-making among, 164 wage contracts, in carpentry trade, 231–32 workers in sequential contracting mechanisms, 66–67 switching costs for, 65 12 Jun 2017 at 22:09:14, subject to the Cambridge ... 978-1-107-13440-9 — Adaptation, Specialization, and the Theory of the Firm Birger Wernerfelt Frontmatter More Information Adaptation, Specialization, and the Theory of the Firm Foundations of the Resource-Based. .. Resource-Based View of the Firm (proposing what is now called the RBV) and “On the Nature and Scope of the Firm (proposing what is here called the “Adaptation Cost,” or just AC, theory of the. .. author Title: Adaptation, specialization, and the theory of the firm : foundations of the resource-based view / by Birger Wernerfelt, J C Penney Professor of Management, MIT Sloan School of Management