留學生經濟學碩士dissertation-Production, Information Costs, and Economic Organ
          
                
          
                    
                    
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          留學生經濟學碩士dissertationProduction, Information Costs, and Economic Organization
          
Armen A. Alchian; Harold Demsetz
          
The American Economic Review, Vol. 62, No. 5. (Dec., 1972), pp. 777-795.
          
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          Thu Nov 15 10:46:02 2007
          
Production, Information Costs, and
          
Economic Organization
          
The mark of a capitalistic society is that
          
resources are owned and allocated by such
          
nongovernmental organizations as firms,
          
households, and markets. Resource owners
          
increase productivity through cooperative
          
specialization and this leads to the demand
          
for economic organizations which facilitate
          
cooperation. \$'hen a lumber mill
          
employs a cabinetmaker, cooperation between
          
specialists is achieved within a firm,
          
and when a cabinetmaker purchases wood
          
from a lumberman, the cooperation takes
          
place across markets (or between firms).
          
Two important problems face a theory of
          
economic organization-to explain the
          
conditions that determine whether the
          
gains from spkcialization and cooperative
          
production can better be obtained within
          
an organization like the firm, or across
          
markets, and to explain the structure of
          
the organization.
          
I t is common to see the firm characterized
          
by the power to settle issues by
          
fiat, by authority, or by disciplinary action
          
superior to that available in the conventional
          
market. This is delusion. The firm
          
does not own all its inputs. I t has no
          
power of fiat, no authority, no disciplinary
          
action any different in the slightest degree
          
from ordinary market contracting between#p#分頁標題#e#
          
any two people. I can "punish" you
          
only by withholding future business or by
          
seeking redress in the courts for any failure
          
to honor our exchange agreement. That is
          
exactly all that any employer can do. He
          
* Professors of economics at the Fniversit~ of California,
          
1.0s Xngeles .\ckno~\ledgment is made for financia1
          
aid from the F. I,ill> Endowment, Inc, grant to
          
cCL.4 for research in the behavioral effects of property
          
rights
          
can fire or sue, just as I can fire my grocer
          
by stopping purchases from him or sue
          
him for delivering faulty products. What
          
then is the content of the presumed power
          
to manage and assign workers to various
          
tasks? Exactly the same as one little consumer's
          
power to manage and assign his
          
grocer to various tasks. The single consumer
          
can assign his grocer to the task of
          
obtaining whatever the customer can induce
          
the grocer to provide at a price acceptable
          
to both parties. That is precisely
          
all that an employer can do to an employee.
          
To speak of managing, directing,
          
or assigning workers to various tasks is a
          
deceptive way of noting that the employer
          
continually is involved in renegotiation of
          
contracts on terms that must be acceptable
          
to both parties. Telling an employee to
          
type this letter rather than to file that
          
document is like my telling a grocer to
          
sell me this brand of tuna rather than that
          
brand of bread. I have no contract to continue
          
to purchase from the grocer and
          
neither the employer nor the employee is
          
bound by any contractual obligations to
          
continue their relationship. Long-term
          
contracts between employer and employee
          
are not the essence of the organization
          
we call a firm. My grocer can count
          
on my returning day after day and purchasing
          
his services and goods even with
          
the prices not always marked on the goods
          
-because I know what they are-and he
          
adapts his activity to conform to my
          
directions to him as to what I want each
          
day . . . he is not my employee.
          
iyherein then is the relationship between
          
a grocer and his different
          
from that between a grocer and his cus-
          
777
          
778 THE AMERICAX ECONOMIC REL'IE\IT
          
tomers? It is in a team use of inputs and a
          
centralized position of some party in the
          
contractual arrangements of all other inputs.
          
It is the centralized contractz~al agent
          
in a team ProductiCLle process-not some
          
superior authoritarian directive or disciplinary
          
power. Exactly what is a team
          
process and why does it induce the contractual
          
form, called the firm? These problems
          
motivate the inquiry of this paper.
          
I. The Metering Problem
          
'The economic organization through
          
which input owners cooperate will make
          
better use of their comparative advantages#p#分頁標題#e#
          
to the extent that it facilitates the payment
          
of rewards in accord with productivity.
          
If rewards were random, and without
          
regard to productive effort, no incentive
          
to productive effort would be provided
          
by the organization; and if rewards
          
were negatively correlated with productivity
          
the organization would be subject
          
to sabotage. Two key demands are placed
          
on an economic organization-metering
          
input productivity and metering rewards.'
          
Metering problems sometimes can be
          
resolved well through the exchange of
          
products across competitive markets, because
          
in many situations markets yield a
          
high correlation between rewards and
          
productivity. If a farmer increases his output
          
of wheat by 10 percent at the prevailing
          
market price, his receipts also increase
          
by 10 percent. This method of organizing
          
economic activity meters the
          
output directly, reveals the marginal product
          
and apportions the rewards to resource
          
owners in accord with that direct
          
measurement of their outputs. The success
          
of this decentralized, market exchange in
          
promoting productive specialization requires
          
that changes in market rewards fall
          
Meter means to measure and also to apportion. One
          
can meter (measure) output and one can also meter
          
(control) the output. LVe use the word to denote both;
          
the context should indicate which.
          
on those responsible for changes in oz~tpz~t.~
          
'I'he classic relationship in economics
          
that runs from marginal productivity to
          
the distribution of income implicitly assumes
          
the existence of an organization, be
          
it the market or the firm, that allocates
          
rewards to resources in accord with their
          
productivity. The problem of economic
          
organization, the economical means of
          
metering productivity and rewards, is not
          
confronted directly in the classical analysis
          
of production and distribution. Instead,
          
that analysis tends to assume sufficiently
          
economic-or zero cost-means,
          
as if productivity automatically created
          
its reward. 'IVe conjecture the direction of
          
causation is the reverse-the specific sys-
          
A producer's wealth would be reduced by the present
          
capitalized value of the future income lost by loss of
          
reputation. Reputation, i.e., credibility, is an asset,
          
which is another way of saying that reliable information
          
about expected performance is both a costly and a
          
valuable good. For acts of Cod that interfere with contract
          
performance, both parties have incentives to
          
reach a settlement akin to that which would have been
          
reached if such events had been covered by specific contingency
          
clauses. The reason, again, is that a reputation
          
for "honest" dealings-i.e., for actions similar to those
          
that would probably have been reached had the contract#p#分頁標題#e#
          
provided this contingency-is wealth.
          
Almost every contract is open-ended in that many
          
contingencies are uncovered. For example, if a fire
          
delays production of a promised product by A to B,
          
and if B contends that A has not fulfilled the contract,
          
how is the dispute settled and what recompense, if any,
          
does A grant to B? A person uninitiated in such questions
          
may be surprised by the extent to which contracts
          
permit either party to escape performance or to nullify
          
the contract. In fact, it is hard to imagine any contract,
          
which, when taken solely in terms of its stipulations,
          
could not be evaded by one of the parties. Yet that is
          
the ruling, viable type of contract. LL:hy? Undoubtedly
          
the best discussion that we have seen on this question is
          
by Stewart Macaulay.
          
There are means not only of detecting or preventing
          
cheating, but also for deciding how to allocate the losses
          
or gains of unpredictable events or quality of items
          
exchanged. Sales contracts contain warranties, guarantees,
          
collateral, return privileges and penalty clauses for
          
specific nonperformance. These are means of assignment
          
of risks of losses of cheating. A lower price without warranty-
          
an "as is" purchase-places more of the risk on
          
the buyer while the seller buys insurance against losses
          
of his "cheating." On the other hand, a warranty or
          
return privilege or service contract places more risk on
          
the seller with insurance being bought by the buyer.
          
.ALCHT-AX AND DEMSETZ: ECONOMIC ORGANIZ.4TION 779
          
tem of rewarding which is relied upon
          
stimulates a particular productivity response.
          
If the economic organization
          
meters poorly, with rewards and productivity
          
only loosely correlated, then productivity
          
will be smaller; but if the economic
          
organization meters well productivity
          
will be greater. What makes metering
          
difficult and hence induces means of
          
economizing on metering costs?
          
11. Team Production
          
Two men jointly lift heavy cargo into
          
trucks. Solely by observing the total
          
weight loaded per day, it is impossible to
          
determine each person's marginal productivity.
          
\I'ith team production it is
          
difficult, solely by observing total output,
          
to either define or determine each individual's
          
contribution to this output of the
          
cooperating inputs. The output is yielded
          
by a team, by definition, and it is not a
          
sum of separable outputs of each of its
          
members. Team production of Z involves
          
at least two inputs, X, and XI, with
          
d2Z1dX,dX,#0.3 The production function
          
is not separable into two functions
          
each involving only inputs X, or only inputs
          
XI. consequently there is no sum
          
of Z of two separable functions to treat
          
as the Z of the team production function.
          
(:In example of a separable case is Z= aX: +b,Y; which is separable into Z,= aX; and#p#分頁標題#e#
          
Zj= blY,L, and Z= Z,+Z,. 'This is not team
          
production.) 'There exist production techniques
          
in which the Z obtained is greater
          
than if X, and XI had produced separable
          
Z. 'l'eam production will be used if it
          
yields an output enough larger than the
          
sum of separable production of Z to cover
          
the costs of organizing and disciplining
          
team members-the topics of this paper.4
          
The function is separable into additive functions if
          
the cross partial derivative is zero, i.e., if a2Z/aAY,a?i,=0.
          
' LVith suficient generality of notation and conception
          
this team production function could be formulated
          
as a case of the generalized production function interpretation
          
given by our colleague, E. A. Thompson.
          
Usual explanations of the gains from
          
cooperative behavior rely on exchange
          
and production in accord with the comparative
          
advantage specialization principle
          
with separable additive production.
          
However, as suggested above there is a
          
source of gain from cooperative activity
          
involving working as a team, wherein individual
          
cooperating inputs do not yield
          
identifiable, separate products which can
          
be sz~mmed to measure the total output.
          
For this cooperative productive activity,
          
here called "team" production, measuring
          
margiltal productivity and making payments
          
in accord therewith is more expensive
          
by an order of magnitude than for
          
separable production functions.
          
Team production, to repeat, is production
          
in which 1) several types of resources
          
are used and 2) the product is not a sum
          
of separable outputs of each cooperating
          
resource. .An additional factor creates a
          
team organization problem-3) not all resources
          
used in team production belong to
          
one person.
          
JI'e do not inquire into why all the
          
jointly used resources are not owned by
          
one person, but instead into the types of
          
organization, contracts, and informational
          
and payment procedures used among
          
owners of teamed inputs. With respect to
          
the one-owner case, perhaps it is sufficient
          
merely to note that (a) slavery is prohibited,
          
(b) one might assume risk aversion
          
as a reason for one person's not borrowing
          
enough to purchase all the assets
          
or sources of services rather than renting
          
them, and (c) the purchase-resale spread
          
may be so large that costs of short-term
          
ownership exceed rental costs. Our problem
          
is viewed basically as one of organization
          
among different people, not of the
          
physical goods or services, however much
          
there must be selection and choice of combination
          
of the latter.
          
How can the members of a team be rewarded
          
and induced to work efficiently?
          
780 THE *IMERICAN ECONOMIC REVIE%'
          
In team production, marginal products of
          
cooperative team members are not so#p#分頁標題#e#
          
directly and separably (i.e., cheaply) observable.
          
IThat a team offers to the
          
market can be taken as the marginal
          
product of the team but not of the team
          
members. The costs of metering or ascertaining
          
the marginal products of the team's
          
members is what calls forth new organizations
          
and procedures. Clues to each input's
          
productivity can be secured by observing
          
behatliar of individual inputs. 'ClThen lifting
          
cargo into the truck, how rapidly does a
          
man move to the nest piece to be ldaded,
          
how many cigarette breaks does he
          
take, does the item being lifted tilt downward
          
toward his side?
          
If detecting such behavior were costless,
          
neither party would have an incentive
          
to shirk, because neither could impose
          
the cost of his shirking on the other (if
          
their cooperation was agreed to voluntarily).
          
Hut since costs must be incurred
          
to monitor each other, each input owner
          
will have more incentive to shirk when he
          
works as part of a team, than if his performance
          
could be monitored easily or if
          
he did not work as a team. If there is a
          
net increase in productivity available by
          
team production, net of the metering cost
          
associated with disciplining the team, then
          
team production will be relied upon rather
          
than a multitude of bilateral exchange of
          
separable individual outputs.
          
Both leisure and higher income enter a
          
person's utility functi0n.j Hence, each
          
person should adjust his work and realized
          
reward so as to equate the marginal rate of
          
substitution between leisure and production
          
of real output to his marginal rate of
          
substitution in consumption. That is, he
          
would adjust his rate of work to bring his
          
demand prices of leisure and output to
          
equality with their true costs. However,
          
llore precisely: "if anything other than pecuniary
          
income enters his utility function." Leisure stands for all
          
nonpecuniary income for simplicity of e~position.
          
with detection, policing, monitoring, measuring
          
or metering costs, each person will
          
be induced to take more leisure, because
          
the effect of relaxing on his realized (reward)
          
rate of substitution between output
          
and leisure will be less than the effect on
          
the trzbe rate of substitutioil. His realized
          
cost of leisure will fall more than the true
          
cost of leisure, so he "buys" more leisure
          
(i.e., more nonpecuniary reward).
          
If his relaxation cannot be detected perfectly
          
at zero cost, part of its effects will
          
be borne by others in the team, thus making
          
his realized cost of relaxation less than
          
the true total cost to the team. The difficulty
          
of detecting such actions permits
          
the private costs of his actions to be less
          
than their full costs. Since each person
          
responds to his private realizable rate of#p#分頁標題#e#
          
substitution (in production) rather than
          
the true total (i.e., social) rate, and so
          
long as there are costs for other people to
          
detect his shift toward relaxation, it will
          
not pay (them) to force him to readjust
          
completely by making him realize the
          
true cost. Only enough efforts will be
          
made to equate the marginal gains of detection
          
activity with the marginal costs of
          
detection; and that implies a lower rate of
          
productive effort and more shirking than
          
in a costless monitoring, or measuring,
          
world.
          
In a university, the faculty use office
          
telephones, paper, and mail for personal
          
uses beyond strict university productivity.
          
The university administrators could stop
          
such practices by identifying the responsible
          
person in each case, but they can do so
          
only at higher costs than administrators
          
are willing to incur. The extra costs of
          
identifying each party (rather than merely
          
identifying the presence of such activity)
          
wouid exceed the savings from din~inished
          
faculty "turpitudinal peccadilloes." So
          
the faculty is allowed some degree of
          
"privileges, perquisites, or fringe benefits."
          
,2nd the total of the pecuniary wages paid
          
ALCHIAN ,AND DEMSETZ: ECONOMIC ORGANIZATION 781
          
is lower because of this irreducible (at
          
acceptable costs) degree of amenity-seizing
          
activity. Pay is lower in pecuniary
          
terms and higher in leisure, conveniences,
          
and ease of work. But still every person
          
would prefer to see detection made more
          
effective (if it were somehow possible to
          
monitor costlessly) so that he, as part of
          
the now more effectively producing team,
          
could thereby realize a higher pecuniary
          
pay and less leisure. If everyone could, at
          
zero cost, have his reward-realized rate
          
brought to the true production possibility
          
real rate, all could achieve a more preferred
          
position. But detection of the responsible
          
parties is costly; that cost acts
          
like a tax on work rewards6 Viable shirking
          
is the result.
          
It'hat forms of organizing team production
          
will lower the cost of detecting "performance"
          
(i.e., marginal productivity)
          
and bring personally realized rates of
          
substitution closer to true rates of substitution?
          
Market competition, in principle,
          
could monitor some team production.
          
(It already organizes teams.) Input
          
owners who are not team members can
          
offer, in return for a smaller share of the
          
team's rewards, to replace excessively (i.e.,
          
overpaid) shirking members. Rlarket competition
          
among potential team members
          
would determine team membership and
          
individual rewards. There would be no
          
team leader, manager, organizer, owner,
          
or employer. For such decentralized organizational
          
control to work, outsiders,#p#分頁標題#e#
          
possibly after observing each team's total
          
Do not assume that the sole result of the cost of
          
detecting shirking is one form of payment (more leisure
          
and less take home money). \Vith several members of
          
the team, each has an incentive to cheat against each
          
other by engaging in more than the average amount of
          
such leisure if the employer can not tell at zero cost
          
which employee is taking more than average. As a
          
result the total ~roductivitv of the team is lowered.
          
Shirking detection costs thus change the form of payment
          
and also result in lower total rewards. Because the
          
cross I,artial derivatives are ,,os,tive, shirking reduces
          
other people's marginal products.
          
output, can speculate about their capabilities
          
as team members and, by a market
          
competitive process, revised teams with
          
greater productive ability will be formed
          
and sustained. Incumbent members will be
          
constrained by threats of replacement by
          
outsiders offering services for lower reward
          
shares or offering greater rewards to the
          
other members of the team. Any team
          
member who shirked in the expectation
          
that the reduced output effect would not
          
be attributed to him will be displaced if
          
his activity is detected. Teams of productive
          
inputs, like business units, would
          
evolve in apparent spontaneity in the
          
market-without any central organizing
          
agent, team manager, or boss.
          
But completely effective control cannot
          
be expected from individualized market
          
competition for two reasons. First, for
          
this competition to be completely effective,
          
new challengers for team membership
          
must know where, and to what extent,
          
shirking is a serious problem, i.e., know
          
they can increase net output as compared
          
with the inputs they replace. To the extent
          
that this is true it is probably possible for
          
existing fellow team members to reccgnize
          
the shirking. But, by definition, the detection
          
of shirking by observing team output
          
is costly for team production. Secondly, assume
          
the presence of detection costs, and
          
assume that in order to secure a place on
          
the team a new input owner must accept
          
a smaller share of rewards (or a promise to
          
produce more). Then his incentive to shirk
          
would still be at least as great as the incentives
          
of the inputs replaced, because he
          
still bears less than the entire reduction in
          
team output for which he is responsible.
          
111. The Classical Firm
          
One method of reducing shirking is for
          
someone to specialize as a monitor to check
          
the input performance of team members.'
          
' \Vhat is meant by performance? Input energy, initiative,
          
work attitude, ~ e r s ~ i r a t i orna,t e of euhaustion?
          
(Contrnut i i )
          
THE ,AMERICAN ECONOMIC REVIEW
          
But who will monitor the monitor? One#p#分頁標題#e#
          
constraint on the monitor is the aforesaid
          
market competition offered by other
          
monitors, but for reasons already given,
          
that is not perfectly effective. Another
          
constraint can be imposed on the monitor:
          
give him title to the net earnings of the
          
team, net of payments to other inputs.
          
If owners of cooperating inputs agree with
          
the monitor that he is to receive any
          
residual product above prescribed amounts
          
(hopefully, the marginal value products of
          
the other inputs), the monitor will have
          
an added incentive not to shirk as a
          
monitor. Specialization in monitoring plus
          
reliance on a residual claimant status will
          
reduce shirking; but additional links are
          
needed to forge the firm of classical economic
          
theory. How will the residual
          
claimant monitor the other inputs?
          
iVe use the term monitor to connote
          
several activities in addition to its disciplinary
          
connotation. It connotes measuring
          
output performance, apportioning
          
rewards, observing the input behavior of
          
inputs as means of detecting or estimating
          
their marginal productivity and giving assignments
          
or instructions in what to do
          
and how to do it. (It also includes, as we
          
shall show later, authority to terminate
          
or revise contracts.) Perhaps the contrast
          
between a football coach and team captain
          
is helpful. The coach selects strategies
          
and tactics and sends in instructions
          
about what plays to utilize. The captain
          
is essentially an observer and reporter of
          
Or output? It is the latter that is sought--the eject or
          
output. But performance is nicely ambiguous because it
          
suggests both input and output. I t is nicely ambiguous
          
because as we shall see, sometimes by inspecting a team
          
member's input activity we can better judge his output
          
effect, perhaps not with complete accuracy hut better
          
than by watching the output of the team. I t is not always
          
the case that watching input activity is the only or best
          
means of detecting, measuring or monitoring output
          
effects of each team member, but in some cases it is a
          
useful way. For the moment the word performance
          
glosses over these aspects and facilitates concentration
          
on other issues.
          
the performance at close hand of the members.
          
The latter is an inspector-steward
          
and the former a supervisor manager.
          
For the present all these activities are included
          
in the rubric "monitoring." All
          
these tasks are, in principle, negotiable
          
across markets, but we are presuming that
          
such market measurement of marginal
          
productivities and job reassignments are
          
not so cheaply performed for team production.
          
And in particular our analysis
          
suggests that it is not so much the costs
          
of spontaneously negotiating contracts in
          
the markets among groups for team production#p#分頁標題#e#
          
as it is the detection of the performance
          
of individual members of the
          
team that calls for the organization noted
          
here.
          
The specialist who receines the residual
          
rewards will be the monitor of the members
          
of the team (i.e., will manage the use
          
of cooperative inputs). The monitor earns
          
his residual through the reduction in
          
shirking that he brings about, not only by
          
the prices that he agrees to pay the owners
          
of the inputs, but also by observing and
          
directing the actions or uses of these inputs.
          
Managing or examining the ways to
          
which inputs are used in team production
          
is a method of metering the marginal productivity
          
of individual inputs to the team's
          
output.
          
To discipline team members and reduce
          
shirking, the residual claimant must have
          
power to revise the contract terms and incentives
          
of indioidual members without
          
having to terminate or alter every other
          
input's contract. Hence, team members
          
who seek to increase their productivity
          
will assign to the monitor not only the
          
residual claimant right but also the right
          
to alter individual membership and performance
          
on the team. Each team member,
          
of course, can terminate his own
          
membership (i.e., quit the team), but
          
only the monitor may unilaterally terminate
          
the membership of any of the
          
ALCHIAS ASD DEMSETZ: ECOSOMIC ORGANTZ=\TTOS
          
other members without necessarily terminating
          
the team itself or his association
          
with the team; and he alone can expand or
          
reduce membership, alter the mix of
          
membership, or sell the right to be the
          
residual claimant-monitor of the team. It
          
is this entire bundle of rights: 1) to be a
          
residual claimant; 2) to observe input
          
behavior; 3) to be the central party common
          
to all contracts with inputs; 4) to
          
alter the membership of the team; and
          
5) to sell these rights, that defines the
          
oelnership (or the employer) of the classical
          
(capitalist, free-enterprise) firm. The
          
coalescing of these rights has arisen, our
          
analysis asserts, because it resolves the
          
shirking-information problem of team
          
production better than does the noncentralized
          
contractual arrangement.
          
The relationship of each team member
          
to the owner of the firm (i.e., the party
          
common to all input contracts and the
          
residual claimant) is simply a ('quid pro
          
quo" contract. Each makes a purchase
          
and sale. The employee ('orders" the owner
          
of the team to pay him money in the same
          
sense that the employer directs the team
          
member to perform certain acts. The
          
employee can terminate the contract as
          
readily as can the employer, and longterm
          
contracts, therefore, are not an essential
          
attribute of the firm. Nor are
          
((authoritarian," "dictational," or ('fiat"#p#分頁標題#e#
          
attributes relevant to the conception of the
          
firm or its efficiency.
          
In summary, two necessary conditions
          
exist for the emergence of the firm on the
          
prior assumption that more than pecuniary
          
wealth enter utility functions: 1) It is
          
possible to increase productivity through
          
team-oriented production, a production
          
technique for which it is costly to directly
          
measure the marginal outputs of the cooperating
          
inputs. This makes it more
          
difficult to restrict shirking through simple
          
market exchange between cooperating inputs.
          
2) It is economical to estimate marginal
          
productivity by observing or specifying
          
input behavior. The simultaneous occurrence
          
of both these preconditions leads
          
to the contractual organization of inputs,
          
known as the classical capitalist firms with
          
(a) joint input production, (b) several input
          
owners, (c) one party who is common
          
to all the contracts of the joint inputs, (d)
          
who has rights to renegotiate any input's
          
contract independently of contracts with
          
other input owners, (e) who holds the
          
residual claim, and (f) who has the right
          
to sell his central contractual residual
          
s t a t u ~ . ~
          
Other Theories of the Firm
          
At this juncture, as an aside, we briefly
          
place this theory of the firm in the contexts
          
of those offered by Ronald Coase and
          
Frank KnighLg Our view of the firm is not
          
necessarily inconsistent with Coase's; we
          
attempt to go further and identify refutable
          
implications. Coase's penetrating insight
          
is to make more of the fact that
          
markets do not operate costlessly, and he
          
relies on the cost of using markets to form
          
contracts as his basic explanation for the
          
existence of firms. IVe do not disagree with
          
the proposition that, ceteris paribus, the
          
higher is the cost of transacting across
          
markets the greater will be the comparative
          
advantage of organizing resources
          
within the firm; it is a difficult proposition
          
to disagree with or to refute. LYe could
          
with equal ease subscribe to a theory of
          
the firm based on the cost of managing,
          
for surely it is true that, ceteris paribus,
          
the lower is the cost of managing the
          
greater will be the comparative advantage
          
of organizing resources within the firm. TO
          
move the theory forward, it is necessary
          
to know what is meant by a firm and to
          
Removal of (b) converts a capitalist proprietary firm
          
to a socialist firm.
          
9 Recognition must also be made to the seminal inquiries
          
by Morris Silver and Richard Auster, and by
          
H. R. Malmgren.
          
784 THE AMERIC.43 ECOKOMIC REVIEW
          
explain the circumstances under which
          
the cost of "managing" resources is low
          
relative to the cost of allocating resources
          
through market transaction. The conception#p#分頁標題#e#
          
of and rationale for the classical firm
          
that we propose takes a step down the
          
path pointed out by Coase toward that
          
goal. Consideration of team production,
          
team organization, difficulty in metering
          
outputs, and the problem of shirking are
          
important to our explanation but, so far
          
as we can ascertain, not in Coase's. Coase's
          
analysis insofar as it had heretofore been
          
developed would suggest open-ended contracts
          
but does not appear to imply anything
          
more-neither the residual claimant
          
status nor the distinction between employee
          
and subcontractor status (nor any
          
of the implications indicated below). And
          
it is not true that employees are generally
          
employed on the basis of long-term contractual
          
arrangements any more than on a
          
series of short-term or indefinite length
          
contracts.
          
The importance of our proposed additional
          
elements is revealed, for example,
          
by the explanation of why the person to
          
whom the control monitor is responsible
          
receives the residual, and also by our
          
later discussion of the implications about
          
the corporation, partnerships, and profit
          
sharing. These alternative forms for organization
          
of the firm are difficult to resolve
          
on the basis of market transaction
          
costs only. Our exposition also suggests a
          
definition of the classical firm-something
          
crucial that was heretofore absent.
          
In addition, sometimes a technological
          
development will lower the cost of market
          
transactions while, at the same time, it
          
expands the role of the firm. When the
          
"putting out" system was used for weaving,
          
inputs were organized largely through
          
market negotiations. LTith the development
          
of efficient central sources of power,
          
it became economical to perform weaving
          
in proximity to the power source and to
          
engage in team production. The bringing
          
in of weavers surely must have resulted in
          
a reduction in the cost of negotiating
          
(forming) contracts. Yet, what we observe
          
is the beginning of the factory system
          
in which inputs are organized within
          
a firm. \Thy? The weavers did not simply
          
move to a common source of power that
          
they could tap like an electric line, purchasing
          
power while they used their own
          
equipment. Now team production in the
          
joint use of equipment became more important.
          
l'he measurement of marginal
          
productivity, which now involved interactions
          
between workers, especially through
          
their joint use of machines, became more
          
difficult though contract negotiating cost
          
was reduced, while managing the behavior
          
of inputs became easier because of the increased
          
centralization of activity. The
          
firm as an organization expanded even
          
though the cost of transactions was reduced
          
by the advent of centralized power.#p#分頁標題#e#
          
l'he same could be said for modern assembly
          
lines. Hence the emergence of
          
central power sources expanded the scope
          
of productive activity in which the firm
          
enjoyed a comparative advantage as an
          
organizational form.
          
Some economists, following Knight,
          
have identified the bearing of risks of
          
wealth changes with the director or central
          
employer without explaining why that is
          
a viable arrangement. Presumably, the
          
more risk-averse inputs become employees
          
rather than owners of the classical firm.
          
Risk averseness and uncertainty ~ l i t hregard
          
to the jirm's fortulzes have little, if
          
anything, to do with our explanation although
          
it helps to explain why all resources
          
in a team are not owned by one
          
person. That is, the role of risk taken in
          
the sense of absorbing the windfalls that
          
buffet the firm because of unforeseen competition,
          
technological change, or fluctuations
          
in demand are not central to our
          
theory, although it is true that imperfect
          
knowledge and, therefore, risk, in this
          
sense of risk, underlie the problem of
          
ALCHIAS -4NT) DEJ ISETZ: ECOSOMIC ORGANIZ-4TIOS 785
          
monitoring team behavior. We deduce the
          
system of paying the manager with a
          
residual claim (the equity) from the desire
          
to have efficient means to reduce shirking
          
so as to make team production economical
          
and not from the smaller aversion to the
          
risks of enterprise in a dynamic economy.
          
We conjecture that "distribution-of-risk"
          
is not a valid rationale for the existence
          
and organization of the classical firm.
          
Although we have emphasized team
          
production as creating a costly metering
          
task and have treated team production as
          
an essential (necessary?) condition for the
          
firm, would not other obstacles to cheap
          
metering also call forth the same kind of
          
contractual arrangement here denoted as
          
a firm? For example, suppose a farmer
          
produces wheat in an easily ascertained
          
quantity but with subtle and difficult to
          
detect quality variations determined by
          
how the farmer grew the wheat. -4 vertical
          
integration could allow a purchaser to
          
control the farmer's behavior in order to
          
more economically estimate productivity.
          
But this is not a case of joint or team
          
production, unless "information" can be
          
considered part of the product. (While a
          
good case could be made for that broader
          
conception of production, we shall ignore
          
it here.) Instead of forming a firm, a buyer
          
can contract to have his inspector on the
          
site of production, just as home builders
          
contract with architects to supervise building
          
contracts; that arrangement is not a
          
firm. Still, a firm might be organized in
          
the production of many products wherein
          
no team production or jointness of use of#p#分頁標題#e#
          
separately owned resources is involved.
          
This possibility rather clearly indicates
          
a broader, or complementary, approach
          
to that which we have chosen. 1) As we do
          
in this paper, it can be argued that the
          
firm is the particular policing device
          
utilized when joint team production is
          
present. If other sources of high policing
          
costs arise, as in the wheat case just indicated,
          
some other form of contractual arrangement
          
\+rill be used. Thus to each
          
source of informational cost there may be
          
a different type of policing and contractual
          
arrangement. 2) On the other hand, one
          
can say that where policing is difficult
          
across markets, various forms of contractual
          
arrangements are devised, but there is
          
no reason for that known as the firm to be
          
uniquely related or even highly correlated
          
with team production, as defined here. I t
          
might be used equally probably and viably
          
for other sources of high policing cost. We
          
have not intensively analyzed other
          
sources, and we can only note that our
          
current and readily revisable conjecture
          
is that 1) is valid, and has motivated us in
          
our current endeavor. In any event, the
          
test of the theory advanced here is to see
          
whether the conditions we have identified
          
are necessary for firms to have long-run
          
viability rather than merely births with
          
high infant mortality. Conglomerate firms
          
or collections of separate production agencies
          
into one owning organization can be interpreted
          
as an investment trust or investment
          
diversification device-probably
          
along the lines that motivated
          
Knight's interpretation. A holding company
          
can be called a firm, because of the
          
common association of the word firm with
          
any ownership unit that owns income
          
sources. The term firm as commonly used
          
is so turgid of meaning that we can not
          
hope to explain every entity to which the
          
name is attached in common or even technical
          
literature. Instead, we seek to identify
          
and explain a particular contractual
          
arrangement induced by the cost of information
          
factors analyzed in this paper.
          
IV. Types of Firms
          
A. Projit-Sharing Firms
          
Explicit in our explanation of the
          
capitalist firm is the assumption that the
          
cost of managing the team's inputs by a
          
central monitor, who disciplines himself
          
because he is a residual claimant, is low
          
786 THE AMEKICXK ECONOhf IC REYIEK
          
relative to the cost of metering the marginal
          
outputs of team members.
          
If we look within a firm to see who
          
monitors- -hires, fires, changes, promotes,
          
and renegotiates-we should find him being
          
a residual claimant or, at least, one
          
whose pay or reward is more than any
          
others correlated with fluctuations in the
          
residual value of the firm. They more#p#分頁標題#e#
          
likely will have options or rights or bonuses
          
than will inputs with other tasks.
          
An implicit "auxiliary" assumption of
          
our explanation of the firm is that the
          
cost of team production is increased if the
          
residual claim is not held entirely by the
          
central monitor. That is, we assume that
          
if profit sharing had to be relied upon for
          
all team members, losses from the resulting
          
increase in central monitor shirking
          
woulti exceeti the output gains from the
          
increased incentives of other team members
          
not to shirk. If the optimal team size
          
is only two owners of inputs, then an
          
equal division of profits and losses between
          
them will leave each with stronger
          
incentives to reduce shirking than if the
          
optimal team size is large, for in the latter
          
case only a smaller percentage of the losses
          
occasioned by the shirker will be borne by
          
him. Incentives to shirk are positively related
          
to the optimal size of the team under
          
an equal profit-sharing scheme. lo
          
The preceding does not imply that profit
          
sharing is never viable. Profit sharing to
          
encourage self-policing is more appropriate
          
for small teams. And, intieeti, where input
          
owners are free to make whatever contractual
          
arrangements suit them, as generally
          
is true in capitalist economies, profit
          
sharing seems largely limited to partner-
          
IVhile the degree to which residual clainis are centralized
          
will afiect the size of the team, this will be only
          
one of many factors that determine team size, so as an
          
approximation, we can treat team size as exogenously
          
determined. Cnder certain assumptions about the
          
shape of the "typical" utility function, the incentive to
          
avoid shirking with unequal profit-sharing can 1)e measured
          
hy the Herfindahl index.
          
'0
          
ships with a relatively small number of
          
uctioe" partners. Another advantage of
          
such arrangements for smaller teams is
          
that it permits more effective reciprocal
          
monitoring among inputs. Rlonitoring
          
need not be entirely specialized.
          
Profit sharing is more viable if small
          
team size is associated with situations
          
where the cost of specialized management
          
of inputs is large relative to the increased
          
productivity potential in team effort. IVe
          
conjecture that the cost of managing team
          
inputs increases if the productivity of a
          
team member is difficult to correlate with
          
his behavior. In "artistic" or "professional"
          
work, watching a man's activities
          
is not a good clue to what he is actually
          
thinking or doing with his mind. 1I:hile it
          
is relatively easy to manage or direct the
          
loading of trucks by a team of dock
          
workers where input activity is so highly
          
related in an obvious way to output, it is#p#分頁標題#e#
          
more difficult to manage and direct a
          
lawyer in the preparation anti presentation
          
of a case. Dock workers can be directed
          
in detail without the monitor himself
          
loading the truck, and assembly line
          
workers can be monitoreti by varying the
          
speed of the assembly line, but detailed
          
direction in the preparation of a law case
          
woulti require in much greater tiegree that
          
the monitor prepare the case himself. As
          
a result, artistic or professional inputs,
          
such as lawyers, advertising specialists,
          
and doctors, will be given relatively freer
          
reign with regarti to intiividual behavior.
          
If the management of inputs is relatively
          
costly, or ineffective, as it would seem to
          
be in these cases, but, nonetheless if team
          
effort is more productive than separable
          
production with exchange across markets,
          
then there will develop a tendency to use
          
profit-sharing schemes to provide incentives
          
to avoid shirking.'"
          
l1 The use of the word active will he clarified in our
          
discussion of the corporation, which follows below,
          
l2 Some sharing contracts, like crop sharing, or rental
          
AILCHIAX AXD I3EAISETZ: ECONOAIIC ORGASIZATION
          
B. Socialist Firms
          
\Ye have analyzed the classical proprietorship
          
and the profit-sharing firms in the
          
context of free association and choice of
          
economic organization. Such organizations
          
need not be the most viable when political
          
constraints limit the forms of organization
          
that can be chosen. I t is one thing to have
          
profit sharing when professional or artistic
          
talents are used by small teams. But if
          
political or tax or subsidy considerations
          
induce profit-sharing techniques when
          
these are not otherwise economically
          
justified, then additional management
          
techniques will be developed to help reduce
          
the degree of shirking.
          
For example, most, if not all, firms in
          
Jugoslavia are owned by the employees in
          
the restricted sense that all share in the
          
residual. This is true for large firms and
          
for firms which employ nonartistic, or
          
nonprofessional, workers as well. \Yith a
          
decay of political constraints, most of
          
these firms could be expected to rely on
          
paid wages rather than shares in the residual.
          
This rests on our auxiliary assumption
          
that general sharing in the resiclual
          
results in losses from enhanced shirking
          
by the monitor that exceed the gains from
          
reduced shirking by residual-sharing employees.
          
If this were not so, profit sharing
          
with employees should have occurred more
          
frequently in IYestern societies where such
          
organizations are neither banned nor
          
preferred politically. \There residual sharing
          
by employees is politically imposed,
          
as in Jugoslavia, we are led to expect that
          
some management technique will arise to#p#分頁標題#e#
          
reduce the shirking by the central monitor,
          
a technique that will not be found frequently
          
in \Yestern societies since the
          
monitor retains all (or much) of the rep-
          
--- --- -
          
paJments based on gross sales In retail stores, come
          
close to profit sharing Honeber, it is gross output 5har
          
ing rather than proht shar~ng If e are unal~le to sl)ecif\
          
the impl~c a t~oonf s t he d~fference\ I e refer the reader to
          
S iT Cheung
          
sidual in the \Test and profit sharing is
          
largely confined to small, professionalartistic
          
team production situations. IYe do
          
find in the larger scale residual-sharing
          
firms in Jugoslavia that there are employee
          
committees that can recommend
          
(to the state) the termination of a manager's
          
contract (veto his continuance)
          
with the enterprise. IYe conjecture that
          
the workers' committee is given the right
          
to recommend the termination of the
          
manager's contract precisely because the
          
general sharing of the residual increases
          
iiexcessively" the manager's incentive to
          
shirk.13
          
C. The Corporation
          
All firms must initially acquire command
          
over some resources. The corporation
          
does so primarily by selling promises
          
of future returns to those who (as creditors
          
or owners) provide financial capital. In
          
some situations resources can be acquired
          
in advance from consumers by promises
          
of future delivery (for example, advance
          
sale of a proposed book). Or where the
          
firm is a few artistic or professional persons,
          
each can "chip in" with time and
          
talent until the sale of services brings in
          
revenues. For the most part, capital can
          
be acquired more cheaply if many (riskaverse)
          
investors contribute small portions
          
to a large investment. The economies
          
of raising large sums of equity capital in
          
this way suggest that modifications in the
          
relationship among corporate inputs are
          
required to cope with the shirking problem
          
l3 Incidentally, investment activity will be changed.
          
The inal~ility to capitalize the investment value as
          
"take-home" proviate property ~c*enlt/orf the members of
          
the firm means that the benefits of the investment must
          
he taken as annual income 11y those who are employed
          
at the time of the income. Investment will he confined
          
more to those with shorter life and with higher rates or
          
pay-offs if the alternative of investing is paying out the
          
firm's income to its employees to take home and use as
          
private propert). 1,'or a development of this proposition,
          
see the pal)ers hy Eirik 1:urohotn and Svetozar
          
Pejovich, and t ~ yPe jovich.
          
788 THE AMERICAN ECOKOMIC REVIEW
          
that arises with profit sharing among large
          
numbers of corporate stockholders. One
          
modification is limited liability, especially#p#分頁標題#e#
          
for firms that are large relative to a stockholder's
          
wealth. I t serves to protect stockholders
          
from large losses no matter how
          
they are caused.
          
If every stock owner participated in
          
each decision in a corporation, not only
          
would large bureaucratic costs be incurred,
          
but many would shirk the task of
          
becoming well informed on the issue to be
          
decided, since the losses associated with
          
unexpectedly bad decisions will be borne
          
in large part by the many other corporate
          
shareholders. More effective control of
          
corporate activity is achieved for most
          
purposes by transferring decision authority
          
to a smaller group, whose main function
          
is tonegotiatewith and manage(renegotiate
          
with) the other inputs of the team. The
          
corporate stockholders retain the authority
          
to revise the membership of the management
          
group and over major decisions that
          
affect the structure of the corporation or
          
its dissolution.
          
As a result a new modification of partnerships
          
is induced-the right to sale of
          
corporate shares without approval of any
          
other stockholders. ,Any shareholder can
          
remove his wealth from control by those
          
with whom he has differences of opinion.
          
Rather than try to control the decisions
          
of the management, which is harder to do
          
with many stockholders than with only a
          
few, unrestricted salability provides a
          
more acceptable escape to each stockholder
          
from continued policies with which
          
he disagrees.
          
Indeed, the policing of managerial
          
shirking relies on across-market competition
          
from new groups of would-be managers
          
as well as competition from members
          
within the firm who seek to displace existing
          
management. In addition to competition
          
from outside and inside managers,
          
control is facilitated by the temporary
          
congealing of share votes into voting blocs
          
owned by one or a few contenders. Proxy
          
battles or stock-purchases concentrate the
          
votes required to displace the existing
          
management or modify managerial policies.
          
But it is more than a change in policy that
          
is sought by the newly formed financial
          
interests, whether of new stockholders or
          
not. I t is the capitalization of expected
          
future benefits into stock prices that concentrates
          
on the innovators the wealth
          
gains of their actions if they own large
          
numbers of shares. IYithout capitalization
          
of future benefits, there would be less incentive
          
to incur the costs required to exert
          
informed decisive influence on the corporation's
          
policies and managing personnel.
          
Temporarily, the structure of ownership is
          
reformed, moving away from diffused
          
ownership into decisive power blocs, and
          
this is a transient resurgence of the classical
          
firm with power again concentrated#p#分頁標題#e#
          
in those who have title to the residual.
          
In assessing the significance of stockholders'
          
power it is not the usual diffusion
          
of voting power that is significant but instead
          
the frequency with which voting
          
congeals into decisive changes. Even a
          
one-man owned company may have a
          
long term with just one manager-continuously
          
being approved by the owner.
          
Similarly a dispersed voting power corporation
          
may be also characterized by a
          
long-lived management. The question is
          
the probability of replacement of the
          
management if it behaves in ways not acceptable
          
to a majority of the stockholders.
          
The unrestricted salability of stock and
          
the transfer of proxies enhances the probability
          
of decisive action in the event current
          
stockholders or any outsider believes
          
that management is not doing a good job
          
with the corporation. We are not comparing
          
the corporate responsiveness to that
          
of a single proprietorship; instead, we are
          
indicating features of the corporate structure
          
that are induced by the problem of
          
.\LCHIAK ASP) DEMSETZ: ECOSO?tlIC ORGASIZA4TIOK
          
delegated authority to manager-monitors.'"
          
D. Mutual and Nonprofit Firms
          
The benefits obtained by the new management
          
are greater if the stock can be
          
purchased and sold, because this enables
          
of anticipated future im-
          
'"nstead of thinking of shareholders as joint oztners,
          
we can think of them as investors, like bondholders,
          
e\-cept that the stockholders are more optimistic than
          
bondholders about the enterprise prospects. Instead of
          
buying bonds in the corporation, thus enjoying smaller
          
risks, shareholders prefer to invest funds with a greater
          
realizable return if the firm prospers as expected, but
          
with smaller (possibly negative) returns if the firm performs
          
in a manner closer to that expected by the more
          
pessimistic investors. The pessimistic investors, in
          
turn, regard only the t~ondsa s likely to pay off.
          
If the entrepreneur-organizer is to raise capital on the
          
best terms to him, it is to his advantage, as well as that
          
of ~ ~ r o s ~ ~ e cintvievseto rs, to recognize these differences in
          
espectations. The residual claim on earnings enjoyed by
          
shareholders does not serve the function of enhancing
          
their efficiency as monitors in the general situation. The
          
stockholders are "merely" the less risk-averse or the
          
more optimistic member of the group that finances the
          
firm. Being more optimistic than the average and seeinq
          
a higher mean value future return, they are willing to
          
pay more for a certificate that allows them to realize
          
gain on their expectations. One method of doing so is to
          
buy claims to the distribution of returns that "they see"
          
while bondholders, who are more pessimistic, purchase a#p#分頁標題#e#
          
claim to the distritjution that they see as more likely to
          
emerge. Stockholders are then con1parat)le to warrant
          
holders. They care not about the voting rights (usually
          
not attached to warrants) ; they are in the same position
          
in so far as voting rights are concerned as are hondholders.
          
The only difference is in the proba1)ility distribution
          
of rewards and the terms on which they can
          
place their bets.
          
If we treat t~ondholders, preferred and convertible
          
preferred stockholders, and common stockholders and
          
warrant holders as simply different classes of investorsdiffering
          
not only in their risk averseness hut in their
          
beliefs about the pro1)ability distritjution of the firm's
          
future earnings, why should stockholders he regarded as
          
"owners" in any sense distinct from the other financial
          
investors? The entrepreneur-organizer, who let us
          
assume is the chief operating officer and sole repository
          
of control of the corporation, does not find his authority
          
residing in common stockholders (except in the case of a
          
take over). Does this type of control make any difference
          
in the way the firm is conducted? Li'ould it make
          
any difference in the kinds of behavior that ~ r o ~ i lbde
          
tolerated 1)y competing managers and investors (and we
          
here deliberately refrain from thinking of them as
          
owner-stockholders in the traditional sense)?
          
provements into present .c:lealth of new
          
managers who bought stock and created
          
a larger capital by their management
          
changes. But in nonprofit corporations,
          
colleges, churches, cou1ltry clubs, mutual
          
savings banks, mutual insurance companies,
          
and "coops," the future c o n s -
          
quences of improved management are not
          
Investment old timers recall a significant incidence of
          
nonvoting common stock, now prohibited in corporations
          
whose stock is traded on listed exchanges. (Li'hy
          
prohibited?) The entrepreneur in those days could hold
          
voting shares while investors held nonvoting shares,
          
which in every other respect were identical. Nonvoting
          
share holders were simply investors devoid of ownership
          
connotations. The control and behavior of inside owners
          
in such corporations has never, so far as we have ascertained,
          
been carefully studied. I'or esample, at the
          
simplest level of interest, does the evidence indicate that
          
nonvoting shareholders fared any worse because of not
          
having voting rights? Did owners permit the nonvoting
          
holders the normal return availaljle to voting shareholders?
          
Though evidence is prohibitively espensive to
          
obtain, it is remarkable that voting and nonvoting
          
shares sold for essentially identical prices, even during
          
some prosy battles. I lo~rever ,o ur casual evidence deserves
          
no more than interest-initiating weight.
          
One more point. The facade is deceptive. Instead of#p#分頁標題#e#
          
nonvoting shares, today we have warrants, convertible
          
preferred stocks all of which are solely or partly "equity"
          
claims xirithout voting rights, though they could he converted
          
into voting shares.
          
In sum, is it the case that the stockholder-investor
          
relationship is one emanating from the divisioiz of
          
owrzerslrip among several people, or is it that the collection
          
of investment funds from people of varying anticipations
          
is the underlying factor? If the latter, why
          
should any of them he thought of as the owners in
          
\vhom voting rights, whatever they may signify or however
          
exercisable, should reside in order to enhance efficiency?
          
IVhy voting rights in any of the outside, participating
          
investors?
          
Our initial perception of this possibly significant difference
          
in interpretation was precipitated by Henry
          
XIanne. -1reading of his paper makes it clear that it is
          
hard to understand why an investor who wishes to back
          
and "share" in the consequences of some new l~usiness
          
should necessarily have to acquire voting power (i.e.,
          
power to change the manager-operator) in order to
          
invest in the venture. In fact, we invest in some ventures
          
in the hope t h a t no other stockholders ~i-ilbl e so
          
"foolish" as to try to toss out the incumbent management.
          
\Ye want him to have the power to stay in office,
          
and for the prospect of sharing in his fortunes we buy
          
nonvoting common stock. Our willingness to invest is
          
enhanced 11). the knowledge that we can act leqally via
          
fraud, emt,ez~lement and other laws to help assure that
          
we outside investors will not be "milked" beyond our
          
initial discounted anticipations.
          
790 THE AMERICAN ECONOMIC REVIEIT
          
capitalized into present wealth of stockholders.
          
(As if to make more difficult that
          
competition by new would-be monitors,
          
mutiple shares of ownership in those enterprises
          
cannot be bought by one person.)
          
One should, therefore, find greater shirking
          
in nonprofit, mutually owned enterprises.
          
(This suggests that nonprofit enterprises
          
are especially appropriate in
          
realms of endeavor where more shirking is
          
desired and where redirected uses of the
          
enterprise in response to market-revealed
          
values is less desired.)
          
Team production in artistic or professional
          
intellectual skills will more likely
          
be by partnerships than other types of
          
team production. This amounts to marketorganized
          
team activity and to a nonemployer
          
status. Self-monitoring partnerships,
          
therefore, will be used rather than
          
employer-employee contracts, and these
          
organizations will he small to prevent an
          
excessive dilution of efforts through shirking.
          
Also, partnerships are more likely to
          
occur among relatives or long-standing#p#分頁標題#e#
          
ac~~uaintances,not necessarily because
          
they share a common utility function, but
          
also because each knows better the other's
          
work characteristics and tendencies to
          
shirk.
          
F. Employee Unions
          
Employee unions, whatever else they
          
do, perform as monitors for employees.
          
Employers monitor employees and similarly
          
employees monitor an employer's performance.
          
Are correct wages paid on time
          
and in good currency? Usually, this is
          
extremely easy to check. Hut some forms
          
of employer performance are less easy to
          
meter and are more subject to employer
          
shirking. Fringe benefits often are in nonpecuniary,
          
contingent form; medical. hospital,
          
and accident insurance, and retirement
          
pensions are contingent payments
          
or performances partly in kind by employers
          
to employees. Each employee
          
cannot judge the character of such payments
          
as easily as money wages. Insurance
          
is a contingent payment-what the
          
employee will get upon the contingent
          
event may come as a disappointment. If
          
he could easily determine what other
          
employees had gotten upon such contingent
          
events he could judge more accurately
          
the performance by the employer.
          
He could "trust" the employer not to
          
shirk in such fringe contingent payments,
          
but he would prefer an effective and economic
          
monitor of those payments. We see
          
a specialist monitor- t h e union employees'
          
agent-hired by them and monitoring
          
those aspects of employer payment most
          
difficult for the employees to monitor. Employees
          
should be willing to employ a
          
specialist monitor to administer such
          
hard-to-detect employer performance,
          
even though their monitor has incentives
          
to use pension and retirement funds not
          
entirely for the benefit of employees.
          
V. Team Spirit and Loyalty
          
Every team member would prefer a
          
team in which no one, not even himself,
          
shirked. Then the true marginal costs and
          
values could be equated to achieve more
          
preferred positions. If one could enhance
          
a common interest in nonshirking in the
          
guise of a team loyalty or team spirit, the
          
team would be more efficient. In those
          
sports where team activity is most clearly
          
exemplified, the sense of loyalty and team
          
spirit is most strongly urged. Obviously
          
the team is better, with team spirit and
          
loyalty, because of the reduced shirking---
          
not because of some other feature inherent
          
in loyalty or spirit as such.15
          
Is Sports Leag~ies: Professional sports contests among
          
teams is typically conducted hy a league of teams iVe
          
assume that sports consumers are interested not only in
          
absolute sporting skill but also in skills relative to other
          
teams. Being slightly better than o[y)osing teams enables
          
one to claim a major portion of the receipts; the#p#分頁標題#e#
          
- -
          
AIXHIAK AKI I I IEMSETZ: ECONOMIC ORGAKIZATIOK 791
          
Corporations and business firms try to
          
instill a spirit of loyalty. This should not ~ ~
          
be viewed simply as a device to increase
          
profits by ocer-working or misleading the
          
employees, nor as an adolescent urge for
          
belonging. I t promotes a closer approsimation
          
to the employees' potentially available
          
true rates of substitution between
          
production and leisure and enables each
          
team member to achieve a more preferred
          
inferior team does not release resources and reduce costs,
          
since they were expected in the play of contest. Hence,
          
absolute skill is developed beyond the equality of marginal
          
investment in sporting skill with its true social
          
marginal value product. I t follows there will he a tendency
          
to overinvest in training athletes and developing
          
teams. ''Reverse shirking" arises, as budding players
          
are induced to overpractice hyperactively relative to the
          
social marginal value of their enhanced skills. To prevent
          
overinvestment, the teams seek an agreement with
          
each other to restrict practice, size of teams, and even
          
pay of the team members (which reduces incentives of
          
young people to overinvest in developing skills). Ideally,
          
if all the contestant teams were owned by one owner,
          
overinvestment in sports would be avoided, much as
          
ownership of common fisheries or underground oil or
          
water reserve would prevent overinvestment. This
          
hyperactivity (to suggest the opposite of shirking) is
          
controlled by the league of teams, wherein the league
          
adopts a common set of constraints on each team's behavior.
          
In effect, the teams are no longer really owned
          
by the team owners but are supervised by them, much
          
as the franchisers of some product. They are not fullfledged
          
owners of their business, including the brand
          
name, and can not "do what they wish" as franchises.
          
Comparable to the franchiser, is the league commissioner
          
or conference president, who seeks to restrain
          
hyperactivity, as individual team supervisors compete
          
with each other and cause esternal diseconomies. Such
          
restraints are usually regarded as anticompetitive, antisocial,
          
collusive-cartel devices to restrain free open competition,
          
and reduce players' salaries. However, the
          
interpretation presented here is premised on an attempt
          
to avoid hyperinvestment in team sports production.
          
Of course, the team operators have an incentive, once
          
the league is formed and restraints are placed on hyperinvestment
          
activity, to go further and obtain the private
          
benefits of monopoly restriction. To what estent overinvestment
          
is replaced by monopoly restriction is not
          
yet determinable; nor have we seen an empirical test of
          
these two competing, but mutually consistent interpretations.#p#分頁標題#e#
          
(This interpretation of league-sports activity
          
was proposed by Earl Thompson and formulated by
          
Michael Canes.) Again, athletic teams clearly exemplify
          
the specialization of monitoring with captains and
          
coaches; a captain detects shirkers while the coach trains
          
and selects strategies and tactics. Both functions may
          
be centralized in one person.
          
situation. The difficulty, of course, is to
          
create economically that team spirit and
          
loyalty. I t can be preached with an aura
          
of moral code of conduct-a morality with
          
literally the same basis as the ten commandments-
          
to restrict our conduct toward
          
what we would choose if we bore our
          
full costs.
          
VI. Kinds of Inputs Owned
          
by the Firm
          
To this point the discussion has examined
          
why firms, as we have defined
          
them, exist? That is, why is there an
          
owner-employer who is the common
          
party to contracts with other owners of
          
inputs in team activity? The answer to
          
that cluestion should also indicate the kind
          
of the jointly used resources likely to be
          
owned by the central-owner-monitor and
          
the kind likely to be hired from people
          
who are not team-owners. Can we identify
          
characteristics or features of various inputs
          
that lead to their being hired or to
          
their being owned by the firm?
          
How can residual-claimant, centralemployer-
          
owner demonstrate ability to
          
pay the other hired inputs the promised
          
amount in the event of a loss? He can pay
          
in advance or he can commit wealth sufficient
          
to cover negative residuals. The
          
latter will take the form of machines, land,
          
buildings, or raw materials committed to
          
the firm. Commitments of labor-wealth
          
(i.e., human wealth) given the property
          
rights in people, is less feasible. These considerations
          
suggest that ,residual claimants-
          
o\n7ners of the firm-will be investors
          
of resalable capital equipment in the
          
firm. The goods or inputs more likely to
          
be invested, than rented, by the owners
          
of the enterprise, will have higher resale
          
values relative to the initial cost and will
          
have longer expected use in a firm relative
          
to the economic life of the good.
          
But beyond these factors are those developed
          
above to explain the existence of
          
THE AMERICAAN ECOKOMIC REVIEIT
          
the institution known as the firm-the
          
costs of detecting output performance.
          
\Then a durable resource is used it will
          
have a marginal product and a depreciation.
          
Its use requires payment to cover at
          
least use-induced depreciation; unless that
          
user cost is specifically detectable, payment
          
for it will be demanded in accord
          
with expected depreciation. *And we can
          
ascertain circumstances for each. indestructible
          
hammer with a readily detectable
          
marginal product has zero user#p#分頁標題#e#
          
cost. But suppose the hammer were destructible
          
and that careless (which is
          
easier than careful) use is more abusive
          
and causes greater depreciation of the
          
hammer. Suppose in addition the abuse
          
is easier to detect by observing the way it
          
is used than by observing only the hammer
          
after its use, or by measuring the
          
output scored from a hammer by a
          
laborer. If the hammer were rented and
          
used in the absence of the o\n7ner, the depreciation
          
would be greater than if the use
          
were observed by the o\n7ner and the user
          
charged in accord with the imposed depreciation.
          
(Careless use is more likely
          
than careful use-if one does not pay for
          
the greater depreciation.) An absentee
          
owner would therefore ask for a higher
          
rental price because of the higher expected
          
user cost than if the item were used by the
          
o\n7ner. The expectation is higher because
          
of the greater difficulty of observing
          
specific user cost, by inspection of the
          
hammer after use. Renting is therefore in
          
this case more costly than o\n7ner use. This
          
is the valid content of the misleading expressions
          
about ownership being more
          
economical than renting-ignoring all
          
other factors that may work in the opposite
          
direction, like tax provision, shortterm
          
occupancy and capital risk avoidance.
          
Better examples are tools of the trade.
          
iyatch repairers, engineers, and carpenters
          
tend to on7n their own tools especially if
          
they are portable. Trucks are more likely
          
to be employee owned rather than other
          
equally expensive team inputs because it
          
is relatively cheap for the driver to police
          
the care taken in using a truck. Policing
          
the use of trucks by a nondriver owner is
          
more likely to occur for trucks that are
          
not specialized to one driver, like public
          
transit busses.
          
The factor with which we are concerned
          
here is one related to the costs of monitoring
          
not only the gross product performance
          
of an input but also the abuse or depreciation
          
inflicted on the input in the course of
          
its use. If depreciation or user cost is more
          
cheaply detected when the owner can see
          
its use than by only seeing the input before
          
and after, there is a force toward
          
owner use rather than renting. Resources
          
whose user cost is harder to detect when
          
used by someone else, tend on this count
          
to be owner-used. AAbsentee ownership, in
          
the lay language, will be less likely. Assume
          
momentarily that labor service cannot
          
be performed in the absence of its
          
owner. The labor owner can more cheaply
          
monitor any abuse of himself than if somehow
          
labor-services could be provided without
          
the labor owner observing its mode of
          
use or knowing what was happening. Also
          
his incentive to abuse himself is increased#p#分頁標題#e#
          
if he does not own himself.16
          
'6 Professional athletes in baseball, football, and basketball,
          
where athletes having 5old their source of
          
service to the team owners upon entering into sports
          
activity, are owned by team owners. Here the team
          
owners must monitor the athletes' physical condition
          
and behavior to protect the team owners' wealth. The
          
athlete has less (not, no) incentive to protect or enhance
          
his athletic prowess since capital value changes have less
          
impact on his own wealth and more on the team owners.
          
Thus, some athletes sign up for big initial bonuses
          
(representing present capital value of future services).
          
Future salaries are lower by the annuity value of the
          
prepaid "bonus" and hence the athlete hasless to lose by
          
subsequent abuse of his athletic prowess. Any decline in
          
his subsequent service value would in part be borne by
          
the team owner who owns the players' future service.
          
This does not say these losses of future salaries have no
          
effect on preservation of athletic talent (we are not making
          
a "sunk cost" error). Instead, we assert that the
          
AALCHIXN AAND DEMSETZ: ECONOMIC ORGAANIZAATION 793
          
The similarity between the preceding
          
analysis and the question of absentee
          
landlordism and of sharecropping arrangements
          
is no accident. The same factors
          
which explain the contractual arrangements
          
known as a firm help to explain
          
the incidence of tenancy, labor hiring or
          
sharecropping."
          
VII. Firms as a Specialized Market
          
Institution for Collecting, Collating,
          
and Selling Input Information
          
The firm serves as a highly specialized
          
surrogate market. Any person contemplating
          
a joint-input activity must search
          
and detect the qualities of available joint
          
inputs. He could contact an employment
          
agency, but that agency in a small to\n7n
          
would have little advantage over a large
          
firm with many inputs. The employer, by
          
virtue of monitoring many inputs, acquires
          
special superior information about
          
their productive talents. This aids his
          
directive (i.e., market hiring) efficiency. He
          
"sells" his information to employee-inputs
          
as he aids them in ascertaining good input
          
combinations for team activity. Those
          
who work as employees or who rent services
          
to him are using him to discern superior
          
combinations of inputs. Not only
          
preservation is reduced, not eliminated, because the
          
amount of loss of wealth suffered is smaller. The athlete
          
will spend less to maintain or enhance his prowess
          
thereafter. The effect of this revised incentive system is
          
evidenced in comparisons of the kinds of attention and
          
care imposed on the athletes at the "eupense of the
          
team owner" in the case where atheletes' future servies
          
are owned by the team owner with that where future#p#分頁標題#e#
          
labor service values are owned by the athlete himself.
          
LVhy athletes' future athletic services are owned by the
          
team owners rather than being hired is a question we
          
should be able to answer. One presumption is cartelization
          
and monopsony gains to team olvners. Another is
          
exactly the theory being expounded in this paper-costs
          
of monitoring production of athletes; we know not on
          
which to rely.
          
l7 The analysis used by Cheung in explaining the
          
prevalence of sharecropping and land tenancy arrangements
          
is built squarely on the same factors-the costs
          
of detecting output performance of jointly used inputs
          
in team production and the costs of detecting user costs
          
imposed on the various inputs if owner used or if rented.
          
does the director-employer "decide" what
          
each input will produce, he also estimates
          
which heterogeneous inputs will work together
          
jointly more efficiently, and he
          
does this in the contest of a privately
          
owned market for forming teams. The department
          
store is a firm and is a superior
          
private market. People who shop and
          
work in one town can as well shop and
          
work in a privately owned firm.
          
This marketing function is obscured in
          
the theoretical literature by the assumption
          
of homogeneous factors. Or it is
          
tacitly left for individuals to do themselves
          
via personal market search, much as if a
          
person had to search without benefit of
          
specialist retailers. Whether or not the
          
firm arose because of this efficient information
          
service, it gives the directoremployer
          
more knowledge about the
          
productive talents of the team's inputs,
          
and a basis for superior decisions about
          
efficient or profitable combinations of
          
those heterogeneous resources.
          
In other words, opportunities for profitable
          
team production by inputs already
          
within the firm may be ascertained more
          
economically and accurately than for resources
          
outside the firm. Superior combinations
          
of inputs can be more economically
          
identified and formed from resources
          
already used in the organization than by
          
obtaining new resources (and knowledge
          
of them) from the outside. Promotion and
          
revision of employee assignments (contracts)
          
will be preferred by a firm to the
          
hiring of new inputs. To the extent that
          
this occurs there is reason to expect the
          
firm to be able to operate as a conglomerate
          
rather than persist in producing
          
a single product. Efficient production
          
with heterogeneous resources is a result
          
not of having better resources but in knowing
          
more accurately the relative productive
          
performances of those resources. Poorer
          
resources can be paid less in accord with
          
their inferiority; greater accuracy of
          
THE AMERICAAN ECONOMIC REIrIEIV
          
knowledge of the potential and actual productive#p#分頁標題#e#
          
actions of inputs rather than having
          
high productivity resources makes a
          
firm (or an assignment of inputs) profitable.
          
18
          
VIII. Summary
          
IVhile ordinary contracts facilitate efficient
          
specialization according to comparative
          
advantage, a special class of contracts
          
among a group of joint inputs to a
          
team production process is commonly
          
used for team production. Instead of
          
multilateral contracts among all the joint
          
inputs' owners, a central common party
          
to a set of bilateral contracts facilitates
          
efficient organization of the joint inguts in
          
team production. The terms of the contracts
          
form the basis of the entity called
          
the firm-especially appropriate for organizing
          
team production processes.
          
Team productive activity is that in
          
which a union, or joint use, of inputs yields
          
a larger output than the sum of the products
          
of the separately used inputs. This
          
la .lccording to our interpretation, the firm is a
          
specialized surrogate for a market for team use of inputs;
          
it provides superior (i.e., cheaper) collection and collation
          
of kno\vledge at)out heterogeneous resources. The
          
greater the set of inputs ahout which knowledge of performance
          
is being collated within a firm the greater are
          
the present costs of the collation activity. Then, the
          
larger the firm (market) the greater the attenuation of
          
monitor control. To counter this force, the firm will 11e
          
divisionalized in \yay that economize on those costs --
          
just as will the market be sl~ecial i~eSdo. far as ive can
          
ascertain, other theories of the reasons for firms have no
          
such implications.
          
In Japan, employees t)y custom ~vork nearly their
          
entire lives with one firm. and the firm aqrees to that
          
expectation. Firms will tent1 to be large and coriglomerate
          
to enable a ljroader scope of input revision. Each
          
firm is, in effect, a small economy engaging in "intranational
          
and international" trade. ;\nalogously, . h e r -
          
icans expect to sljenrl their whole lives in the United
          
States. and the bigger the country, in terms of variety
          
of resources. the easier it is to adjust to changing tastes
          
and circumstances. Japan, with its lifetime employees,
          
should he characterized more by large, conglomerate
          
firms. Presum;~hly, at some size of the firm. specialized
          
knowletlge about inputs becomes as expensive to transmit
          
across divisions of the firms as it does acrozs markets
          
to other firms.
          
team production requires-like all other
          
production processes-an assessment of
          
marginal productivities if efficient production
          
is to be achieved. Nonseparability
          
of the products of several differently
          
owned joint inputs raises the cost of assessing
          
the marginal productivities of
          
those resources or services of each input#p#分頁標題#e#
          
owner. Monitoring or metering the productivities
          
to match marginal productivities
          
to costs of inputs and thereby to
          
reduce shirking can be achieved more
          
economically (than by across market bilateral
          
negotiations among inputs) in a
          
firm.
          
The essence of the classical firm is
          
identified here as a contractual structure
          
with : 1) joint input production; 2) several
          
input owners; 3) one party who is common
          
to all the contracts of the joint inputs;
          
1)who has rights to renegotiate any
          
input's contract independently of contracts
          
with other input owners; 5) who
          
holds the residual claim; and 6) who has
          
the right to sell his central contractual
          
residual status. The central agent is called
          
the firm's owner and the employer. S o
          
authoritarian control is involved; the arrangement
          
is simply a contractual structure
          
subject to continuous renegotiation
          
with the central agent. ?'he contractual
          
structure arises as a means of enhancing
          
efficient organization of team production.
          
In particular, the ability to detect shirking
          
among owners of jointly used inputs in
          
team production is enhanced (detection
          
costs are reduced) by this arrangement and
          
the discipline (by revision of contracts) of
          
input owners is made more economic.
          
Testable implications are suggested by
          
the analysis of different types of organizations--
          
nonprofit, proprietary for profit,
          
unions, cooperatives, partnerships, and by
          
the kinds of inputs that tend to be owned
          
by the firm in contrast to those employed
          
by the firm.
          
IVe conclude with n highly conjectural
          
ALCHrAN AND DEMSETZ: ECONOMIC ORGAANIZXTION 795
          
but possibly significant interpretation. As
          
a consequence of the flow of information
          
to the central party (employer), the firm
          
takes on the characteristic of an efficient
          
market in that information about the productive
          
characteristics of a large set of
          
specific inputs is now more cheaply available.
          
Better recombinations or new uses of
          
resources can be more efficiently ascertained
          
than by the conventional search
          
through the general market. In this sense
          
inputs compete with each other within and
          
via a firm rather than solely across markets
          
as conventionally conceived. Emphasis on
          
interfirm competition obscures intrafirm
          
competition among inputs. Conceiving
          
competition as the revelation and exclzange
          
of knowledge or information about qualities,
          
potential uses of different inputs in
          
different potential applications indicates
          
that the firm is a device for enchancing
          
competition among sets of input resources
          
as well as a device for more efiiciently rewarding
          
the inputs. In contrast to markets
          
and cities which can be viewed as publicly
          
or nonowned market places, the firm can#p#分頁標題#e#
          
be considered a privately owned market;
          
if so, we could consider the firm and the
          
ordinary market as competing types of
          
markets, competition between private
          
proprietary markets and public or communal
          
markets. Could it be that the
          
market suffers from the defects of communal
          
property rights in organizing and
          
influencing uses of valuable resources?
          
REFERENCES
          
M. Canes, "A Model of a Sports League," unpublished
          
doctoral dissertation, UCL.4 1970.
          
S. N. Cheung, The Theory of Share Tenalzcy,
          
Chicago 1969.
          
R. H. Coase, "The Xature of the Firm," Econonzica,
          
Xov. 1937, 4, 386-405; reprinted in
          
G. J. Stigler and K. Boulding, eds., Readings
          
in Price Theory, Homewood 1952, 331-51.
          
E. Furobotn and S. Pejovich, "Property Rights
          
and the Behavior of the Firm in a Socialist
          
State," Zeitschrift fiir 2Vationalokolzonzie,
          
1970,30,431-454.
          
F. H. Knight, Risk, Crl.tcertainty and Profit,
          
Sew York 1965.
          
S. Macaulay, "Non-Contractual Relations in
          
Business: A Preliminary Study," Anzer. Sociological
          
Rev., 1968, 28, 55-69.
          
H. B. Malmgren, "Information, Expectations
          
and the Theory of the Firm," Quart J. Econ.,
          
.LZug. 1961,75,399-421.
          
H. Manne, "Our Two Corporation Systems:
          
Law and Econon~ics," L7irginia L a z ~ Rcv.,
          
Mar. 1967, 53, No. 2, 259-54.
          
S. Pejovich, &'The Firm, Monetary Policy and
          
Property Rights in a Planned Economy,"
          
Tl'cstern Econ. J., Sept. 1969, 7, 193-200.
          
M. Silver and R. Auster, ',Entrepreneurship,
          
Profit, and the Limits on Firm Size," J. Bus.
          
Ulziv. Clzicago, A4pr. 1969, 42, 277-51.
          
E. A. Thompson, "Nonpecuniary Rewards and
          
the Aggregate Production Function," Rezt.
          
Econ. Statist., Xov. 1970, 52, 395-404.
          
You have printed the following article:
          
Production, Information Costs, and Economic Organization
          
Armen A. Alchian; Harold Demsetz
          
The American Economic Review, Vol. 62, No. 5. (Dec., 1972), pp. 777-795.
          
Stable URL:
          
This article references the following linked citations. If you are trying to access articles from an
          
http://www.mythingswp7.com/dissertation_writing/Ecommerce/ off-campus location, you may be required to first logon via your library web site to access JSTOR. Please
          
visit your library's website or contact a librarian to learn about options for remote access to JSTOR.
          
References
          
The Nature of the Firm
          
R. H. Coase
          
留學生經濟學碩士dissertationEconomica, New Series, Vol. 4, No. 16. (Nov., 1937), pp. 386-405.
          
Stable URL:
          

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