Thank You, Boeing
For providing such a clear illustration of the forces driving the theory of the firm.
Oliver Williamson shared the 2009 Nobel mainly because of his work on a question that may seem obvious, but is much less so once you think about it: why are there so many big companies? Why not just rely on markets to coordinate activity among individuals or small firms? Why, in effect, do we have a lot of fairly large command-and-control economies embedded in our market system?
Williamson answered this in terms of the difficulties of writing complete contracts; when the tasks that need to be done are complex, so that you can’t fully specify what people should do in advance, there can be a lot of slippage and strategic behavior if you rely on market incentives; in such cases it can be better to do these things in-house, so that you can simply tell people to do something a particular way or to change their behavior.
In Boeing’s case, they outsourced far too much, only to find that they were getting parts that didn’t do what they were supposed to — and also to find that the subcontractors were seizing a lot of the rents. They discovered, in effect, that there are times when it’s better to rely on central planning than to leave things up to the market.
Obviously this isn’t always true. There’s a tradeoff. But that’s the point — and it’s this tradeoff that determines how big firms should be. Boeing has now provided a clear motivating example. Their loss, the economics profession’s gain.
*******
These "incomplete contracts" are used by director-primacy type scholars to justify a command-and-control structure. The board and management run the show and, as long as they're not stealing, everyone else has got to eat the results or get out. Theoretically, according to these scholars, it's more efficient for everyone. Having to re-negotiate with adverse third parties every time you want to get something done can be wasteful and counterproductive.
Thus, adding in shareholder meddling in corporate governance can undermine the efficiencies of command-and-control. Suddenly, stuff's being re-negotiated again. Usually to the benefit of the shareholder. And the company is spending time and resources re-negotiating.
Yet, allowing more negotiation isn't inherently a bad thing. It can also lead to fairer results and efficiencies.
The problem comes when you only allow one group to re-negotiate. The folks without a seat at the table tend to get screwed over.
Think of it this way: a subcontractor that provides mail and shipping services to a corporate client will get paid better than in-house secretaries, file clerks, and drivers. They can negotiate their prices upwards, while secretaries, file clerks and drivers can only apply the same amount of leverage through collective bargaining -- and then, only when employment contracts come up for renegotiation. Meanwhile, they've just got to swallow orders.
In the public corporation, because they have a seat at the table, shareholders can force directors to pay more attention to stock price. Non-unionized employees have no such power. The result? lower wages and layoffs.
