Strategy and Institutional & Organizational Economics

By Jackson A. Nickerson (Washington University in St. Louis) and Brian S. Silverman (University of Toronto)

The field of strategy draws on several cognate disciplines, with the goal of addressing one overarching question: Why are some firms able to obtain sustainable competitive advantage (i.e., consistently higher profits than competitors)? In the 1990s, this motivating question for the field was codified into four fundamental subsidiary questions (Rumelt, Schendel & Teece 1994):

  1. How do firms behave? Or, do firms really behave like rational actors, and, if not, what models of their behavior should be used by researchers and policy makers?

  2. Why are firms different? Or, what sustains the heterogeneity in resources and performance among close competitors despite competition and imitative attempts?

  3. What limits the scope of the firm? Or, what is the function of or value added by the headquarters unit in a diversified firm?

  4. What determines success and failure in international competition? Or, what are the origins of success and what are their particular manifestations in international settings of global competition?

Although more recent scholarship has expanded the range of these queries, chiefly by applying variations to non-firm entities such as alliances, open-source movements, and the like, these four fundamental questions continue to constitute the chief concerns in strategy research today. Insights from institutional and organizational economics (IOE) have shed substantial light on these inquiries, and the IOE lens holds the promise of further insights and contributions to strategy research.

What limits the scope of the firm? At the core of IOE’s contribution to the field of strategy is the economic theory of the firm. Theories of organizational economics, especially transaction cost economics (TCE), address the fundamental strategic question of firm scope. The canonical organizational decision in TCE, the “make or buy” decision, is precisely an examination of the vertical scope of a firm (Williamson 1975, 1985). Early extensions of TCE applied the theory’s logic to lateral product diversification, thus addressing limits to the horizontal scope of the firm as well (Teece 1980, 1982).

The strategy field largely has adopted the transaction-cost explanation for firm scope decisions, and has in turn contributed to the development of TCE by exploring the performance implications of scope choice (e.g., Nickerson & Silverman 2003, Nickerson & Zenger 2008, Novak & Stern 2008, Hoetker & Mellewigt 2009; Forbes & Lederman 2010), by integrating TCE with other theoretical lenses (e.g., Silverman 1999, Leiblein & Miller 2003, Macher 2006), and by introducing broader notions of competitive dynamics in product (or resource) markets in tandem with conventional TCE concerns (e.g., Dyer & Singh 1998, Coff 1997, Argyres & Bigelow 2010). Arguably, the extension of TCE logic to consider the problem of knowledge appropriability was driven by strategy scholars who extended the theory to make sense of strategic challenges in technology-based industries (Teece 1986; Pisano 1990; Oxley 1997, Sampson 2007, Dushnitsky & Shaver 2009). Finally, strategy scholars have largely driven the recent study of make-and-buy, also known as “plural sourcing” (e.g., Azoulay 2004, Parmigiani 2007). In sum, the application of TCE to strategy research has offered benefits both to strategy scholarship and to IOE scholarship.

Property rights theory (Grossman & Hart 1986, Hart & Moore 1990) has begun to make inroads in strategy research as well. Strategy research tends to rely less on formal theoretical models than does economics, perhaps because the field skews more heavily toward empirical studies, and this may explain the slower diffusion of property rights theory into strategy. But in recent years scholars have applied insights from property rights to scope-related questions of asset ownership by firms (Foss & Foss 2005; Wang, He & Mahoney, 2009), and strategy research has used relevant empirical phenomena to begin to distinguish among the predictions of property rights, transaction costs, and other organizational economics approaches (Kim & Mahoney 2005).

Finally, institutional economics is relevant because background institutions help determine the relative cost of scope choices. For example, intellectual property laws affect the feasibility of protecting patented knowledge and hence both alliance strategy (Oxley 1997, 1999) and patenting strategy (Ziedonis 2004); the enforceability of non-compete clauses affects workers’ exit options and hence within-firm information sharing and effort (Marx, Strumsky & Fleming 2009); and “norms” affect which organizations are able to take advantage of new opportunities (Argyres & Liebeskind 1998).

IOE also has contributed to our understanding of the remaining questions:

Why are firms different? In a neo-classical world of free competition and imitation, it is difficult to explain persistent heterogeneity in performance among competing firms. Strategy scholars have devoted substantial effort to exploring the sources of sustained performance differences, with the bulk of scholars acknowledging the importance of value-generating “resources” or “capabilities” that are not easily tradeable on markets, hence less subject to competition or imitation than traditional assets. Chief among these resources is idiosyncratic tacit knowledge (Teece 1988). Yet additional theoretical and empirical analysis can further dimensionalize this “secret sauce” that yields differential performance.

Strategic management research on persistent firm differences has drawn on diverse theoretical lenses from economics including non-cooperative game theory, cooperative game theory, evolutionary economics, as well as other areas of social science. (e.g., Saloner 1991, MacDonald & Ryall 2004, Nelson and Winter 1982). Nonetheless, IOE ideas arguably have yielded the most substantive contributions from economics. The importance of, and focus on, idiosyncrasy and firm-specificity of key resources is explicitly linked to the concept of asset-specificity in TCE and property rights theory. “Sticky” firm attributes such as relational capital or experience-based contracting expertise are also implicated in firm heterogeneity (Poppo & Zenger 2002, Argyres, Bercovitz & Mayer 2007, Lazzarini et al. 2008). And one of the most promising current avenues for systematizing our understanding of capabilities – after 20 years, still a rather elastic term – stems from recent research that applies relational-contracts logic to understand “implicit contracts” within firms that may allow one firm to elicit effort from its employees that an ostensibly similar firm cannot (Gibbons & Henderson 2012).

How do firms behave? As a field, strategy has generally been oriented toward explaining real-world phenomena. Perhaps for this reason, it has been more receptive than economics to the idea that firm behavior deviates from the rational actor paradigm. The behavioral assumptions of organizational economics, particularly the bounded rationality and opportunism propounded by transaction cost economics, have been widely adopted in the field. Strategy scholars continue to experiment with additional behavioral assumptions such as “associative thinking” and “ego preservation” that systematically introduce biases into strategic decision-making and governance (e.g., Furr, Nickerson, & Wuebker 2015). Other lines of research have highlighted the role of implicit contracts and social norms that shape firm behavior as well as the interactions between firms in the vertical chain (e.g., Baker, Gibbons & Murphy 2002). At the same time, strategists have applied insights from TCE – which is conventionally focused “inwardly” on efficient organization for a firm – to make predictions about the relative competitive intensity generated by firms with different organizational boundaries (Negro & Sorenson 2006, de Figueiredo & Silverman 2012).

What determines success and failure in international competition? IOE scholars note that variation in national or regional background institutions causes competition and organization to differ, deviating in myriad ways from neoclassical models. The national institutional environment affects the nature of multinational investment (e.g., Henisz 2000), the location of activities vulnerable to knowledge spillovers (Alcacer 2006, Zhao 2006), and the broader relevance of geographic strategy (e.g., Shaver & Flyer 2000, Ramos & Shaver 2009). In essence, research indicates that international competition involves the interaction of firm strategy with the political and regulatory institutions, as the latter affect business transactions as well as the efficacy of property rights. Relatedly, non-market strategy scholars have employed IOE (notably TCE) logic to make sense of firms’ efforts to influence the regulatory/political environment in which they operate (de Figueiredo & Tiller 2001; Holburn & Vandenbergh 2008).

The field of strategy has been profoundly shaped by institutional and organizational economics. Indeed, an assessment of citation patterns from 1985 to 2008 in strategy illustrates that new institutional scholars such as Oliver Williamson are among the most highly and enduringly cited in the field (Nickerson & Silverman 2009). When the wider list of contributions is considered, it is easy to conclude that IOE is one of the core pillars of the field of strategic management.



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