Economics, organization theory, and property rights

Consider again the efficiency objective: to maximize net social value from the limited resources available. The economic model of social effi- ciency is based on a society that consists of consumers and producers who engage in individual self-interested (that is, not social) behavior. Each consumer wants the greatest satisfaction for himself or herself and each producer wants the greatest profit for himself or herself. Yet in this model it is this individual self-seeking behavior that, through free mar- ket exchanges, generates the greatest possible net value of resource use to society. The market in this model is the exchange process; there is neither formal organization nor any organizational structure.

Consider now the existence of organizations and organizational struc- ture, organizational objectives, and the issue of social efficiency. Where do the objectives of organizations come from? How do the objectives of an organization relate to the decision maker? How does the relationship between the objectives of the organization and the decision maker relate to social value and affect social efficiency? I address each of these questions in the context of the approaches taken by economists and organization theorists.

Economists and organization theorists from other disciplines view the objective  of  an  organization  as  that  of  a  collective,  distinct  from the objectives of individuals within the organization. The concept of an objective of an organization is treated differently by economists and by organization theorists, however. Economists define the objectives of an organization in the context of optimization: something to be maxi- mized.1 Organization theorists define the objectives of an organization in the context of more general goals: the purpose or mission of the organization (Wilensky, p. 3). Etzioni (1964, p. 6) describes the objective of an organization as ‘ … a desired state of affairs which the organization attempts to realize.’ For some specific organizational forms or issues, these two approaches may be consistent; for others they are not. For example, both groups of theorists are of the understanding that a firm or corporation has as its objective the pursuit of profit; an economist would characterize this more specifically as profit maximization.

Even when there is agreement, however, the agreement may be more apparent than real. Both economists and organization theorists may define the objective of a public sector organization to be the provision of services to the public. Economic models may characterize this objec- tive as seeking to supply the greatest amount of public services (output maximization, for example, or possibly budget maximization for a spe- cific relationship between budget and output). Even among economists, as noted in Chapter 6, there may be variations in model specifications that define their interpretation of the objective of a public bureau. Various economic interpretations of bureau objectives include maxi- mizing any one of the following: gross (total) budget, net or discre- tionary budget (that is, profit), total output, ‘visible’ outputs, or inputs. Organization theorists may characterize the objective of a public bureau as a process of both provision and distribution of services across certain social or political groups rather than the attainment of a specific quan- tifiable outcome. That is, organization theorists see bureaus as attempt- ing to provide some amount of services to the public in a way that is effective and fair. Etzioni (1964, p. 8) distinguishes between the econo- mist’s and organization theorists’ characterization of organizational objec- tives that can be applied in the context of public bureaus: ‘Organizations are constructed to be the most effective and efficient social units. The actual effectiveness of a specific organization is determined by the degree to which it realizes its goals. The efficiency of an organization is meas- ured by the amount of resources used to produce a unit of output. Output is usually closely related to, but not identical with, the organi- zational goals’ (italics in the original).2 An example of this is that organization theorists may focus on public access to output more than on the amount of the service that is provided in total.

There is also variation in the interpretation between economists and organization theorists, and again among economists as well, of the objectives of nonprofit organizations.  The  general  goal  or  objective of any 501(c)3 or 501(c)4 US tax exempt nonprofit organization is to serve a charitable or social purpose through the provision of some specific  service(s)  to  the  public,  unencumbered  by  explicit  political constraints (as are public sector organizations). Economic optimization models interpret this in a number of ways. These interpretations include (1) seeking to provide the largest possible amount of services to the public (output maximization); (2) seeking the greatest amount of fund- ing so that services and/or quality may be increased (gross (total) rev- enue maximization); (3) seeking the largest profit to ensure long term survival through reinvestment in the organization (net revenue or profit maximization); or (4) to provide a higher quality of service to the public that would be otherwise unavailable (quality maximization).3 Organization theorists focus on both the provision and distribution of services through nonprofit organizations, similar to the analysis of pub- lic bureaus but again taking note of the nonprofit’s independence from political mandates (Hall, 1987). Douglas (1987) emphasizes the latter point of nonprofit independence from  political  mandates  and  adds the dimension of commercial market mandates by pointing out the added component of diversity to objectives of (at least some) nonprofit organizations.

Objectives of organizations therefore, whether defined by economists or organization theorists from other disciplines, arise from the historical and social setting in which the organization operates. The commercial setting of the market provides the basis for the pecuniary profit objective of a firm. The noncommercial, nonmarket setting of public and social service is derived from traditions in government (for example, in the area of national defense) and in religious and secular philanthropy (for example, in the areas of education, health care and equal opportunity). This setting provides the basis for the nonpecuniary objectives of pro- viding social (as opposed to commercial) services and redistribution. The partial translation of these nonpecuniary objectives by economists into the pecuniary form, such as budget and revenue, reflects their basic concern with the resource requirements associated with achieving these goals or objectives.

The second question I raise concerns the relationship between the objectives of the organization and the objectives of the individual deci- sion maker, or manager. Both economists and organization theorists acknowledge that individual managerial objectives are likely to differ from the objectives of the organization. In addition, both groups of theorists are concerned with the implications of the differences in these personal (managerial) and organizational objectives. In the economic theory of organizations this is demonstrated through managerial models of the firm, where the manager is regarded as an individual with personal preferences that are distinct from the profit objective of the firm owners (Cyert and Hedrick, 1972). In organization theory this is demonstrated through analysis of alternative organizational structures as mechanisms through which personal goals of individuals within the organization may conform to organizational objectives (Thompson, 1961).

In economic models of organizations the managerial objective is util- ity maximization. Thus in the neoclassical economic model of organi- zations (and in any model assuming perfect agency behavior in an organization-as-principal and manager-as-agent relationship) there is no distinction between managerial (utility maximization) and organi- zational objectives. The firm and firm manager maximize profit; there- fore in the neoclassical model profit is the sole source of managerial utility. As noted in Chapters 6 and 7, the neoclassical model has been applied to alternative forms of organizations as well (see, for example, Niskanen, 1971 and James and Rose-Ackerman, 1986). The bureau and bureau manager, or nonprofit organization and nonprofit manager, maximize budget (total revenue) or output. In the neoclassical models of these organizations the sole source of utility for the bureau manager or the nonprofit manager is the budget (revenue) or output that the bureau or the nonprofit organization seeks to maximize.

In managerial economic models of organizations, however, managers have their own preferences and maximize their utility that reflects these individual preferences. This then may put them at odds with the objectives of the organization. This self-interested behavior is limited, of course, by some organizational constraint that is assumed to be moni- tored, such as a minimum profit or output level, or level of funding (revenue requirement) or level of quality.

It is important to note that the nature of these managerial objectives and their relationship to organizational objectives in economic models, whether neoclassical or managerial, is established by assumption. It can be claimed that these assumed managerial objectives are based on obser- vations (Williamson, 1963 and Baumol and Quandt, 1964). Yet it remains that these are assumptions and simplifications and are open to question (Simon, 1979).

I argue here that these assumed managerial  objectives  are  derived from the property rights structure inherent in the organization. When ownership and property rights are clearly defined and enforceable, there is no distinction made between organizational and managerial  objec- tives. This is the essence of the neoclassical economic approach to any organizational form: the firm, where rights (to profit) are assigned to the owner-manager; the Niskanen (1971) bureau, where rights (to benefits of a budget) are assigned to the bureau-bureaucrat; and the nonprofit organization, where rights (to the benefits of quality or income or revenue, for example) are assigned to the nonprofit-decision maker (see, for example, Newhouse, 1970; Pauly and Resdisch, 1974 and James and Rose-Ackerman, 1986).

When property rights are less well defined so that at least some rights may be expropriated from the organization by the organization’s deci- sion maker, organizational and managerial objectives must differ. This is the essence of the managerial models discussed in earlier chapters. As shown there, the implication of the difference between organizational and managerial objectives in economic models in any organizational form is some degree of inefficiency. Resources are diverted from the goals of the organization to fulfilling those of the manager.

Property rights theory provides a bridge between economic theories of organizations and organization theories of other disciplines in the analysis of managerial decision behavior. Once economists depart from the simplistic neoclassical model of an organization as a monolithic entity engaged in production of some good or service, the importance of individual behavior within the organization becomes recognized. Economic theory of organizations can no longer ignore either the indi- vidual behavior within the organization or the implications of the indi- vidual behavior for the allocation of resources through organizations. Managers are separate from the firm or the bureau or the nonprofit organization. They have separate preferences that may not be consistent with the objectives of the organization whose resources they direct. By acting in accordance with their individual preferences, managers affect the way resources are used within the organization and therefore they also affect the allocation of resources in society.

Organization theorists recognize this phenomenon as well. This is typically examined in the context of internal organizational structure, hierarchy, and rules. In theories of organization and decision theory, organizational structure, hierarchy, and rules are examined in terms of the way they promote effective managerial decision making. By this is meant that managerial decisions conform to the objectives of the organ- ization. This is achieved through the incentives that are created by the structure, hierarchy, and rules in place within the organization which direct managerial behavior, and which are consistent with the external image (that is, the goals) of the organization. The structure, hierarchy, and rules in organization theory essentially establish property rights for the individuals in the organizations.

Wilensky (1967) illustrates this in  his  analysis  of  hierarchy  and the requirements of information in an organization. His discussion demonstrates that hierarchy can establish property rights to intelligence (that is, information). He then demonstrates, as property rights theory does, that different rights systems will have different effects on the communication of intelligence (that is, on the allocation of resources) within the organization. He states this as follows:

Insofar as the problem of control … is solved by rewards of status, power, and promotion, the problem of obtaining accurate, critical intelligence is intensified … Thus, if an organization has many ranks and if in its administrative style and symbolism it emphasizes rank, the greatest distortion and blockage will attend the upward flow of information … Status symbols serve to motivate performance, legitimize positions, and facilitate some kinds of communication. (pp. 42, 44)

Property rights theory thus provides a link between economic theory of organizations and organization theory in their analysis of individual behavior, and therefore of managerial decision making, in organizations. The third question I address concerns how the relationship between the objectives of the organization and those of the decision maker affect social efficiency. The implication of decision making for efficiency is the basic question addressed by economic models of organizations. The nature of property rights and the assumptions of managerial objectives are therefore essential to the means (the model) and the ends (the pre- dictions and implications) of the economic approach to the relationship between organizational objectives and the objectives of the decision maker.

Organization theorists are also concerned with the efficiency of organizations.4 In the process of analyzing organizational efficiency, organization theorists focus on issues that are less central to economic models. These are: analyzing the conditions under which organizational and managerial objectives and goals differ; and determining the orga- nizational design that would align these goals.5

In their analysis of these two issues, organization theorists explicitly consider social and psychological aspects of the organizational environ- ment. In particular, these aspects are distribution, orientation, accom- modation, and motivation, discussed in Chapter 3. They refer to access to power and authority, the willingness to adapt to the organizational environment or to adjust to changes in it, and the willingness to take action to promote the organizational objective. For an organization man- ager, these may include, for example, lines and forms of communication with investors and donors, with the board of directors, or with subordi- nates who may affect the manager’s organizational loyalty and identifi- cation, and sense of value and effectiveness (Thompson, 1961, Etzioni, 1964, Wilensky, 1967, Pfeffer, 1990, and Fischoff and Johnson, 1997).

This, too, relates to property rights. The design of an organizational environment is a design of a property rights structure: a system of incen- tives. Galaskiewicz and Bielefeld (1998) argue that the niches within which an organization operates (that is, the organizational environment) has an important role in shaping behavior exhibited through the organ- ization. They indicate the significance of this in their statement that ‘… the distinction between for-profits and nonprofits may not be as important as the degree to which organizations are dependent upon dif- ferent niches for their inputs and conditions within those niches’ (p. 35). Kramer (1987) concurs with this point. He states that there have been attempts to develop criteria for having services provided by nonprofit organizations rather than for-profit firms. The criteria would classify the service according to the extent that it is individualized, involves coer- cion, or where clients are vulnerable to exploitation. These are consistent with Weisbrod (1988) who proposes that nonprofits tend to provide services for which a certain amount of trust is required. Kramer expresses concern over the idea of establishing criteria, however. He suggests that ‘legal status as a nonprofit organization is much less significant than other organizational variables, such as size, complexity, core technology, type of population and interorganizational relations, degree of profes- sionalization and bureaucratization, and so on, as they affect cost, qual- ity, effectiveness, and accountability’ (1987, p. 252).

Thus, although  economic  theory  of  organizations  is  an  important component of organization theory, organization theory is consistent with and extends the economic analysis of organizations in a meaning- ful way. Property rights theory provides a connecting link. Hansmann (1996, p. 239) demonstrates this in his statements on the lack of differ- ences between the situation facing managers in for-profit corporations and nonprofit firms which support the positions of Glaskiweicz and Bielefeld and Kramer described above. Indeed, property rights theory incorporates the legal, social, and cultural mores and traditions of soci- ety as the source of defining a property rights system (Furubotn and Pejovich, 1974c, p. 3). These are important components of the analysis of decision behavior in organization theory. A rights system based in social and cultural norms explicitly acknowledges both pecuniary and nonpecuniary  incentives  that  are  applied  by  organization  theorists. I consider this point further below.

Source: Carroll Kathleen A. (2004), Property Rights and Managerial Decisions in For-Profit, Nonprofit, and Public Organizations: Comparative Theory and Policy, Palgrave Macmillan; 2004th edition.

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