Incentive Limits of the Employment Relation

As indicated in Chapter 4, the employment relation permits long-run incentives of a promotion ladder sort to be effectuated that are unavailable in market contracting. The firm consequently enjoys an advantage over the market in this respect. Firms, however, have very real limitations when it comes to the award of large bonus payments for entrepreneurial activities. The dilemma here is of two kinds. First, such payments may be regarded as a status threat by higher-level managers. [Buttrick’s discussion of the problems posed when the incomes of inside contractors occasionally exceeded that of the capitalist-manager with whom they negotiated terms (1952, pp. 210, 214) is illustrative.] Second, and more important, awarding bonuses for exceptional performance introduces transaction-specific elements into the contract. This jeopardizes the integrity of the employment relation. The long-term systems considerations on which it relies would give way to a series of quid pro quo bargains. Given that the relation between the parties is commonly of a small- numbers sort, on account of task idiosyncracies, transaction costs would quickly escalate.

Any organizational imperative to maintain strict correspondence be- tween income and hierarchy naturally serves as a disincentive to entrepre- neurial types who might otherwise be prepared to accept a position in the firm. The special relevance of this condition for firm size and vertical integration is in connection with new product and process development — which is the subject of Chapter 10. But for the qualifications given there, the large firm is frequently at a disadvantage to the small enterprise in supporting early stages of development — because, among other things, of the bureaucratized reward structure in the large firm which relies on salan and promotion rather than direct participation in the earnings associated with successful innovation.

Source: Williamson Oliver E. (1975), Markets and hierarchies: Analysis and antitrust implications, A Study in the Economics of Internal Organization, The Free Press.

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