The economic theory of organizations, as any field, is subject to limita- tions. First, at its present stage of development, the economic theory of organizations is less a theory of organizations than it is a theory of the firm. Second, the economic theory of organizations includes analysis of decisions. However, in this area the field focuses on decision outcomes and tends to ignore the decision process. Third, although economics is a social science, the economic theory of organizations is not a social theory of organizations. Consider each of these limitations.
First, the economic theory of organizations almost exclusively focuses on the traditional concept of the firm in the US economy. As noted ear- lier, there are relatively recent extensions of the basic analysis of the firm as organization to include analysis of alternative organizational forms, such as markets, governments, and nonprofit organizations (see, for example, Niskanen, 1971, James and Rose-Ackerman, 1986; Weingast and Marshall, 1988; Pejovich, 1990; Hansmann, 1996 and Furubotn and Richter, 2000). These extensions to organizational forms other than for- profit firms constitute a relative small part of the extensive economic literature in this area.
Other organizational forms have received little or no attention from economists, although there are some notable exceptions. There has been some research by US and other economists on firms and organizations in Asian and European markets (see, for example, Furubotn and Pejovich, 1974a and Carpenter and Rondi, 2000), and on other organizational forms such as producer and consumer cooperatives (Hansmann, 1996). These are presented primarily as variations on the theme of the US profit-maximizing firm, however. Other organizational forms, such as quasi-public organizations, have received little or no attention by econ- omists (see, for example, Jackson, 1983).
Admittedly, the historical focus of economic theory has been on pro- duction and exchange through markets. The organization that econo- mists would most rationally examine, therefore, would be the firm. For this reason, however, the economic theory of organizations has been primarily an economic theory of the firm. Extensions of this theory to other organizational forms have most often been one of two things. Economists have applied various theories of the firm, both neoclassical and managerial theories, to alternative organizational forms (see, for example, Newhouse, 1970; Niskanen, 1971; Fama and Jensen, 1983; James and Rose-Ackerman, 1986 and Brody, 1996). Alternatively, econo- mists explain the existence of alternative organizational forms in a mar- ket environment (see, for example, Hansmann, 1987a; James, 1987 and Weisbrod, 1988).
The thrust of much of economic analyses of alternative organiza- tional forms has been to view their performance in terms of economic criteria that have been designed for a profit-oriented environment (Jackson, 1983). These organizations are then sometimes seen as sources of inefficient production in an economy characterized by efficient firms. Furubotn and Richter reflect this point in their comment that ‘economic activities that are supposedly carried out within one universe are judged relative to an efficiency standard or other considerations that have their origin and justification in a completely different universe’ (2000, p. 445).
Second, economic theory of organizations includes analysis of deci- sion making but tends to ignore the decision making process. Indeed, Williamson (1993) notes that the ‘proposition that process matters is widely resisted and has attracted little concerted research attention from economists’ (p. 94). That decisions occur and organizations operate over time and that the decision maker must adapt to new information dur- ing the process is not consistently incorporated into economic models of managerial decisions in organizations.
To a limited extent, game theoretic models, transactions cost analysis, and principal–agent models incorporate some adaptation. Game theo- retic models lay out alternative decision paths, or strategies, under well defined informational scenarios and assumptions which define the rules of the game. Transactions cost analysis incorporates costs of nego- tiation and enforcement in contractual relations. Agency theory incor- porates the use of incentive systems to direct behavior. None of these approaches captures the essential nature of information processing and adaptation that is inherent in the decision process, however. Boulding (1966) considered decision making as a learning process. He noted that ‘it is to the interstitial discipline of economic psychology that we must look for answers … Another profitable line of study lies in economic sociology, in the analysis of the way in which organizational structure affects the flow of information, hence affects the information input into the decision-maker, … even perhaps his value function’ (p. 8). To this end Williamson (1993) notes that economists must look to other disci- plines to augment the economic theory of organizations: ‘A combined economic and organizations perspective is needed’ (p. 95).
Coase, who originated the economic theory of organizations, came to his inquiry into the nature and structure of the firm as an organization not from having been trained as an economist. Rather, as he himself describes, he came to his theory from this study of history, law, and other subjects related to business, and from his observations of decision behavior by individuals in large firms. This multidisciplinary back- ground led him to question the premise that competition in a market provides all the coordination required for firms to make efficient decisions so as to maximize their profits (1993a). He also notes that his concept of the firm could be analyzed using standard economic theory (1993b). It is interesting to note that the economic theory of organiza- tions, in its progression and attribution to Coase, has emphasized the latter at the cost of ignoring the former.
Third, the economic theory of organization is not a social theory of organizations, or even a social theory of the firm. That is, the economic theory of organizations is not a theory of organizations as social struc- tures. This limitation derives from the central interest of economists in the efficiency of the use of scarce resources, and the corresponding focus by them on organizations as economic, that is, that allocate scarce resources in different ways. Some economists have recognized that the structure of an organization (including a firm) involves social relationships among individuals that can affect the way these scarce resources may be allocated (Radner, 1992; Staw, 1997 and Zajac and Westphal, 1997). These relationships are viewed for the most part according to their effect on costs, such as information costs or moni- toring costs. At times these costs may be altered through the position- ing of individuals to have better access to resources. Such positioning creates social waste and is therefore inefficient (see, for example, Buchanan and Tullock, 1962; Buchanan, Tollison, and Tullock, 1980; Milgrom, 1988 and Furubotn and Richter, 2000).
Other aspects of social relationships that also enter into organiza- tional decision behavior, such as social norms or cultural traditions, are not usually considered by economists in their analysis of either firms or alternative organizations. These aspects of social relationships are most often considered by sociologists and organization theorists, political scientists, psychologists, and public administration theorists in their analyses of organizations and decision making (Pfeffer, 1990 and Zhou, 1997).
Custom and tradition are considered by Furubotn and Richter (2000), although this is done primarily in the context of the effects of a legal framework on markets. Some consideration of culture and tradition has been incorporated into analysis of certain alternative organizations such as nonprofit organizations, for example as a rationale for the origin of nonprofit organizations in a market economy (James and Rose- Ackerman, 1986 and Weisbrod, 1988). The role of culture and tradition is considered less important in the economic theory of organizations where organizations are singularly viewed as constructs of efficiency and where efficiency is the essence of social welfare. Indeed, the role of culture and tradition tends to be ignored or even rejected by economists in favor of a market based rationale (James, 1987 and Hansmann, 1996). Frank (1992) points out that ‘social norms are of tremendous impor- tance in the task of explaining behavior, and economists can ill afford to ignore this message’ (p. 151). He also notes that cultural norms are important in the objectives of alternative organizational forms. He states that social scientists ‘have argued persuasively that political deci- sion often differ significantly from the dictates of narrow self-interest and that political ideals like equality and public service appear to play a major role in the process’ (p. 161). I consider the role of property rights systems in this issue throughout my analysis in subsequent chapters.
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.