The economics of business enterprise : an introduction to economic organization and the theory of the firm

To own or not to own? To make or to buy? To franchise or to manage? To contract long or to contract short? To trust or not to trust? To license or not to license? These and other questions are the subject matter of this excellent introduction to the theory of economic organisation.

This fully updated edition of Martin Ricketts's 1987 book includes:

New developments in the property rights theory of the firm Further extended treatment of co-operative and mutual forms of enterprise Entirely new sections on transactions cost economics and public policy New chapters on the economics of privatisation and the regulation of 'natural monopoly'.

In addition, transaction cost, property rights and agency approaches are contrasted, and Austrian and evolutionary criticisms of standard theory are explored. The author applies these theories to a wide range of questions from the choice of piece rates or time rates in contracting to the debate on Anglo-American versus other 'varieties of capitalism'. Public policy in the fields of regulation and privatisation is also considered using the same framework.

Non-specialists will find this book to be an accessible introduction to the main theoretical approaches to economic organisation. Students and researchers specialising in the fields of economics and business will find that this third, updated edition of The Economics of Business Enterprise continues to provide stimulating insights suggestive of further research.

Author Notes

Martin Ricketts, Professor of Economic Organisation, University of Buckingham, UK

Figures	p. xiv
Tables	p. xvi
Preface	p. xvii
Preface to the first edition	p. xix
Preface to the second edition	p. xxiii
Acknowledgement	p. xxv
Part 1 Basic Concepts
1. The gains from the trade	p. 3
1. Production and the firm	p. 3
2. Scarcity	p. 4
3. The allocation problem	p. 6
4. Recontracting and the allocation problem	p. 11
5. Tatonnement	p. 12
6. The equilibrium method	p. 15
7. Institutions and information	p. 16
8. Institutions and contract enforcement	p. 18
8.1 The exchange game	p. 18
8.2 Conventions and norms	p. 20
8.3 Reputation	p. 23
8.4 Monitoring and penalties	p. 23
8.5 Moral leadership	p. 24
9. Conclusion	p. 25
2. Transactions costs	p. 27
1. The process of exchange	p. 27
2. Contracts and information	p. 30
2.1 Adverse selection or 'hidden information'	p. 30
2.2 Moral hazard or 'hidden action'	p. 34
2.3 Bounded rationality	p. 35
2.4 Asset specificity and 'hold-up'	p. 36
3. Institutional responses to transactions costs	p. 38
3.1 Money	p. 39
3.2 Political institutions	p. 42
3.3 The firm as a nexus of contracts	p. 43
4. Conclusion	p. 49
Appendix	p. 51
3. The entrepreneur	p. 53
1. Introduction	p. 53
2. Contrasting views of the entrepreneur	p. 54
2.1 The classical tradition	p. 54
2.2 Knight	p. 55
2.3 Kirzner	p. 58
2.4 Schumpeter	p. 65
2.5 Shackle	p. 69
2.6 Casson	p. 71
3. The entrepreneur and the firm	p. 76
3.1 The small entrepreneurial firm	p. 77
3.2 The firm as a coalition of entrepreneurs	p. 80
Appendix	p. 84
4. Property rights	p. 86
1. Introduction	p. 86
2. Types of property rights	p. 88
2.1 Private rights	p. 88
2.2 Communal rights	p. 89
2.3 Collective rights	p. 89
2.4 Exchangeable rights	p. 90
2.5 Alienable and inalienable rights	p. 92
2.6 Exclusion	p. 92
3. The development of property rights	p. 92
4. Team production and the classical capitalist firm	p. 98
5. Alternative structures of property rights	p. 101
5.1 The single proprietor	p. 102
5.2 The partnership	p. 104
5.3 The joint-stock company	p. 108
6. Property rights and managerial theories of the firm	p. 111
7. Property rights and transactions cost approaches to the firm	p. 113
7.1 'Ownership' of the firm	p. 113
7.2 Hansmann and the costs of ownership	p. 115
7.3 Grossman, Hart and the property rights theory of the firm	p. 118
8. Entrepreneurship and property rights	p. 122
8.1 'Ownership' and the entrepreneur	p. 122
8.2 The property rights approach to the finance of the entrepreneur	p. 124
9. Conclusion	p. 125
Appendix The assignment of residual control rights	p. 131
5. Principal and agent	p. 136
1. Introduction	p. 136
2. Observability and the sharecropper	p. 137
3. Risk sharing	p. 141
4. Effort incentives	p. 146
5. Information	p. 150
6. Examples of incentive contracts	p. 154
6.1 Health and motor insurance	p. 155
6.2 Law enforcement	p. 155
6.3 Employment contracts	p. 156
7. Monitoring the effort of team members	p. 158
8. Incentive contracts and the firm	p. 162
9. Conclusion	p. 165
Appendix The Von Neumann--Morgenstern axioms of choice under uncertainty	p. 167
Part 2 The Structure of Economic Organisations
6. Hierarchies	p. 171
1. Introduction	p. 171
2. Piece-rates and time-rates	p. 173
2.1 Payment schedules, moral hazard and effort	p. 173
2.2 Payment schedules, adverse selection and worker sorting	p. 177
3. The role of the monitor	p. 179
3.1 Monitoring and moral hazard	p. 179
3.2 Monitoring and adverse selection	p. 180
4. Contracts and adverse selection: the screening mechanism	p. 182
5. Moral hazard, penalties and wage payments	p. 184
5.1 The efficiency wage	p. 185
5.2 Deferred compensation and 'bond-posting'	p. 187
6. The rank-order tournament	p. 189
6.1 Incentives and the structure of a tournament	p. 189
6.2 Further problems with high-powered incentives	p. 195
7. Idiosyncratic exchange	p. 197
8. Rent seeking, entrepreneurship and opportunism	p. 199
9. The firm as a governance structure	p. 203
9.1 The internal labour market	p. 203
9.2 Specific human capital	p. 204
9.3 Behavioural norms and perceptions of fairness	p. 207
9.4 Company unions and disputes procedures	p. 208
10. The Japanese firm	p. 208
11. Conclusion	p. 210
Appendix	p. 214
7. Integration and the visible hand	p. 217
1. The variety of business enterprise	p. 217
1.1 Vertical integration	p. 217
1.2 Conglomerate diversification	p. 218
1.3 International integration	p. 219
2. Strategy and structure	p. 220
3. Visible and invisible hands	p. 226
3.1 The boundary of the firm	p. 226
3.2 Arm's length and obligational transactional relations	p. 227
3.3 The franchise chain	p. 229
3.4 Quasi-vertical integration	p. 230
4. Integration, complexity and environmental uncertainty	p. 232
4.1 Integration, coordination and complexity	p. 232
4.2 Integration, coordination and uncertainty	p. 235
5. Integration, internalisation and market failure	p. 238
5.1 Monitoring input quality	p. 239
5.2 Internalisation and the multinational firm	p. 241
5.3 Integration and market power	p. 242
5.4 Transaction-specific investments and opportunistic recontracting	p. 246
5.5 Enforcing intertemporal commitments	p. 250
6. Integration and innovation	p. 251
6.1 Research and development	p. 252
6.2 Schumpeter's entrepreneur	p. 255
7. Conclusion	p. 258
8. Corporate governance 1: managerial incentives	p. 261
1. Who controls the joint-stock firm?	p. 261
2. Four views of corporate control	p. 262
2.1 Control and the shareholder: the traditional view	p. 262
2.2 The managerial interest and the Berle--Means critique	p. 264
2.3 Entrepreneurship and the neo-Austrian critique	p. 265
2.4 Contractual incompleteness, dependency and control	p. 267
3. Corporate governance as a principal--agent problem	p. 269
4. Managerial incentive contracts	p. 271
4.1 Managerial incentives and the theory of principal and agent	p. 271
4.2 Some early studies of managerial contracts	p. 273
4.3 Interpretative problems and more recent studies	p. 275
5. Monitoring managers	p. 282
5.1 Do shareholders monitor managers?	p. 282
5.2 The costs of monitoring	p. 283
5.3 The degree of shareholder control	p. 284
6. The managerial labour market	p. 290
7. The product market	p. 293
8. Conclusion	p. 297
9. Corporate governance 2: the takeover and capital structure	p. 301
1. The entrepreneur and the takeover	p. 301
2. The takeover and the free-rider problem	p. 302
3. Minority shareholders and the takeover	p. 303
4. Hold-up, breach of faith and the takeover	p. 305
5. Adverse selection, short-termism and the takeover	p. 306
6. Moral hazard, monitoring costs and the takeover	p. 309
7. The takeover and capital market efficiency	p. 310
8. Defences against hostile takeovers	p. 313
8.1 Supermajority amendments	p. 313
8.2 Dual-class recapitalisations	p. 314
8.3 Poison pills	p. 314
8.4 Greenmail	p. 315
8.5 Golden parachutes	p. 316
9. Do takeovers improve economic efficiency?	p. 316
9.1 The takeover wave of the 1980s	p. 316
9.2 Moral hazard and the free cash-flow theory	p. 317
9.3 The role of the 'junk bond'	p. 318
9.4 Gains to target and bidding companies	p. 319
10. Capital structure and corporate governance	p. 321
10.1 The Modigliani--Miller theorem	p. 321
10.2 The agency costs theory of financial structure	p. 323
10.3 Agency problems, debt and the Hart--Moore theory of financial structure	p. 326
10.4 Bounded rationality and financial structure	p. 331
11. Corporate governance--bank versus market systems	p. 332
11.1 The United Kingdom and the United States	p. 332
11.2 Japan and Germany	p. 333
11.3 Differences in capital structures	p. 335
12. Conclusion	p. 337
10. Profit-sharing, cooperative and mutual enterprise	p. 341
1. Residual claims and enterprise governance	p. 341
2. Principal--Agent theory and profit sharing	p. 344
2.1 Type of firm classified by distribution of residual claims	p. 344
2.2 Monitoring effort and the profit-sharing firm	p. 348
3. Profit sharing and contractual incompleteness	p. 350
3.1 Debt finance	p. 350
3.2 Hold-up	p. 351
3.3 Bargaining within the firm	p. 352
4. The problem of investment decisions	p. 353
5. The size of the team	p. 355
5.1 Employment in the labour-managed firm	p. 356
5.2 Employment and profit sharing	p. 360
6. The labour--capital partnership	p. 361
7. The role of peer pressure	p. 364
7.1 Internal pressure	p. 364
7.2 External pressure	p. 365
8. The retail cooperative	p. 368
8.1 Transactions costs and the retail cooperative	p. 368
8.2 Role of retail cooperatives in nineteenth-century England	p. 369
9. Marketing and supply cooperatives	p. 371
9.1 Marketing and distribution	p. 371
9.2 Supply cooperatives and the utilities	p. 373
10. Mutual enterprise	p. 374
11. Stakeholding	p. 377
12. Conclusion	p. 379
11. Non-profit and charitable enterprise	p. 383
1. The non-profit enterprise	p. 383
2. Governance problems and the non-profit enterprise	p. 384
3. The rationale of the non-profit enterprise	p. 387
3.1 Contract failure	p. 387
3.2 Government failure	p. 389
3.3 Tax advantages	p. 390
4. Examples of non-profit enterprise	p. 391
4.1 Hospitals	p. 391
4.2 The university	p. 394
4.3 The arts	p. 395
4.4 The club	p. 397
5. Bureaucracy	p. 400
6. Conclusion	p. 403
12. Evolution and economic organisation	p. 406
1. The variety of theoretical approaches	p. 406
1.1 Neoclassical analysis of organisations	p. 407
1.2 Radical approaches to organisations	p. 408
2. The resources of the firm	p. 409
3. Evolution in economics	p. 411
3.1 Biological Analogies	p. 411
3.2 The evolution of the firm	p. 412
3.3 Market relationships and evolution	p. 413
3.4 An ecology of institutions	p. 415
4. Evolution and efficiency	p. 416
5. Conclusion	p. 418
Part 3 Public Policy and Economic Organisation
13. Economic organisation and the role of the state	p. 423
1. Introduction	p. 423
2. The neoclassical tradition	p. 424
3. The new institutional economics and public policy	p. 425
3.1 Establishing external institutions	p. 426
3.2 The normative Hobbes and Coase theorems	p. 427
4. The public interest approach	p. 433
5. Criticisms of the public interest approach to policy	p. 436
5.1 The Austrian critique	p. 437
5.2 The 'public choice' critique	p. 443
5.3 Contracting and the property rights critique	p. 445
6. Conclusion	p. 451
14. Private and public enterprise: the ownership of business	p. 453
1. Introduction	p. 453
2. Some historical background	p. 453
2.1 The growth of public enterprise in the UK to 1980	p. 453
2.2 Public enterprise in other mixed economies	p. 454
2.3 Reform after 1980	p. 455
3. Public versus private enterprise	p. 455
3.1 Empirical studies in the 1970s	p. 455
3.2 Reform of public enterprise	p. 457
3.3 The forces of competition	p. 462
4. The process of privatisation in the 'mixed economies'	p. 466
4.1 Stock market flotation	p. 466
4.2 The employee buy-out	p. 467
4.3 The private sale	p. 468
4.4 Voucher privatisation	p. 468
5. Privatisation--policy dilemmas	p. 469
5.1 The Austrian view	p. 469
5.2 The public choice view	p. 469
5.3 Privatisation and the normative Hobbes and Coase theorems	p. 471
6. Mass privatisation	p. 472
6.1 The political economy of mass privatisation	p. 473
6.2 Vouchers and privatisation	p. 475
6.3 The governance of enterprise after mass privatisation	p. 477
7. The effects of privatisation	p. 478
7.1 Comparisons between firms of differing ownership types	p. 478
7.2 Case studies of firms' performance before and after privatisation	p. 479
7.3 Econometric studies of the effects of changes in governance	p. 480
7.4 Use of multinational data	p. 482
8. Conclusion	p. 482
15. Economic regulation and the structure of business	p. 485
1. Introduction	p. 485
2. The 'natural' monopoly problem	p. 486
2.1 Definition of 'natural' monopoly	p. 486
2.2 Contestability	p. 487
2.3 Sustainability	p. 490
2.4 Intertemporal unsustainability	p. 493
3. Organisational structure and competition	p. 498
3.1 Vertical disintegration in the public utilities	p. 498
3.2 Competition policy	p. 500
4. Regulating utilities	p. 509
4.1 Regulation as a contract	p. 509
4.2 Regulation as rent seeking	p. 512
4.3 Rate of return regulation	p. 514
4.4 RPI minus X	p. 516
4.5 Sliding-scale profits tax	p. 519
5. Franchising	p. 522
5.1 Auctioning the right to serve the market	p. 522
5.2 The Chadwick--Demsetz auction	p. 523
6. Control of natural monopoly networks--a summary of organisational models	p. 525
6.1 Government ownership and operation of the network	p. 525
6.2 Government ownership with assets leased to a private operator	p. 526
6.3 Network assets owned and operated by a franchisee	p. 526
6.4 Network assets owned and operated by a regulated public company	p. 527
6.5 Network assets owned by a network user but leased to a separate company	p. 527
6.6 Network assets owned and operated by an unregulated public company	p. 528
7. Deregulation	p. 529
7.1 Production and supply in the public utilities	p. 529
7.2 Deregulation outside the public utilities	p. 531
8. Conclusion	p. 532
Bibliography	p. 537

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