An Influence-Cost Model of Organizational Practices and Firm Boundaries

Abstract

This paper combines Milgrom and Roberts’s influence-activity paradigm with the alienable control-rights approach of the Property Rights Theory to develop a unified theory of organizational practices and firm boundaries. Business relationships are optimally organized to curtail influence activities—costly activities aimed at persuading decision makers. Sometimes, rigid organizational practices that reduce ex post decision-making quality may be adopted if they reduce managers’ incentives to engage in influence activities. Unifying control (integration) may improve ex post decision making, but it intensifies disempowered managers’ returns to influence activities unless accompanied with rigid organizational practices. Interpreting influence costs under non-integration as "haggling costs" between firms and rigid organizational practices under integration as "bureaucracy". this model provides a unified account of the costs of both markets and hierarchies that accords with Williamson’s classic trade-off. Under this view, however, bureaucracy within firms is not a cost of integration, but rather an endogenous response to influence activities. (JEL D02, D23, D73, D83.)