Slides by Minjae Lee, BADM 545 Fall 2013

1. Market frictions as building blocks of an organization economics approach to strategic managementMahoney and Qian, 2013 SMJ Slides by Minjae Lee, BADM 545 Fall 2013

2. Overview A wider recognition of the role of market frictions is useful to • Identify an evolving market-frictions paradigm in strategic management • Show how two primary questions in strategy and three primary strategic goals can be better joined and evaluated • Why firms exist and why some firms outperform others • Cost minimization, value creation, and value capture • Generate new research questions and advance theory development in the strategic management field

3. Overview • An evolving market-frictions logic can serve as a common language • Three strategic goals are often intertwined and a framework that simultaneously consider these three goals is likely to be more relevant for management practice and to be more fruitful for richer theory development • Pairwise joining of these theories suggests the presence of logical coherence, but does not fully reveal the fundamental commonalities among all these theories.

4. Taking a Stock: Market-frictions logic • Develops the market-friction logic • Identifying the concept of market-frictions through first fundamental welfare theorem of economics

5. Taking a Stock: Market-frictions logic • Economic consequences of a particular combination of market frictions

6. Taking a Stock: Market-frictions logic • Organizational economics approach to cost minimization • Transaction costs theory • Opportunism, • Asset specificity • Uncertainty

7. Taking a Stock: Market-frictions logic • Organizational economics approach to value creation • Resource-based approach (Value creation) • Valuable: luck and/or asymmetric information • Rare: asymmetric information about the economic value of those resources / resources that are created by a firm (spillover) • Heterogeneity: asymmetric information, causal ambiguity, and asset specificity/uniqueness • Complementarity: positive inter-project spillovers, such as economies of scope & positive inte-temporal spillovers, such as asset accumulation or interconnectedness over time

8. Taking a Stock: Market-frictions logic • Organizational economics approach to value creation • Resource-based approach (Value Sustainability) • Low transferability: information asymmetry between sellers and buyers, tacitness and intangibility, difficulties in partitioning, isolating mechanisms such as patent and trademark enforcement • Inimitability: interfirm externalities, intra-firm spillovers, and asymmetric information • Non-substitutability: • Real options theory • uncertainty in investment decisions, the (in)flexibility in strategic choice, and the inter-project as well as inter-temporal spillovers

9. Taking a Stock: Market-frictions logic • Organizational economics approach to value capture • Resource-based approach • Complementarity: asset specificity • Embeddedness: interconnectedness of resources • Property rights theory • Poorly or undefined property rights • Imperfection in residual control assignments can lead to poor resource allocation

10. Taking a Stock: Market-frictions logic Building on the same fundamental logic, each theory branches out by emphasizing different but overlapping combinations of market frictions to address its canonical problem.

11. Recent developments in organization economics approach • Considering more than one strategic goal has already enabled greater theory development • Cost minimization coupled with value creation. • Intra-firm spillovers and governance inseparability => Transaction cost theory => Dual role of governance structure and Interaction between goals • Intra-firm spillovers and economies of scale/scope • when economies of scope or technical complementarity are combined with intra-firm spillovers and market frictions

12. Recent developments in organization economics approach • Cost minimization coupled with value capture • Property rights theory • Asset specificity and negative inter-firm externalities • Asset specificity and loss of positive intra-firm spillovers

13. Recent developments in organization economics approach • Value creation coupled with value creation. • Poorly or undefined property rights and capabilities with value creation potential • Asset specificity and positive intra-firm spillovers Focusing on the concept of market friction as the key unit of analysis may prove useful in explaining the two primary questions

14. Generalized market-frictions approach • One example • Alchian and Demsetz (1972) • Due to nonseparability problem, ex ante free-riding (shirking) and ex post haggling can occur. Hierarchical monitoring is suggested as a solution to this problem • Rajan and Zingales (1998) • build upon the nonseparability of team production and join it with the market friction of asset specificity • Contrary to the recommendations by property rights theory, assigning ownership to that team member may reduce incentives in firm-specific investment by all team members, including the one that is assigned ownership • use the property rights mechanism of restricted access to critical assets, instead of ownership

15. Generalized market-frictions approach • Market-frictions logic enables us to explore the intertwined relationships between the economic rents question and the organizational boundary decision, instead of treating these two questions in isolation • Organization boundary decision can be further examined through a value creation and value capture lens via learning, dynamic capabilities, and knowledge spill-in • Kang et al.(2009)

16. Using the market-frictions logic • First approach is to start with the research gap identified within the existing literature • Second approach is to start with the strategic phenomenon of interest