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Summary of Williamson (1988), La Porta et al (1999) and Alchian & Demsetz (1972)...

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LESSON 4 Alchian and Demsetz (1972) - Production, Information Costs, and Economic Organization Expands on Coase’s transaction cost explanation and focus on the firm’s role in managing cooperative teams in light of information costs and the subsequent need for a central contracting authority. Firms exist because “resource owners increase productivity through cooperative specialization, and this leads to the demand for economic organizations which facilitate cooperation”. o Key transaction costs become costs attributed to monitoring and measuring performance of cooperative resources. These are explained by metering and shirking problems. The metering problem: How to measure what a cooperative/team does? Individual output is extremely difficult to directly observe – only collective output can be. The shirking problem: As benefits from efforts are shared by the whole group, but costs are borne individually, this gives rise to shirking. Contracting (explicitly or implicitly) is the primary means of organizing sustained cooperative effort among people. o Teams, or team production, are a form of cooperative effort that may yield substantial economic gains but involve significant contracting and monitoring efforts. (Agency theory is built on monitoring costs vs. shirking costs). In a classical view of the firm, ownership is rewarded in the form of residual (net) returns available after the agents have been compensated. Further, ownership is defined as having the rights to; o Be the residual claimant, o Observe input behavior, o Be the central party common to all contracts with input, o Alter the membership of the team, o Sell the above rights.

LaPorta et al (1999) – Corporate Ownership around the World Study about the ownership structures of large corporations in 27 wealthy economies to identify the ultimate controlling shareholders of this firms. American companies have modest owner concentration of ownership, several hundred PTC have majority shareholders (more than 51% stocks). In developing economies this is also the case, large corporations have large shareholders which are active in CG (in contrast to study that managers are unaccountable). Who owns firms? Among corporations with owners, the principal owner types are the families and the State. The high percentage of companies with State control in this sample is not surprising given that we are sampling the largest firms, and privatization is not finished in most countries. he fact that 70 percent of the largest traded firms in Austria, 45 percent in Singapore, and 40 percent in Israel and Italy are State-controlled is a reminder of massive post-war State ownership around the world. It is perhaps more surprising that by far the dominant form of controlling ownership in the world is not that by banks and other corporations, but rather by families. Japanese firms shift into the miscellaneous category because, like Toyota, they are controlled by groups with no dominant members. most shares in Japanese firms are owned by small individual shareholders and relatively small corporate share- holders (French and Poterba 1991). The bottom line is that the largest firms typically have ultimate owners, particularly in countries with poor shareholder protection. For medium firms, the percentage of firms controlled by families rises to a world average of 45 percent, making it the dominant ownership pattern. The conclusion from this evidence is inescapable: If we look at the largest firms in the world and use a very tough definition of control, dispersed ownership is about as common as family control. But if we move from there to medium-sized firms, to a more lenient definition of control, and to countries with poor investor protection, widely held firms become an exception. Berle and Means have created an accurate image of ownership of large American corporations, but it is far from a universal image. How are firms owned? In this subsection, we describe some of the mechanisms through which controlling shareholders exercise their power in the large firm sample. This subsection has demonstrated that 1) controlling shareholders often have control rights in excess of their cash flow rights, 2) this is true of families, who are often the controlling shareholders, 3) controlling families participate in the management of the firms they own, 4) banks do not often exercise much control over firms as shareholders, and 5) other large shareholders are usually not there to monitor the controlling shareholders. Family control of firms appears to be common, significant, and typically unchallenged by other equity holders. Conclusion. Results present a different picture of the ownership structure of a modern corporation than that suggested by Berle and Means. Outside the United States, particularly at countries with poor shareholder protection, even the largest firms tend to have controlling shareholders. Sometimes that shareholder is the State; but more

often it is a family, usually the founder of the firm or his descendants. Large firms have a problem of separation of ownership and control. These firms are run not by professional managers without equity ownership who are unaccountable to shareholders, but by controlling shareholders.

Williamson (1988) – Corporate Finance and Corporate Governance Proposes a combined treatment of corporate finance and corporate governance, where debt and equity are treated as alternative governance structures. Transaction Cost Economics (TCE) regards the firm as a governance structure and assumes bounded rationality, giving rise to problems of incomplete contracts. The transaction is made the basic unit of analysis, where asset specificity is the most important dimension. o Because transactions differ in their attributes, governance structures differ in their costs and competencies. The goal is to find the optimal math for one’s firm (debt vs equity). o In general, simple governance structures (often debt) are able to cope with needs of simple transaction. (i.e. managers take the risk, unitary ED board). However, when transactions get more complex, more complex and costly governance systems are often favorable. (i.e. equity, separation of ownership and control). o The TCE approach maintains that some project could and should be financed by debt. These are projects with low to moderate asset specificity. o With high specificity, however, equity finance is preferred as it affords more intrusive oversight and involvement through the board of directors. Differences between AT and TCE

Agency Theory

TCE

Unit of analysis

Individual (agent)

Focal dimension

Incomplete contracts Asset specificity

Focal cost concern Residual loss

Transaction

Maladaptation

Contractual focus Ex ante alignment

Ex post governance...