A STRATEGIC THEORY OF THE FIRM AS
A NEXUS OF INCOMPLETE CONTRACTS:
A PROPERTY RIGHTS APPROACH
Authors:
Kim, Jongwook and Joseph T. Mahoney
Presenter:
Cheng (Orange) Wang
Presentation Structure
1
Research Question
2
Definitions of Terms
3
4
Paper Structure / Presentation
Paper Discussion
Research Question
The paper reviews existing literature and suggests a strategic theory
of the firm: the contracting process is a form of the entrepreneurial
discovery enabling firms to sense and seize new economic
opportunities.
This paper:
Applies property rights theory in defining resources and capabilities as
bundles of property rights.
Suggests that developing, deploying, and renewing resources and
dynamic capabilities is a process of bundling and re-bundling resource
combinations.
Suggests that bundling resources is a contracting process that generates
more information, increases efficiency and discovers new opportunities.
Firm is a nexus of incomplete contracts rather than complete contracts.
Definitions of Terms
 Firm boundary choice: Informed by transaction costs theory and the firm resources and
capabilities, like productivity, complementary capabilities and non-deployable capabilities.
(Dynamic interaction between a firm’s capability development and its boundary choice can
occur in a variety of ways, such as possible constraint by a firm’s prior capability
development on its current choice set of boundaries (Argyres and Liebeskind, 1999),
possible real options value embedded in a certain boundary choice (Kang, Tan
and Mahoney, 2009), and potential capability development facilitated by a chosen
governance structure (Wang and Barney, 2006) ---- From Lihong Qian’s dissertation)
 Bundles of Property Rights: a common way to explain the complexities
of property ownership. It is strongly rooted in common law to explain how a property can
simultaneously be "owned" by multiple parties. It implies rules of specifying, proscribing, or
authorizing actions on the part of the owner. (E.g,. the rights to pick apple but not the right to cut the
tree. Also a solution to both common and anti-commons tragedies)
 Internalize externality: The act of making a change in a company's private costs or benefits
in order to make them equal to the company's social costs or benefits.
 The Austrian View: 1, the society is a combination of people; 2, marginal utility theory of
value, i.e. the value depends on utility and scarcity; 3, subjective opportunity set
 Sanctioned behavior: Property rights are sanctioned behavioral relations among
decision makers in the use of potentially valuable resources. In law, the word sanction
can mean “a provision of a law enacting a penalty for disobedience
or a reward for obedience.”
Definitions of Terms
 Economic/ Resource rent: a surplus value after all costs and normal
returns have been accounted for, i.e., the difference between the price at
which an output from a resource can be sold and its respective extraction
and production costs, including normal return.
 Ricardian rents: Loosely, it is a return or profit from a differential
advantage for production, as in case of income or earnings due to rare
natural gifts creating a natural monopoly. In Peteraf 1993, The
conventional resource-based logic indicates that economic profits
that accrue from scarce resources (which are more efficient) are
Ricardian rents.
 Entrepreneurial rents: also called quasi-rent, can accrue due to
entrepreneurial skills or managerial investments.
Paper Structure
 Introduction: Background and Literature Review
 Establishing Property Rights:
- Contributions of Property Rights Theory
- Resources as Bundles of Property Rights
 Property Rights and Dynamic Capabilities
- Firm Boundaries
- Generating Economic Rents
- Dynamic Capabilities and Property Rights - Toward a
More Systemic View
 A Nexus of Incomplete Contracts: A synthesis
 Conclusions
Introduction: Background and Literature Review
Why this paper?
To link specific organizational processes that are the foundations of dynamic
capabilities to how the firm might realize or capture economic rents, we must track
contractual processes of bringing resource combinations together.
Valuable, Rare, Inimitable, Non-substitutable
RBV
Sustainable competitive advantage
In a equilibrium view and assume no
change
Dynamic
Capability
Process Oriented; Path-dependency
Relate to RBV
Process is based on the VRIN
condition
Property
Rights
Provides a contractual process-oriented
approach for how dynamic capabilities are
developed, sustained, and rejuvenated and in
so doing intertwines firm boundary issues with
the capabilities dimension of a strategic theory
of the firm.
Dynamic
Capabilities
Resource
Based
View
Property
Rights
Theory
Establishing Property Rights:
Establishing Property Rights:
 Contributions of Property Rights Theory
 Resources as Bundles of Property Rights
Establishing Property Rights:
Contributions of Property Rights Theory
TCE
1. TCE and PR see
entrepreneurial and
innovative economic
actors as opportunism
2. Opportunism vs
Opportunity
3. Internalize externalities
RBV
1. Oil field case
2. PR and free riding
3. markets, hierarchies,
or some hybrid
governance structure
at the firm level are
not enough to attain
efficiency
Dynamic
Capabilities
1. the processes
whereby entrepreneurs
internalize certain
aspects of externalities
through innovations in
property rights
4. Well defined PR and
economic value
creation
Classical Property Rights Theory (who get the residual claimant)
provide foundations for TCE, RBV and Dynamic Capabilities
Establishing Property Rights:
Resources as Bundles of Property Rights
TCE
RBV
Dynamic
Capabilities
1. Economic transactions
are exchanges of
bundles of PR.
2. the right to appropriate
economic returns from
a resource (in team
labor production the
right to receive the
residual income) --Alchian & Demsetz
(1972)
1. the PR to use a
resource may be held
separately from the PR
to buy or sell that same
resource
2. the right to use and
change the form of the
resource (in the case of
labor the right to
terminate or revise
membership) --- Alchian
& Demsetz (1972)
1. Help to consider firm
boundaries; and to
consider how to create
and how to capture the
value creation
2. Cospecialized resources;
difficult to imitate via
MKT mechanism.
3. the right to transfer the
above-mentioned rights
(i.e., alienability) --Alchian & Demsetz (1972)
Bundles of Property Rights: Property Rights can be Partitioned
Define resources and capabilities as partitioned PR can
- Help to clearly define what are resources and capabilities
- Help to tell how to confer economic rents to the firm as a
result of developing and utilizing those resources and
capabilities
Establishing Property Rights:
Property Rights and Dynamic Capabilities
Property Rights and Dynamic Capabilities
 Firm Boundaries
 Generating Economic Rents
 Dynamic Capabilities and Property Rights - Toward a
More Systemic View
Property Rights and Dynamic Capabilities:
Firm Boundaries
RBV and Dynamic
Capabilities
Contractual/TCE
How do they
view Firm
Boundaries
Pros
and
Cons
-
Firm to reduce
transaction costs
-
TC aspects determine the
decisions of organization
forms or governance
such as make or buy
-
A broader view than
Penrosean
-
Concern about
contracting difficulties in
coordinating economic
activities across firm
boundaries
-
-
-
Differences in capabilities can
partially explain firm boundaries
RBV, not directly deal with
boundaries
Penrose: firms as administrative;
managerial attention and
training affect growth
Consider market failure
and growth opportunities
Consider physical and
human capital
But how does it affect
administration?
Property Rights and Dynamic Capabilities:
Generating Economic Rents
Dynamic RBV
TCE
-
Rent
Generating
Economic Profit from:
-
How does
Property Rights
Theory relate to
them?
Economizing on governance
costs (i.e., ex ante incentive
provisions and ex post
attenuation of opportunism)
Economizing on the costs of
transacting across firm
boundaries
-
Production-side efficiencies and
dynamic capabilities
Economic Profit from
-
Ricardian Rent from scarce
resources
Entrepreneurial rent through
Penrose Resource view.
-
Capturing at least a part of the
quasi-rents
-
Competitive market, we need identify trade parters ect
-
The entrepreneurial discovery needs knowledge of value
-
PR theory brings a contractual approach to the Austrian idea of
entrepreneurial discovery
-
The Dynamic capabilities view entrepreneurial rent seeking as a
discovery process
-
Market incompleteness --- opportunism --- firms try to capture PR,
ect
Property Rights and Dynamic Capabilities
Toward a More Systematic View
Contracting processes: heart of creating and capturing value rejuvenating economic value over time.
- How certain resource combinations might be implemented;
- How such combinations might be kept within the organization.
TCE
-
Economic
Value
How does
Property Rights
Theory relate to
them?
Dynamic Capabilities
While dynamic capabilities
approach emphasizes
economic value creation,
transaction cost economics
emphasizes capturing
economic value (distribution).
-
Process of establishing
property rights is also
generating relevant infor.
about bundles of PR and
about transactions,
whether those rights are
realized or remain
unrealized.
-
-
Firms’ capabilities to sense
opportunities and utilize them
through organizational process
such as learning, integration, etc.
Difficult to predict ex ante; “Flaw”
Sense new opportunities
requires access to information
and the ability to recognize and
shape opportunities
Bundles of PR is shaped
through Dynamic contractual
process
-
process is crucial for
uncovering new infor. about the
MKT and possible economic
value creation
-
Complementary: more valuable,
more incentive to make PR
precise and more valuable
PR theory
can fit in
both value
creation
and value
distribution
PR theory is
complementary with
both TCE
and dynamic
capabilities
Property Rights and Dynamic Capabilities
Toward a More Systemic View
A Nexus of Incomplete Contracts: A synthesis
 The coordination of resources and capabilities, within or across firm boundaries, is done
through various (price and non-price) mechanisms. So economic activities (within or across
firm boundaries) can be understood as being coordinated by multiple mechanisms.
 Incomplete contracts run the risk of various exchange hazards (from asymmetric information and
opportunism); Solutions require adaptive responses such as vertical integration or mutual
credible commitments.
 A nexus of incomplete contracts implies that the firm has many different providers of resources
and capabilities contributing to the value-creation process but with varying degrees of overlap in
commitment and alignment of incentives.
Firm
Property
Rights
Dynamic
Capabilities
Nature of the firm:
- Increasing the
economic value of
the firm’s resource
portfolio
Enables an
institutional
analysis of the
competitive
process
brought up by
DC
Combining the
previous two, we
define the firm as
Incomplete
Contract
Conclusions
Strategic Management Question:
Sustainable competitive advantage
How to build it?
How to maintain it
RBV
VRIN
Maintain
stability;
exploration
Sustainable
Competitive
Advantage
Create/ exploit MKT
opportunities
Integration,
reconfiguration,
learning,
transformation
PR:



Dynamic Capabilities: concerning the nature of
organizational processes and resource positions
RBV and TCE and DC:
PR and legal framework is a institution;
deal with ex post governance issues (TCE)
acquire and/or develop VRIN resources
and capabilities (RBV and DC)
Dynamic
Capabilities
Discussions
 Contributions: This paper joins different theories and suggests a more
comprehensive way to look at firms and firms’ behavior. As is suggested by
Van de Ven (2007), we need “triangulation” to better understand the world.
This paper provides theoretical triangulation.
 Limitations:
- while this paper suggests we need to combine different theories together,
we need to keep in mind that we also face the constraints of “Boundaries”,
i.e. we need to know the “map size” we need and find a niche.
- the paper talks about Austrian Economics but does not explain why Austrian
Economics ideas will fit in the paper or the strategy field.
- There is a “changing word” problem in this paper. E.g. “dynamic RBV” and
“dynamic capabilities” are interchangeable which is kind of confusing.
 Future Research: triangulation and empirical