Economic Organisation and the Knowledge Economy

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Int. J. oftheEconomics ofBusiness, Vol. 9, No. 1, 2002, pp. 935

`Coase vs Hayek: Economic Organization and the

Knowledge Economy

NICOLAIJ.FOSS

ABSTRACT

Many writers argue that economic organization is undergoing majotransformation in the emerging knowledge economy; authority relations are withering; lega

and ownership-based definitions of the boundaries of firms are becoming irrelevant an

there are increasingly few constraints on the set of feasible combinations of coordinatio

mechanisms. The present paper critically deals with these claims, beginning from the bas

idea that they may be analysed as turning on the implications for the Coasian firm of th

Hayekian notion that the distributed knowledge is a strong constraint on the use of planne

coordination. It argues that there are efficiency reasons for the existence of authority unde

Hayekian distributed knowledge; that the increasing importance of knowledge i

production does not render legal and ownership-based notions of the boundaries of the firm

irrelevant; and that coordination mechanisms will also cluster in certain, predictabl

combinations in the emerging knowledge economy. Thus, Coasian firm organization

consistent with Hayekian knowledge conditions.

Key words: The knowledge economy; Authority; Firms boundaries; Interna

organization.

JEL classification:D23,L14,L22,D80.

1. Introduction

Duringthelastdecade,managementacademicshavestronglystressedtheroleo

organizational factors in the process of building knowledge-based strategies tha

will bring sustained competitive advantage.1 Thus, it is typically argued tha

adopting`neworganizational forms(Daft and Lewin,1993) that is, newway

ofstructuringinternalorganizationandtheboundariesoffirms isnecessaryfo


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10 N. J. Foss

becoming the `information ageorganizations(MendelssonandPillai,1999) tha

can build the `dynamic capabilities required for competing in the emergin

`knowledge economy. Radical changes in the organization of economic activitie

arearguedtotakeplaceintandemwith,andperhapspromptedby,changesinth

composition of inputs toward knowledge inputs, an increase of the `knowledge

content of outputs, the declining importance of physical capital in productioand the parallel and increasing importance of human capital, a stepping up o

innovative activity, and increasingly inexpensive networked computing that is

those changes that are increasingly taken to indicate the emergence of th

knowledge economy (Halal and Taylor, 1998; Prusac, 1998; Tapscott, 1999

Munro, 2000).

There is growing, although still somewhat sparse, evidence that firms are, i

fact, increasinglyexperimentingwithnewwaysofstructuring theirgovernanceo

transactions, and that these changeshave implications forprofitability(MendelssonandPillai,1999),productivity(Ichniowskiet al.,1996;CappelliandNeumark

2001), and innovationperformance(Laursen 2002; Laursenand Foss, 2002). I

seemsthatsomeofthesechangesarerelatedtochangesintheformofcompetitiv

activities, infirms inputrequirements,andtheiruseof informationtechnologie

(Rajan and Zingales, 1998).The still rather open questions are how, and how

much, economic organization will be affected. Much more empirical work

neededtoassess thevalidity of thesometimes rather far-reaching claims that ar

put forward by advocates of the radical decentralization of firms, empowermen

schemes,andthelike.However,itiscertainlypossibletoengageindialogueon

purelytheoreticallevelwiththosewhoarguethateconomicorganizationis inth

processofaradicaltransformationasaresultoftheemergenceoftheknowledg

economy.Todo so is the purpose of thepresentpaper.Thus,Ishalldiscuss th

implications for the organization of economic activities of industries becomin

increasingly `knowledge-intensive,2 an increasing share of the workforce bein

constituted by `knowledge workers, commercially useful knowledge becomin

increasingly distributed, etc., accepting, for the sake of argument, these allege

tendenciesasfacts.Ingenerictheoreticalterms,IdiscusstheimplicationsforthCoasianfirmoftheHayekiannotionthatthedistributedandsubjectivecharacte

ofeconomicallyrelevantknowledgeisastronglybindingconstraintontheuseo

plannedcoordination.Hence,thetitleofthepaper.

Understandingeconomicorganizationinthecontextoftheemergingknowledg

economyisanimportantchallengeforanumberofreasons.Strongclaimsarebein

madeonthesubject,particularlybymanagementscholarsandsociologists,and

isimportanttoexaminethevalidityandreachofthoseclaims.Sofar,organizationa

economistshaveonlygivensporadicattentiontotheseissues(e.g.,HolmstromanRoberts,1998;MendelssonandPillai,1999),althoughtheygorighttothehearto

h i l d i l i i h h f i i i Th i


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Economic Organization and the Knowledge Economy 1

Thefollowingargumentsandpositionsaredevelopedinthepaper.Although

is a justified complaint that organizational economics so far has not serious

addressed economic organization in the context of the knowledge economy

organizational economics insights are extremely useful for framing the issue

Moreover,theyhelptotemperbymakingclearthelimitsofmoreextremeclaim

about organization in the knowledge economy. Among such claims are thaauthority relations will strongly diminish in importance (Zucker, 1991); tha

ownership-based and legal definitions of the boundaries of firms will becom

increasingly irrelevant for understanding the organization of economic activitie

(Helperet al.,2000);andthatconstraintsonthespaceoffeasiblecombinationso

coordination mechanisms will be very significantly relaxed (Miles, et al. 1991

Tapscott,1999).

Thispapershowsthatevenintheknowledgeeconomy,authorityrelationswi

continuetoexistasefficientcoordinationmechanisms,definingtheboundariesofirms in terms of asset ownership is entirely meaningful, and relations o

complementarity between coordination mechanisms will obtain, so that transac

tionswilltendtocluster indiscretestructuralforms(i.e.,governancestructures)

However,thisdoesnotmeanthatorganizationaleconomicscansurviveconfronta

tion with the knowledge economy in a completely unchanged form. On th

contrary, work needs to be done to better understand the impact of knowledg

assets (cf. also Holmstrom and Roberts, 1998), distributed knowledge (Foss

1999), and environmental complexity on organizational design.4 In particular

organizational economists need to develop a more refined and realistic unde

standing of authority than the existing crude view which has been essentiall

unchangedsinceCoase(1937)andSimon(1951).

The design of the paper is as follows. I begin byclarifying the subject unde

discussion,isolatingtwoassumptionsontheroleofknowledgeinproductionan

fourpropositionsthatconcernhowchangesinauthorityrelations,theboundarieso

the firm and internal organization are driven by changes in the way in whic

knowledgeentersintoproductiveactivities.Takentogether,theseassumptionsan

propositions are intended to capture the main thrust of recent claims aboueconomicorganizationintheknowledgeeconomy(section 2).Thestrategy inth

remainingpartsofthepaperthenistoexaminewhetherthestatedassumptionso

the role of knowledge in production imply the propositions as these pertain t

authority (sections 3 and, 4), the boundaries of the firm (section 5), and th

combinabilityofcoordinationmechanisms(section6).

2. Economic Organization in the Knowledge Economy: An Interpretationof Recent Debate


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12 N. J. Foss

Thus, a typical line of argument begins from noting that because of th

increasing importance in knowledge-intensive industries of combining divers

knowledge inputs, sourcing knowledge for this purpose, and keeping sourcin

optionsopen,networksbetweenagentscontrollingcriticalknowledgeincreasingl

become the relevant dimension for understanding the organization of econom

activities(Powell,1990; Zucker, 1991;Harryson,2000).Suchnetworks typicallcutacrosstheboundariesofthefirm,atleasttotheextentthatthesearedefinedi

termsofownership.5The legalboundariesofthefirmwillonlycoincidewithth

boundaries of knowledge-based networks if considerations of appropriability

imposing a need for protecting knowledge, dominate considerations of sourcin

knowledgefromnetworks.More likely,however,theboundariesbetweenmarket

andfirms,asdefinedinlegaland/orownershipterms,willfadeintoinsignificanc

asgeneralizedreciprocalknowledgeexchangeincommunitiesofpracticeandothe

networkforms,aswellashyper-competitiveconditions,makeknowledgeprotectioissueslessrelevant.

Thus, according to this argument the (presumed) fact that knowledge

becomingmoredispersed,andincreasinglymustbesourcedoutsideofthefirma

traditionallydefined,hasprofoundimplicationsforourunderstandingofthelocio

economicactivitiesandtheboundariesbetweenthese.Anaccompanyingargumen

asserts thatas knowledgebecomes increasinglydispersed, authority also tendst

shifttoexpertindividualswhocontrolimportantknowledgeresources.Thishastw

effects. First, to the extent that the agents controlling these resources are no

employees orotherwise agentsofthefirm, this contributes to theblurringof th

boundariesofthefirm.6Second,totheextentthatimportantknowledgeassetsar

increasinglycontrolled byemployees(`knowledgeworkers)themselves,authorit

relations are fading into insignificance.This is partly a result of the increase

bargaining power on the partof knowledge workers(stemming from the contro

overcriticalknowledgeassets)(Coff,1999),andpartlyaresultoftheincreasingl

specialist nature of knowledge work (Hodgson, 1998a).The specialist nature o

knowledge work implies that principals/employers become increasingly ignoran

aboutthemembersofthesetofactionsthatareopentospecialistagents/employeethusmakingtheexerciseofauthoritythroughdirectionincreasinglyinefficient.Th

combinedeffectofthesetendenciesistowrecktheeconomiststraditionalauthorit

and/or ownership-based criteria of what distinguishes market transactions from

hierarchical transactions (Zingales, 2000).Thus, whether direction by means o

ordergiving(Coase,1937;Simon,1951;Williamson,1985;Demsetz,1988)an

backedupbytheownershipofalienableassets(HartandMoore,1990)obtainso

not is increasingly irrelevant for understanding the organization of econom

activitiesinaknowledgeeconomy(Grandori,2002).Theemergingknowledgeeconomyalsoinfluencesthedesignoffirmsinterna

i i h i h i i l ll i f d i i i h d h i i


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In the future, cellular organizations will be used in situations requiring

continuouslearningandinnovation.

Bysuggestingthatradicalinternalhybrids,`builtontheprinciplesofentrepreneur

ship, self-organization, and member ownership, are emerging asstable organiza

tionalmodes,suchquotationssuggestthatmechanismsforcoordinatingeconomactivities are more combinable, and that the set of stable discrete governanc

structuresislarger,thanisconventionallyassumedinmuchoforganizationtheor

andintheeconomicsoforganization(e.g.,Coase,1937;Williamson,1996).7Thes

newgovernancestructuresareincreasinglyreferredtoas neworganizationalform

(Daft and Lewin, 1993; Zenger and Hesterly, 1997). To the extent that new

organizational forms represent new ways of combining mechanisms that hav

traditionally been seen as characteristic of governance structures that are pola

opposites, they also exemplify the fading boundaries between markets and firm(Helperet al.,2000).

What Is Going On Here? Some Interpretive Assumptions and Propositions

Itisfirstnecessarytodefinethoseaspectsoftheknowledgeeconomythataremos

obviously relevant for an understanding of economic organization. Existin

treatmentsemphasizephenomena,suchasincreasedknowledgecontentofoutput

and the composition of inputs, hyper-competition and therefore the paramoun

importance of learning, decreasing average corporate size, the importance of IT

innovations,increasingdifferentiationofdemand,increasedgeneralenvironmenta

complexity, increasing importanceofnetworksforthetransfer andproductiono

knowledge, etc.(e.g.,DAveni, 1994; Nonaka andTakeuchi,1995;Grant,1996

Mileset al., 1997;Boisot, 1998; MatusikandHill, 1998;Coombs andMetcalfe

2000;Zingales,2000).

Dealingwithalloftheseastheyimpactoneconomicorganization isatasko

forbiddingcomplexity.Forthe purposes of understanding economic organization,recenclaimsabouttheimpactoftheknowledgeeconomyoneconomicorganizationma

be usefully narrowed down to two basic assumptions about knowledge i

production and four basic propositions about economic organization.8 Th

assumptionsare:

d Assumption 1: Knowledge that is sourced for productivepurposes is becomin

increasinglydistributed(e.g.,CoombsandMetcalfe,2000).9

d Assumption 2: Knowledge assets controlled by individual agents (`knowledgworkers) are becoming increasingly important in production in terms o

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14 N. J. Foss

d Proposition 2:Theboundariesoffirmsblurbecauseoftheincreasingimportanc

ofknowledgenetworksthattranscendthoseboundaries.Thus,whileformallega

andownership-baseddefinitionsoftheboundariesofthefirmmaybemade,the

will be increasingly irrelevant from an economic perspective (e.g., Badaracco

1991;Zucker,1991;Helperet al.,2000).

d Proposition 3: Coordinationmechanisms arecombined in new, innovativeway(i.e., neworganizationalforms).10Thissuggeststhatefficiencydoesnotrequir

suchmechanismstobecombinedindiscretegovernancestructures.Coordina

tion mechanisms combine over a continuum, not in discrete chunks (e.g

Grandori,1997,2002).

Although these propositions are rather open-ended, they are open to theoretica

treatment(andinprincipletoempiricaltestaswell).Soisthefinalproposition:

d Proposition 4:The effects described in Propositions 1, 2 and 3 are driven b

changes in the way in which knowledgeenters into the productive process, a

describedinAssumptions1and2.

Proposition4iscriticallydiscussedinthefollowingsectionsbyexaminingwhethe

theeffectsdescribedinPropositions1,2and3necessarilyfollowfromAssumption

1and2.Idiscusstherole(ifany)ofauthority inHayekiansettings,examineth

connections between authority and ownership, and finally discuss how authorit

and ownership constrain the malleability and combinability of coordinatio

mechanisms.

3. The Knowledge Economy as a Challenge to Authority Relations

The Standard Economics View of Authority: Coase and Simon

ItisconventionaltodatethebirthoforganizationaleconomicstoRonaldCoase

1937paper,`TheNatureoftheFirm.ThisisjustifiedbyCoasesstressonmarkefailurecausedbytransactioncostsasthestartingpointforanyexplanationoffirm

andbyhiscontractualapproach,comparativeinstitutionalism,andclearidentifica

tionofthemainexplanatoryrequirementsofatheoryofthefirm(i.e.,explainin

the existence, boundaries, and internal organization of firms).11 Of particula

interest here, Coase also founded the widespreadpracticeof identifying the firm

with theemployment contract; indeed, he putsmuch emphasis on the flexibilit

afforded by incomplete employment contracts and the authority relation as th

ultimate reason for the existence of firms.12

Thus, as Langlois and Foss (1999argue, Coases explanation for the emergence of the firm is ultimately

di i Th fi i i i i h l h f li i


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`worker to select actions, A0cA, where A is the set of the workers possibl

behaviours. More or less authority is then simply defined as making the set A

largerorsmaller.Themodel isbasicallyamulti-stagesgame inthecontextofa

incomplete contract with ex post governance: In the first period, the prospectiv

worker decides whether to accept employment or not.Then nature intervenes

uncertainty is resolved, and the costs and benefits associated with the varioupossible tasks are revealed. Finally, the boss directs the worker to a task.To th

extent that the boss cares about his reputation, he will not direct the worker t

undertake tasks that lie outside the latters `zone of acceptance, and there ma

thus bean equilibrium in the three-stages game.15

To sum up, in the Coase-Simon view of authority, the action space is wel

defined and known both to the boss and the worker; the boss observes thos

statesofnaturetowhich itisnecessarytoreact(e.g.,arealizationofdemando

the firms productmarkets); he possesses theright to direct the worker, and thworker obeys the boss instructions`within limits.

The Sources of Authority

TheCoase-Simonviewofauthorityraisesanumberofproblems.Oneofthese

well-establishedin the literature, and concerns the problemof what isultimatel

thesourceoftheemployersauthoritygiventhathumanassetsare inalienable,s

thatslaveryisusuallynotaviablearrangement.Aswillbediscussedsubsequently

there are other problems that only become apparent in what was earlier calle

`Hayekiansettings,andwhichrelatetothecritiqueputforwardbyproponentso

the knowledge economy of authority relations. However, since addressing thes

latter problems is made easier by an understanding of the more conventiona

problem concerning the sources of the employers authority, we briefly conside

thisproblem first.

Theproblemofthesourcesofemployersauthoritywasfamously initiatedb

AlchianandDemsetzs(1972)argumentthatitisnotmeaningfultoassumethata

employercanforceanemployeetodowhattheemployerwantsintheabsenceocoercion.Animplicationofthisviewisthatthedistinctionbetweentheauthority

basedandtheprice-basedmodesofallocationemphasizedbyCoaseandSimon

superficial.Onemayperhapstalkaboutanexusofcontractsbecomingmore`firm

like, as continuity of association among input owners increases and/or residua

claimancybecomesmoreconcentrated,butitisnotingeneralusefultotalkabou

`firmsasdistinctiveentities.Inreality,theyargue,thereisnoeconomicdifferenc

between`firingonesgrocerandfiringonessecretary.16

Oneresponseto thisview istheWilliamsonian one(Williamson,1985,1996thatthereareinfactfundamentaleconomicdifferencesbetweenfirmsandmarket

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16 N. J. Foss

indirectly acquired through authority (ownership)over alienable assets.Since us

willbemadeofthiskindofreasoninglater,itisworthbrieflyexaminingit.

Contributorstotheincompletecontractliteraturedistinguishtwobasictypeso

decisionrights(`property rights), namelyspecific rights and residual rights.Th

latteraregenericrightstomakedecisionsincircumstancesnotspelledoutinth

contract,andimplytheabilitytoexcludeotheragentsfromdecidingontheuseocertain assets. Residual control rights are conferred by legal ownership.17 I

contrast, specific rights are allocated through contract terms. If contracts wer

complete,allrightswouldbespecific,andtherewouldbenoresidualrights.Tw

kinds of assets are distinguished, namely alienable (i.e., non-human) and non

alienable(i.e.,human)assets.Giventhis,thedistinctionbetweenanindependen

contractor and an employee (i.e., between an inter-firm and an intra-firm

transaction)nowturnsonwhoownsthenon-alienableassetsthatanagent(whethe

independentoremployee)utilizesinhiswork.Anindependentcontractorownshtoolsetc.,whileanemployeedoesnot.Theimportanceofassetownershipderive

from the fact that the willingness of an agent to undertake a non-contractib

investment(say,exertionofeffortorinvestmentinhumancapital),whichisspecifi

totheasset,dependsonwhoownstheasset.

As inAlchianandDemsetz,the partiestoarelation whether customeran

grocer,oremployerandemployeeareseenasbeinginabargainingsituation,eac

having an outside option. Although the parties are assumed to always reach a

efficientagreement,thedivisionofthesurplusfromtherelationwillnevertheles

depend on who owns the alienable assets in the relation, since the pattern o

ownership will influence the parties outside options. In this scheme `. . . a

employers authority is represented notbytheability to force an employee tod

whats/hewants,butratherbytheabilitytoobtainasubstantialshareoftheex po

surplusfromtherelationshipthroughthecontrolofnon-humanassets(Hart1996

379).Efficiencyconsiderationsthensuggestthatauthority(i.e.,ownershiptoth

alienableassets) should beallocatedto theagentwhomakes the most importan

(non-contractible) relation-specific investment.Thus, in an elegant manner Har

(andhiscolleagues)linktogethertheissuesoftheboundariesofthefirm(whichardefinedintermsofownershipofalienableassets)andauthority.18Usewilllaterb

madeofthisargument.However,theproblemofthesourcesofauthorityisnotth

onlychallengetothenotionofauthority.

Knowledge-based Challenges to Authority

Sofar,thedebateonauthorityinorganizationaleconomicshasalmostexclusivel

centred on providing responses to the Alchian and Demsetz (1972) challengeHowever,theseresponsesdonotmeet(atleastdirectly)theargumentsofthosewh

l i h h i l i ill i h i h i k l d (i


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possibilityisexplicitlyexcludedintheCoase-Simon viewofauthority(Simon

1951).

(2) If the employee is better informed than the employer with respect to how

certain tasksshould(optimally) becarried out? In the Coase-Simon view o

authority there is an implicit assumptionthattheemployer isatleastas we

informed, and presumably better, about the efficiency implications of alternativeactions.19

Onereasonwhysolittleattentionhasbeendevotedtotheseproblemsarguably

that they are not necessarily problems of `asymmetric information as this

understoodininformationeconomics(sothatstandardmodelingtoolsarenoteas

to apply). In a typical asymmetric information problem, an uninformed agen

knowswhatheisuninformedabout(e.g.,theprecisequalityofacar).However,thi

excludes ignorance (Kirzner, 1997; Foss, 1999).A possible interpretation of thclaimthatauthorityrelationswillbetransformed,andlikelywither,intheemergin

knowledgeeconomy isthatsuchrelationsarebreakingdownundertheimpacto

principalsbecomingincreasinglyuninformedabouttheactionsopentoagents(a

effectofAssumption1)andatthesametimebecomingincreasinglyreliantonth

knowledgecontrolledbyagents(i.e.,Assumption2).20Thesearethecharacteristic

ofHayekiansettings.

Distributed Knowledge, Delegated Rights, and Authority

Hayekmaywellhavebeenthefirsteconomisttoclearlyframetheissueofhowt

makebestuseofdistributedknowledge(1945:778;seealsoHayek,1937).Ash

explained:

Theeconomicproblemofsocietyis. . .notmerelyaproblemofhowto

allocate givenresourcesif givenistakentomeangiventoasinglemind

which deliberately solves the problem set by these `data. It is rather a

problemofhowtosecurethebestuseofresourcesknowntoanyofthemembers of society, for ends whose relative importance only these

individualsknow.Or,toputitbriefly,itisaproblemoftheutilizationof

knowledgewhichisnotgiventoanyoneinitstotality.

As the date of Hayeks paper suggests, the problem of making optimal use o

distributed knowledge is, of course, not a novel one, only brought about by th

emergenceoftheknowledgeeconomy;rather,any complexsocialsystemconfront

it(Hayek,1964).However,proponentsofthepositionthateconomicorganizatioisundergoingaradicaltransformationasaresultoftheemergenceoftheknowledg

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18 N. J. Foss

useofthem;asystemwithalienablepropertyrightssolvessimultaneouslybothth

assignment and the moral hazard problem. However, firms solve these problem

differently.Thus, resources within firms are directed (to a larger extent than i

markets), and motivation of employees is engineered (to larger extent than i

markets). From a Hayekian perspective, firms would seem to be inherentl

disadvantagedrelativetomarkets,forfirmsencounterafundamentalproblemthamarkets donot, namely `. . . the problem whichany attempt to bring order int

complexhumanactivitiesmeets:theorganizermustwishtheindividualswhoaret

cooperatetomakeuseofknowledgethathehimselfdoesnotpossess(Hayek,1973

49).Thefactthatfirmsdoexistisprima facie evidencethattheycansomehowcop

withtheproblem.21

One obvious way to handle the Hayekian knowledge-problem in firms is t

suppressdistributedknowledgeas far as possiblebydiscouraging local initiative

indoctrinatingemployeesharshly,andoperatingwithrigidroutinesandoperatinprocedures.22 The archetypal `machine bureaucracy fits this overall character

ization.However,totheextentthatcompetition isincreasinglyknowledge-based

this isaself-defeating strategy,becausesuppressingdistributedknowledge inthi

wayalso implies thatbeneficialexplorativeand innovativeeffortsare suppressed

Therefore, an often more attractive way to handle the presence of distribute

knowledgeinsideistodelegatedecisionrights(cf.Hayek,1945:834;Galbraith

1974: 314;Jensen and Meckling, 1992), balancing the resulting agency cost

against the benefits from improved use of distributed knowledge.23 An inter

pretationofinternalhybrids,suchasteamorganization,`molecularforms,andth

like,isthatthesemanifestattemptstodelegatedecisionrightsandstructurerewar

schemes so that such optimal tradeoffs are reached (Jensen andWruck, 1994

ZengerandHesterly,1997;FossandFoss,2002;Zenger,2002).

WhileHayekiandistributedknowledgemaybeanimportantcomponentinth

understandingofinternalhybrids,itdoesnotanswerthepuzzleofwhysuchhybrid

areorganizedinside firmsatall,beingsubjecttotheexerciseofauthority.Althoug

remuneration schemes are often adjusted to complementary changes in th

delegation of decision rights, implementing internalhybrids does, of course,noimplythatemployeesbecomefullresidualclaimants.Moreover,beingoverruledb

formalhierarchicalsuperiorsmayharmmotivation(AghionandTirole,1997;Frey

1997).Thus,moving internalhybrids,suchasteams,outoffirmswouldseemt

yieldefficiency gains, because this will strengthen incentives.24 In fact, spin-off

carve-outs,andlikepracticesmaybeexplainedinsuchterms,soweshouldaskwh

notall internalhybridsarespun-off.Addingtothepuzzle isthatauthorityinth

Coase-Simon sense appears to play at best a very limited role under Hayekia

dispersedknowledge.ThisisbecausetheCoase-Simon notionofauthorityassumethatadirectingprincipalisatleastasknowledgeableabouttherelevanttasksasth

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allocatedtoasinglepartythroughassetownership,meansthattheonlyroomleftfo

delegation is that agents receive well-specified rights to carry out well-specifie

actions.However,thisimpliesthatifagentscantakeactionsaboutwhichprincipa

have no knowledge or are better informed about how certain actions should b

carriedout,thesuperiorknowledgeofagentscannotbeutilized.Asecondreaso

whyHartianownership-basedauthoritymaybeirrelevantisthattheassetsthatiHarts scheme confer authority are physical assets (Hart, 1995). However, a

importantclaiminrecentdebateontheknowledgeeconomyisexactlythatphysica

assetsareofwaningimportance,andthatknowledgeassetscontrolledbyknowledg

workersarebecomingmoreimportant(Myers,1996;Boisot,1998;Neef,1998).O

course, the implication is that ownership over physical assets is an increasingl

ineffectivesourceofbargainingpowerandthat,therefore,authoritymustwanea

bargainingpowerincreasinglybecomesmoresymmetricallydistributed.

Narrow and Broad Notions of Authority

Although there are reasons to expect authority to be a highly inefficien

coordinationmechanismundertheconditionsdescribedbyAssumptions1and2

wedonotobservethewell-nighcompletebreakdownofauthorityrelationsthatthi

line of thinking may imply. One reason is the possibility of benefits of firm

organization that offset the knowledge-related inefficiencies of authority, a

mentionedearlier.Another reason is the simple one thatthere isa largedistanc

betweentherealphenomenonofauthorityandourmodelsofthatphenomenon.I

fact,boththosewhohavecriticizedauthorityforbeingan increasinglyinefficien

coordination mechanism intheemergingknowledgeeconomyandorganizationa

economists may be criticized for working with a too narrow understanding o

authority.Forexample,arepresentativeofthefirstgroup,AnnaGrandori(1997

35)arguesthat

. . . whateveritsbasis,authorityisafeasiblegovernancemechanismonlyif

information and competence relevant to solving economic action prob-lemscanbetransferredtoandhandledbyasingleactor,apositivezone

of acceptance exists, the actions ofother supervised actorsare observ-

able, and if the system is not as large as to incur an overwhelming

communicationchanneloverloadandcontrollosses.

ThiscritiqueseemstobedirectedattheCoase-Simon viewofauthority,andis,a

such,avalidcriticism.TheCoase-Simonview is(too)narrow,because it implie

thatthebossdirectstheworkersactionsindetail,basedonacompleteknowledgoftheworkersactionset,andbecauseitimplicitlyassertsthatthebossisalwaysa

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20 N. J. Foss

worktowardsaspecifiedgoal,forexample,backedupbysomesuperiorbargainin

power, is entirely consistent with Assumptions 1 and 2. Indeed, in most larg

decision rights are allocated by the top-management team and the board o

directors to lower hierarchical levels, presumably in order to cope better wit

distributedknowledge(JensenandMeckling,1992).However,typicallytheseright

arecircumscribed.Forexample,therightto use anasset incertainwaysmaybdelegated;however,itisunderstoodthatthatrightdoesnotentailtherighttous

the asset in theserviceof a competitor firm(Holmstrom, 1999).Thus, decisio

rights are delegated in firms, but they aredelegatedasmeans to anend(Hayek

1973);theiruseismonitored(JensenandMeckling,1992),andtop-managemen

reserves ultimate decision rights for itself(Baker et al., 2000).This suggests tha

authorityinthesenseofdirectionandcentralizeddecision-makingwhichdoesno

necessarilyrequiredetailedknowledgeaboutasubordinatesknowledgeoravailabl

actions may persist in Hayekian settings, including the emerging knowledgeconomy.Thefollowingsectiondiscussesthisingreaterdetail.

4. Authority in Hayekian Settings

Hidden Knowledge

This section examines the role of authority, understood in the broad sense o

directingsomebodytocarryoutanactivitysothatsomeendgoalisreached,unde

distributed knowledge.To increase concreteness, situations involving distributeknowledgeareapproximatedby`hiddenknowledge(Minkler,1993)inprincipa

agentrelations.Thatis,itwillbeassumedthattheproblemfacingaprincipalisno

justthatsheisuninformedaboutwhatstateofnaturehasbeenrevealedorofth

realizationoftheagentseffort(i.e.,hiddeninformation),asinthestandardagenc

paradigm. Rather, the agents knowledge issuperior to that of theprincipalwit

respect to certain productionpossibilities(i.e.,hidden knowledge).The principa

may be ignorantabout somemembers of the setof possibleactions open to th

agent,ortheagentmaybebetterinformedthantheemployerwithrespecttohow

certain tasks should (optimally) be carried out, or both. Given this, the issue

whetheritispossible,underhiddenknowledge,tomakesenseoutofthisnotiono

authorityongroundsofefficiency.Itturnsoutthatitisindeedpossibletoexplai

thepresenceofauthorityinsuchasetting.Thekeyfactorsthatwillbeconsidere

inthefollowingare(1)theurgencyofdecisions,(2)decisiveknowledge,and(3

monitoring, incentives,andexternalities.

The Urgency of Making Decisions

WhileHayek(1945)didmuchtoidentifythebenefitsofthepricewithrespectt

i i h h bl i d d b di ib d k l d d


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takenactionsoronlycoordinate these aftercostly trials anderrors(forareview

Foss,2001).Authoritymaybealeast-costresponsetosuchproblems.

In order to isolate the costs and benefits of centralized and decentralize

decision-making in a specific context, Bolton and Farrell (1990) study

coordinationproblemwithprivateinformationinthesettingofanaturalmonopo

market.The coordination problem concerns who should enter the market whecostsaresunkandthesizeofcostsisprivateinformation.Underdecentralization

whichisrepresentedasatwo-periodincompleteinformationgameoftiming(sin

costs/enterorwaitanotherperiod),eachfirmisuncertainaboutwhethertheothe

firmwillenter.However,theincentivetoenterdependsonagivenfirmscost,low

costfirmsbeinglessworriedthattheirrivalwillenter(andvice versa).Ifcostsar

sufficiently dispersed, the optimal outcome prevails, that is, the lowest-cos

producerentersandpreemptstherival(s).However,ifcostsareequalorarehighfo

both, inefficiencies may obtain, since firms will then enter simultaneousl(inefficientduplication)orwillwait(inefficientdelay).

Enteracentralauthoritywhosejobistonominateafirmforentry.Inthespir

of Hayek, Bolton and Farrell assume that this central authority cannot posses

knowledge about costs. In their model, the authority nominates the high cos

producer half of the time, which is clearly inefficient. However, this cost o

centralizationshouldbecomparedagainstthecostsofdecentralization(delayan

duplication). Bolton and Farrell show that . . . the less important the privat

informationthattheplannerlacksandthemoreessentialcoordinationis,themor

attractivethecentralplanningsolutionis(1990:805).Moreover,thedecentralize

solutionperformspoorlyifurgencyisimportant.Centralizationisassumedtono

involvedelayandistherefore,underthisstrongassumption,agoodmechanismfo

dealingwithemergencies,aconclusiontheyargueisconsistentwiththeobserve

tendenciesoffirmstorelyoncentralizedauthorityincasesofemergencies.25

The inefficienciesunder decentralization(duplication, delay) that Boltonan

Farrell point to may arguably be particularly relevant for much knowledge

intensive production.This isbecausemuchof this production is`pooled rathe

than`sequentialor`reciprocal(intheterminologyofThompson,1967).`Pooleactivities involve relatively decentralized efforts aiming at a common end

Research-based organizationswheremuchproductiontakesplaceindecentralize

project-groupsisaclearexample.Insuchorganizations,acentralizedauthorityma

benecessarytogiveprioritytocertainprojectsratherthanothers,eventhoughtha

authorityisbasicallyveryillinformedabouttheprojects(foranexample,seeFoss

2000).

Decisive Knowledge

E h h hidd k l d di i b i h i i l ill h l


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22 N. J. Foss

conditions(changing sales and/or tastes), it may pay to investigatesupply befor

investigatingdemand.Infact, ifsupplyvolatility isconsiderablyhigher, itmayb

evident what the firm should do in terms of its output and pricing decision

without checkingdemand conditions. Inboth cases, information aboutsupply

decisive(and more so in the lattercase).

AccordingtoCasson(1994),decisivenessandthecostatwhichknowledgecabe communicated explains the allocation of decision rights. In terms of th

examples, if furthermore the decisive knowledge is costly to communicate

decisiveness and costly communication suggest that decision rights should b

allocatedtowardstotheproductionsideofthefirm.Thisisaninstanceofthemor

generalprinciplethatdecisionrightswilltendtobeconcentratedinthehandsofth

individualwhohasaccesstothedecisiveinformation,andparticularlysothemor

costlyitistocommunicatethisinformation.Casson(1994)usesthisreasoningt

whyfirmsarehierarchicalandtoaddressotheraspectsoforganizationalstructureThereasoningnotonlycastslightovertheallocationofauthority,butalsooverwhy

under hidden knowledge, interacting parties may rationally choose an authorit

relation.Whenknowledgeishidden,butnotdecisiveandthecostsofanincorrec

decision are (on average) less than the costs of trying to communicate th

knowledgefromagenttoprincipal,directingtheagentthroughanauthorityrelatio

will beefficient.Also, themoredecisive theprincipalsknowledgerelative to th

agents,themoreattractive willtheauthorityrelationbe,allelseequal.Authorit

willbelessefficient,thegreaterthenumberofpartieswhoholddecisiveknowledge

and the lower the costs of communication. In such cases, partnerships ma

substitutefortheauthorityrelation.

Monitoring, Incentives and Externalities

Hidden knowledge would seem to introduce special problems for the use o

monitoringmechanismsandincentivepay,asdiscussedinthemainstreamagenc

literature(e.g.,Holmstrom,1979;Minkler,1993;AghionandTirole,1997;Fos

1999;FossandFoss,2002).WithrespecttomonitoringunderhiddenknowledgeMinkler (1993: 23) argues that `. . . if the worker knows more than th

entrepreneur, it is pointless for the entrepreneur to monitor the worker. In th

extreme case, both the agents type and actions may be fully observable by th

principal but the latter may still not understand the full set of productio

possibilities open to the agent. If monitoring is not workable, the problem is t

designacontractthatallowstheagenttousehissuperiorknowledgeex post,an

giveshimtheincentivetodosoefficiently.Thiswillamounttoallocatingdecisio

rightsaswellasrightstoresidualincomestreamstotheagent,26

asinapartnershipAuthorityseemstobeas`pointlessasmonitoring, sincetheexerciseofauthorit

ld i l d f i i ( h ki h h d


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reached,maybeentirelyworkableunderhiddenknowledge.Theholderofauthorit

cancheckwhethertheendgoalwas,infact,reached,andcanrewardorsanctionth

agentaccordingly.Thus, although thenarrow(Coase-Simon)notionofauthorit

may be compromised by hidden knowledge conditions, the broad notion o

authorityisnot.

Recent work in agency theory(Holmstrom and Milgrom, 1991; Holmstrom1999;Prendergast,1999)suggeststhat(loosely)themorewemovetowardsmult

tasking,costly-to-measureactivities,multipletypesofagents,etc.,themorelikely

itthattheprincipalwillchoosetorelyonmanydifferentincentiveinstrumentst

influencetheagentsbehaviour.Akeythemeinmuchrecentworkonorganizatio

in the knowledge economy is that tasks are becoming increasingly complex an

difficulttomeasurebecauseoftheirincreasing knowledge-content,andthatthisi

itselfisaforcethatisdestructiveofauthorityrelations(Hodgson,1998a).However

ratherthanreducingtheneedfortheexerciseofauthority,thesechangesimplyrenewedroleforauthority.Akeymanagerialtaskistobalanceincentiveinstrument

(Holmstrom, 1999), that is, design and maintain coherence between thevariou

ways in which an employee may be motivated so that negative spill-over effect

betweenthesewaysareminimized.27Thismanagerialtaskwillbecomeincreasingl

important, as firms have to use multiple incentive instruments to motivat

`knowledgeworkers.Inadynamiceconomy,maintainingcoherencebetweensuc

instrumentsmaybearecurrenttask.Theremaybeeconomiesofscaleandlearnin

economies in this task(Hermalin,1999),suggesting that it be centralized in th

handsofacentralauthority.

Summing Up

It has been argued that it is possible to give efficiency explanations of authorit

under conditions corresponding to Assumption 1, at least if authority is unde

stood in the broad sense of commanding somebody to work towards a specifie

goal. Admittedly, the narrow (Coase-Simon ) notion of authority at directio

basedonsuperiorknowledgeandaimedatthecarryingofspecificactionsonthpartofemployees,ishardertoalignwithdistributedknowledgeconditions.Thu

the limitsof Proposition 1 have beenclarified: the proposition at best applies t

thenarrow(`Coase-Simon)notionofauthority.Moreover,somedeterminantso

theuseofauthorityhavebeenisolated.Thus,theurgencyofdecisions,theexten

of decisiveness, the need to balance different incentive instruments and scal

activities in this activity are all forces that promote the use of authority, all els

equal.28

The increasing prevalence of internal hybrids that go beyond traditionahierarchieswithrespecttohowdecisionrightsandrewardschemesarestructure

(Z d H l 1997 Z 2002) b l d b h i


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24 N. J. Foss

5. Ownership and Firm Boundaries in Hayekian Settings

Ownership and Assets in the Knowledge Economy

Although the previous section argued that authority can exist under distribute

knowledge,littlewassaidthereaboutthesourcesofauthority.However,recallth

earlierargumentsthatownershipmayplayakeyroleasasourceofauthority.Th

purposeofthepresentsectionistogomoreintoownershipissuesparticularlyth

ownershipofknowledgeassetsandthereforethe issueof theboundariesof th

firm.Oneofthekeycharacteristicsoftheknowledgeeconomyisusuallytakentob

the increased importance in production of knowledge assets and the decreasin

importance of physical assets (Boisot, 1998). A further argument is that thi

transformation will also transform economic organization, because knowledg

assets have different implications forthe boundaries of firms thanphysical asset

(e.g.,Powell,1990;Zucker,1991;KogutandZander,1992;Boisot,1998;Mahnke2002).29

Thecategoryof`knowledgeassetsisabroadoneencompassingindividuall

heldtacitknowledge,firm-levelcapabilities(`organizationalknowledge),patents

client lists, etc. and, partly for this reason, difficult to analytically frame.3

Differentalbeitallsomewhatunderdevelopedmodelingstrategiesareavailable

One strategy is to stress problemsof appropriability as a key determinant of th

boundaries of the firm (Teece, 1987; Liebeskind, 1997). In this scheme, th

boundariesofthefirmreflectattemptstomaximizetherentstreamsfromthefirmvaluableknowledgeassets(rather than the hold-upproblem).Asecondone ist

stressthatmanyknowledgeassetsarecollectiveorpublicgoods(e.g.,capabilitieso

reputational assets) and that this creates free-rider problems, causing a need t

delimitaccesstosuchgoods(HolmstromandRoberts,1998;Osterlohet al.,2002

A third strategy is to argue that knowledge assets in the form of differentia

capabilitiesgiverisetocommunicationcostsandattemptstoeconomizewithsuc

costs help determining theboundaries of the firm(Langlois, 1992; Monteverde

1995). Finally, a fourth possibility is to rely on transaction cost economics an

incompletecontractstheoryargumentsabouttheneedtoprotectspecializedasset

and investmentsspecific tosuchassetsfromrent-captureattempts(Rabin,1993

Brynjolfsson,1994;Putterman,1995).Sincethelatterstrategyistheonethatmos

obviouslyconnectstothethemeofauthoritythathasbeenpursuedinsomucho

thispaper,Ibrieflyapplythisapproach.

Knowledge Assets and the Boundaries of the Firm

Following Brynjolfsson (1994), use will be made of the incomplete contract

d li h d l f H d M (1990) d di f h


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TheprimaryrequiredchangeinthebasicHartandMooreframeworkisamor

explicitintroductionofknowledgeassets(whichmaybealienableornon-alienable

In fact, we can dispense entirely with physical assets, and discuss a purel

knowledge-based firm.31 Itisassumedthatagents enter into productiverelation

withotheragentsbutthatsynergiesbetweenagentsoccuronlythroughtheasset

thattheycontrol(andnotthroughtheactionstheytake).Furthermore, althougassetsmayinfluencethevalueofactions,thereverseisnottrue(Brynjolfsson,1994

433).This means that wecanwrite the cost of agent is actionas c (xi) and th

marginalvalueofisactionswhenheisinaproductiverelationwithotheragent

simplyasvi (A),whereAisthesetofallassetsownedbyagents(andtheiraction

canbesuppressed).32

For simplicity, assume that two agents interact and that one of these, `th

entrepreneur, owns a knowledge asset, K, that is `inside his head (e.g., a

entrepreneurialidea)andtheotheragent,`thescientist,ownstheonlyotherasseintherelation,P,whichwemayassumetobea`patent.Bothassetsarenecessar

tothecreatevalueintherelation,andKandPare(strictly)complementary,sotha

theoneisofvalue0withouttheother.Itisprohibitivelycostlytocommunicateth

knowledgeembodiedinKfromtheentrepreneurtothescientist,soKiseffectivel

non-alienable,althoughtheservicesofKmayofcoursebetraded.Moreover,it

notpossibletowriteacomprehensivecontract,governingtheuseoftheassetsina

contingencies.Giventhis,wemayaskwhoshouldownthealienableasset,P,whic

intermsoftheHartandMoore(1990)analysis istantamounttoaskingwh

shouldownthefirm.

In this setting, if the entrepreneur makes an effort investment, xe, that is

elaboratesonhisideaandcreatesextravalue,thescientistcaneffectahold-upo

theentrepreneur,sincethelatterneedsaccesstothepatenttocreatevalue(andth

contract is incomplete). Of course, the reversealso holds, so that if the scienti

makesaneffortinvestment,xs,(e.g.,aspin-offpatent),theentrepreneurcanhold

upthescientistbythreatheningtowithdrawfromtherelation.Underthestandar

assumptionofNashbargaining,theentrepreneurandthescientisteachrealizesha

of the extra value created as a result of their efforts. Because of the externalitproblem,eachunderinvests;specifically,eachpartyinveststothepointwhereth

marginalcostofeffortinvestmentequals12 ofthemarginalvalue.

33Supposeinstea

thattheentrepreneurownsboth thepatentandtheentrepreneurialidea.Thiswi

strengthentheentrepreneursincentives(thescientistcannotholdhimupanymore

and it will leave thescientists incentives unaffected.34 Obviously, this ownershi

arrangementshouldbechosen.

Aconclusionatthisstageisthatitis possibletospeakoftheboundariesofth

firmintermsofownership(andthereforealsoinlegalterms)eveninasituatiowhereallassetsareknowledgeassets.However,thisdoesnotyetdemonstrateth

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26 N. J. Foss

of the other agents produce zero value.The coordinator may improve on thi

decisiveknowledge.EachagentneedsaccesstohisownpatentandtoCinordert

be productive. Given this assumption (which means that we need only conside

relations between any agent and the coordinator), we have the by now familia

under-investment problem for both the coordinator and the scientists.36 If th

coordinatorisgivenownershiptoallpatents,thingschange:Whiletheincentivesothe scientists are not affected,37 the incentives of the coordinator to invest i

augmenting his decisive coordination knowledge are strengthened. Thus, thi

ownershiparrangementshouldbechosen.

Summing Up

Althoughtheframeworkthathasbeenappliedinthissectionisextremelystylize

andinmanywaysquitelimited(Holmstrom,1999;FossandFoss,2001),itdoeprovideananswertoProposition2.Thereasoningshows,first,thatitmakesperfec

sensetoaddressownershipissuesintermsofknowledgeassets,and,second,tha

ownershiptosuchassetsmaybeimportantinsituationswhereagentsneedtob

providedwithincentives(andwherecontractsareincomplete),and,third,thateve

thoughknowledgeassetscontrolledbyindividualagents(`knowledgeworkers)ar

becoming increasinglyimportant inproductionintermsofcontributiontovalue

added (i.e., Assumption 2), it still does not follow from this alone that th

boundaries of firms will blur. The economically important distinction is nobetweenphysicalandknowledgeassets,asitisoftenasserted(e.g.,Boisot,1998)

butbetweenalienableandinalienableassets,andmanyknowledgeassetsareperfec

alienable.The implication is that to the extent that not all knowledge assets ar

inalienable,ownership-based(andthereforealsolegal)definitionsoftheboundarie

ofthefirmwillcontinuetobe important.Finally,thediscussiontiestogetherth

notionsofauthorityandownershipinthecontextofknowledge-basedproduction

sinceitsuggeststhatwhenthereisaneedforcentralizeddecision-making,itisofte

efficient to have this backed up by asset ownership. As will be argued in th

following section, this has implications for the issue of the extent to whic

coordinationmechanismscanbecombined,thatis,Proposition3.

6. Organization Design in Hayekian Settings

The Malleability and Combinability of Coordination Mechanisms

So far, ithasbeenargued that there isatight connectionbetweenauthorityanownershipandthatthisconnectionwillalsobemanifestinHayekiansettings.Th

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In contrast to this, it has been argued that there are no compelling reason

why specific coordination mechanisms should necessarily cluster in a few idea

typical governance structures of the `firm-hybrid-market variety (particularl

Grandori,1997,2002).Inparticular,advancesinnetworkedcomputing,manage

ment informationsystems, andmethodsofmeasuring performancehavestrongl

expanded the setof feasible combinations of coordination mechanisms (Miles eal.,1997, 1998).`Cellular or `molecular forms,which are particularlysuited t

the requirements introduced by the knowledge economy, are examples.The fac

that these forms which much operate on market-like principles (Miles et al

1997; Cowen and Parker, 1997) are still organized inside firms just serve t

illustrate the malleable nature of coordination mechanisms. However, in th

following,Iargueconcentratingonfirmsinternalorganizationthatcoordina

tion mechanisms are not completely malleable, and that such mechanisms wi

cluster in discrete governance structures, also in the emerging knowledgeconomy.

Incentive Limits to the Use of Market Mechanisms

To an economist, the debate in the management and organization fields o

`combiningcoordinationmechanismsismirroredbydebatesoncombiningmarke

and hierarchy in the comparative systems and transfer pricing literatures. Fo

example,inthecontextofcomparativesystems,Mises(1949:709)longagoargue

thatthereareinherentcontradictionsinvolvedin`playingmarket,thatis,tryingt

simulate a market inside a hierarchy. His arguments anticipated later incentiv

arguments, including the importance of credible commitment for incentive

Referringtovarioussocialistschemesofhisdaythattriedtopreservesomemarke

relations while eliminatingcapital andfinancialmarkets,Misesargued thatthes

schemes would be unworkable. The concentration of ultimate decision-makin

rights and responsibilities, and therefore ownership, in the hands of a centra

planning board would dilute the incentives of managers.Thus, while plannin

authoritiescoulddelegaterights tomakeproductionandinvestmentdecisionstmanagers, these rights were likely to be used inefficiently. First, since manager

couldntbesurethattheywouldnotbeoverruledbytheplanningauthorities,the

werenotlikelytotakealongview,notablyintheirinvestmentdecisions.Moreove

since managers were not the ultimate owners, they were not the full residua

claimants of their decisions and, hence, would not make efficient decision

Therefore,Misesdeclared,theattemptto playmarketundersocialismwouldlea

to inefficiencies. In a related vein, the attempt to simulate markets in a firm

hierarchymayleadtoinefficiencies.As later research has clarified, the problem may be handled if the plannin

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28 N. J. Foss

Implications

Animplicationisthatmixingverydifferentcoordinationmechanismsmayleadt

efficiencylosses,andmaynotbesustainableforthisreason.39Thebasicproblem

thatemulatingmarketorganizationinsidefirmsamountsto playingmarket.Unlik

independent agents in markets, corporate employees never possess ultimat

decision rights. They are not full owners. This means that those who posses

ultimatedecisionrightscanalwaysoverruleemployees.Thus,therearefundamenta

incentivelimitstotheextenttowhichmarketprinciplescanbeappliedinsidefirm

Theseinsightssuggestthat,contrarytoProposition3,coordinationmechanismsd

cluster incertain predictable ways. Inparticular, there are incentive limits to th

extenttowhichtheintroductionofcoordinationmechanismscharacteristicofth

market can be introduced in firms. Advances in measurement methods an

networkedcomputingmayhaveeasedtheextent to whichdecision rightscanb

delegatedinsideacorporatehierarchy(ZengerandHesterly,1997).However,therareinherenttensionsbetweenauthority(asbackedupbyownership)anddelegate

rights which constrains the space of feasible combinations of coordinatio

mechanisms.Totheextentthatauthoritypersistsintheknowledgeeconomy,sowi

theselimits.

7. Conclusions

Addressing economic organization in the context of the emerging knowledg

economyisataskofalmostforbiddingcomplexity.Itisalsoinherentlyspeculative

suggesting to some that the use of scenario techniques is appropriate(Hodgson

1998a) orthatamulti-disciplinary approach is justified(Daft andLewin, 1993)

Thepresentpaperhastakenanarrowerapproach,beingfoundedonthenotiontha

organizationaleconomicsishelpfulforclarifyingthecentralissuesandforprovidin

tentativeanswers.Admittedly,therichnessoftherecentliteratureonorganizatio

intheknowledgeeconomymayhavebeensacrificedbytherelativenarrownesso

thepresentapproach.Howeverithastheadvantageofmakingissuesofcontentioandthetermsofthedebateexplicit,thuscontributingapossiblestartingpointfo

furtherempiricalandtheoreticalwork.

Thus,ithasbeenarguedthattherecentliteratureoneconomicorganizationi

theknowledgeeconomymaybesummarizedinahandywaybymeansoftwobasi

assumptionsandfourpropositions.Itwasfurtherasked:acceptingthatknowledg

has become increasingly distributed and that knowledge assets are increasingl

importantinproduction,isitthentruethatauthorityrelationswillwither,thatlega

andownership-baseddefinitionsoftheboundarieswillbecomeunimportant, anthatcoordinationmechanismscanbecombinedvirtuallyatwill?Theanswerstoa

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obtainaneasyvictory.Tworesponsesarepertinenthere.First,theproponentso

Propositions (1) to(4) that have been cited are not unimportant extremists, bu

establishedandrespectedacademics.Second,evenifthestatementscontainedinth

Propositionsare,perhaps,extreme,investigatingthemisstillaworthwhiletask.Th

isbecausesuchanactivityhelpsestablishingtheboundariesofthediscussion.Fo

example,although it may be argued that nobody trulybelieves that all authoritrelationswilldisappearcompletelyintheknowledgeeconomy,westillneedtoknow

whyauthorityrelationswillpersistandhowtheywillchange.Thus,oneresultofth

present discussion is the clarification of the conditions under which authorit

relationswillexistwhenknowledgeisdistributed.

Notes

1. See,forexample,NonakaandTakeuchi(1995),Grant(1996),Myers(1996),BrownandEisenhard

(1998),DayandWendler(1998),Mileset al. (1997,1998)fordifferentperspectivesonthisoveraidea. The pedigree of this goes back a long time, including, for example, Burns and Stalke

(1961).

2. Forempiricalevidence,seeTomlinson(1999).

3. For example, Helper et al., (2000: 443) argue that `. . . firms are increasingly engaging i

collaborationswiththeirsuppliers,evenastheyarereducingtheextenttowhichtheyarevertical

integratedwiththosesuppliers.Thisfactseems incompatiblewithtraditionaltheoriesofthefirm

which argue that integration is necessary toavoid thepotentials forhold-upscreated whennon

contractibleinvestmentsaremade.

4. Itisalsotruethatorganizationaleconomicsneedstodevelopabetterunderstandingofparticular

internalhybrids(Zenger2002;Foss2000a).Notably,transactioncosteconomicsdoesnotserioustreatinternalhybrids.

5. The reasoning turning on the proposition that networks are particularly useful organization

arrangementsforsourcingandtransferringknowledgebecausetheyallegedlyavoidthecostsofpricin

knowledgeinamarketortransferringitinahierarchy(Powell,1990:304;Liebeskindet al.,1995:7

6. As Zucker(1991: 164) argues: `While bureaucratic authority is by definition located within th

firmsboundaries,expertauthoritydependsontheinformationresourcesavailable toanindividua

andnotontheauthorityofoffice.Thus,authoritymaybelocatedwithintheorganization. . .bu

whenanexternalmarket source canprovide information that leadsto greatereffectiveness, the

authoritytendstomigrateintothemarket.

7. SeeGrandori(1997,2002)forasophisticatedargumentthatbecausebothorganizationtheoryanorganizational economics have put too much of an emphasis on discrete, stable, `consisten

governancestructures,andtoolittleonmoremicro-analyticcoordinationmechanisms(e.g.,pric

norms,authority, teams,etc.),thenumberofwaysinwhichsuchmechanismsmaybecombinedha

beenstronglyunder-estimated.

8. The possible risk of constructing a strawman is admitted. This is discussed further in th

Conclusion.

9. `Distributedknowledge isknowledgethatisnotpossessedbyanysinglemindandwhichmayb

privateandtacit,butwhichitwillneverthelessbenecessarytosomehowmobilizeforthecarryin

outofaproductivetask(Hayek,1945).Manywritershavearguedthatsuchdistributedknowledg

isofincreasingimportanceinaninnovation-rich,knowledge-basedeconomy(e.g.,Ghoshal,Moraand Almeida-Costa, 1995; Hodgson, 1998a; Coombs and Metcalfe, 2000). Grant (1996: 378

th t H ki di t ib t d k l d i i l t th d t di f i ti


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30 N. J. Foss

12. `Itmaybedesiredtomakealong-termcontractforthesupplyofsomearticleorservice,Coasewrite

`Now,owingtothedifficultyofforecasting,thelongertheperiodofthecontractisforthesupplyofth

commodityorservice,thelesspossible,andindeed,thelessdesirableitisforthepersonpurchasingt

specifywhattheothercontractingpartyisexpectedtodo.. . .Therefore,theservicewhichisbein

providedisexpressedingeneralterms,theexactdetailsbeingleftuntilalaterdate.. . .Thedetailso

whatthesupplierisexpectedtodoisnotstatedinthecontractbutisdecidedlaterbythepurchase

Whenthedirectionofresources(withinthelimitsofthecontract)becomesdependentonthebuyerithisway,thatrelationshipwhichItermafirmmaybeobtained(Coase,1937:2423).

13. Apparently,someorganizationscholarsdisagreewiththis.Thus,Grandori(1997:37)notesthat

has been `well-documented in organization studies that `. . . authority is not very effective i

managinguncertainty.Itwilllaterbearguedthatthisdependsmuchonthecontext;forexampl

ifstronginterdependencies(`complementarities)betweenactivitiesareinvolved,authoritymayb

extremelyeffectivefor`managinguncertainty.

14. SeeHodgson(1998b)foraninterestingcriticaldiscussionofCoasesnotionsofauthorityandth

employmentcontract.

15. Inarecentcontribution,Wernerfelt(1997)elaboratesontheseCoasianandSimonianpremises.B

portrayinggovernancemechanismsasgameforms(spotcontracting,pricelists,hierarchy)chosentregulatetradeWernerfeltmakespreciseCoasesideathatthechoiceofagovernancemechanism

partlydeterminedbytheflexibilityaffordedbythatmechanismandheextendsSimonsanalysisb

explicitlycomparingalternativemechanisms.Specifically,gameformsdeterminehowplayersadap

tochangesintheenvironmentandcommunicateaboutthesechanges.Wernerfeltsconjectureisth

thesedifferentgameformswillbesystematicallycharacterizedbydifferentlevelsofcostsofmakin

adaptations.Forexample,authorityissimplyanimplicitcontractwhichstatesthatoneoftheparti

shouldhavetheauthoritytotelltheotherwhattodo(asinCoase,1937).Thisgame-formrequire

lessbargaining overpricesthanthemarketgame-form,andisselectedtosavetooncommunicatio

(adaptation )costs.Theagreementtoplaybytheleastcostlyadaptation-mechanismisupheldbyth

partiesconcernforreputationinarepeatedgame.16. Notethatthis`nexusofcontractspositionisremarkablyclosetothepositionthatinaknowledg

based economy, the firm/marketboundary isunclearand thenotionofauthority elusiveatbes

although itsconceptualbasisisratherdifferent.

17. Foracritiqueoftheseaspectsoftheincompletecontractliterature,seeFossandFoss(2001).

18. ThisisnottosaythattheHartapproachisentirelyunproblematicasanapproachtotheemploymen

contract or the firm. For example, thebargaining power possessed bya principal whoowns th

complementaryphysicalassetsinarelationmaybeexercisedoveranemployeeoritmaybeexercise

overalegallyindependentpartywhojusthappenstohavegivenupownershipofalienableassetst

strengthenincentives(i.e.,verticalquasi-integration)(FossandFoss2001).Inotherwords,there

no one-to-one correspondence between the firm and the Hart understanding of the exerciseauthority.Infact, asBengtHolmstrom(1999:87)hasrecently argued, the incompletecontrac

literature`. . .isatheoryaboutassetownershipbyindividualsratherthanbyfirms.

19. ThisisexplicitlyarguedinDemsetz(1988)andConnerandPrahalad(1996).

20. Of course, thereare many other reasonswhy economic organizationmay differ in the emergin

knowledgeeconomy.Forexample,totheextentthat increasedinnovative activityistakentobe

hallmarkoftheknowledgeeconomy(BrownandEisenhardt,1998;CoombsandMetcalfe,2000

thismayrequirechangesinthedistributionofdecisionrightsandrewardschemesinorganization

SuchchangesdontturnontheHayekianproblemofdistributedknowledgeper se.

21. And/orthatthereareoffsettingbenefitsoffirmorganization,suchasthesuperiorabilityoffirmst

organizetransactionscharacterizedbyhighlevelsofrelation-specificinvestments(Williamson,1981996;GrossmanandHart,1986;HartandMoore,1990).

22 M li (1974) t ll h t f th f it li t th it ( lth h h


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24. Somewritersdrawwhatappearstobe the logicalconsequenceofaHayekianstartingpoint,an

flatlyarguethatonlyfirmsthatexplicitlyemulatemarketorganizationtothelargestpossibleexten

cansurviveandprosperintheknowledgeeconomy(CowenandParker,1997).However,theyfa

toexplainwhyfirmsshouldexistunderthesecircumstances.

25. AlthoughBoltonandFarrelldonotnotethis,theexampleisvulnerabletothecritiquethatthetw

firms may enter a court-enforceable contract that let entry depend on the flipping of a coin

However,inmanyrealisticsituations,particularlywhenurgencyisinvolved,contractsmaynotbcourt-enforceableorthepotentialdelayintroducedbyusingthecourtsystemmaybe intolerable

26. Theprecisearrangementsmayalsoinvolvethepaymentofalumpsumfromtheagenttoprincip

(as in franchisingrelationships), and it will beshaped by the risk-preferencesof theparties an

whetherliquidityconstraintsarepresentornot.

27. Forexample,ifmotivationismainlysecuredbypecuniarymeans,thismayharmotherinstrument

suchastryingtomotivatebyfosteringaculturethatemphasizestrustandsharing.

28. These reasons also seem broadly consistent with organization theory work on authority in th

contextofflathierarchies(whereHayekiandistributedknowledgeisparticularlytoexist).Inastud

of authority in newspaper publishing companies, Brass (1984) identified the determinants o

authority as `criticality (i.e., decisive knowledge), `centrality (i.e., centralized decision righbecauseofeconomiesofscaleincertaintasks),and`thefriendshipnetwork.

29. Infact,twooftheflagbearersofmodernformalcontracteconomics,HolmstromandRoberts(199

90),recentlyobservedthat`Informationandknowledgeareattheheartoforganizationaldesign

becausetheyresultincontractualandincentiveproblemsthatchallengebothmarketsandfirms.

Inlightofthis,itsurprisingthatleadingeconomictheories. . .havepaidalmostnoattentiontoth

roleoforganizationalknowledge.

30. Forexample, it is not clearwhat itmeans tospeakof ownershipof firm-levelcapabilities. For

discussionofthisandrelatedissues,seeZingales(2000).

31. Thisisbecausethekeyissueisnotwhetherassetsarematerialorimmaterial,butwhethertheyar

alienableornon-alienable.32. OnemaywonderwhathashappenedtothenotionofHayekiandistributedknowledgeinthissettin

(i.e.,Assumption1).However,although it isanecessaryassumption thattheagentscanobserv

eachothersmarginalproductvalues, theydontneed to observeeachothersspecific actions o

know the underlying knowledge.Thus, Hayekian distributed knowledge is consistent with th

assumptionsbeingmadehere.

33. Thefirst-orderconditionsaregivenby12ve(K,P) +

12 v

e (K) = c(xe)and12 v

s (K,P) +12 v

s (P

= c(xs).Since ithasbeenassumedthat thevalueoftheassetsoutside therelation iszero,th

secondterminthesetwoexpressionsequalszero.

34. ThismaybeseenfrominspectingthefirstorderconditionswhentheentrepreneurownsbothKan

P:1

2 ve

(K,P) +1

2 ve

(K,P) = c(xe)and1

2vs

(K,P) = c(xs).35. Thissuggeststhatincentivesarelikelytobestrengthenedbyspinningoffemployeeswhocomeupwit

idiosyncraticentrepreneurialideasthatarecostlytocommunicatetotherestofthefirm.

36. Thisisastrongassumption,butonethatismadeforanalyticalconvenience.Themainpointsimp

isthatthereisacentralagentwhosecentrality intheinformationnetworkiscrucialtothevalu

creatingeffortsofotheragents.

37. Forexample,thefirst-orderconditionforanyindividualscientistis:12 v

i (P,C) +12 v

i (P) = c(xiwherethesecondtermiszero.

38. Thefirst-orderconditionforanyindividualscientistisnow:12vi (P,C) = c(xi),whichisthesam

asasthepreviousfirst-ordercondition.

39. Williamson(1996)referstothesekindsofproblemswithhisconceptofthe impossibilityof(efficienselectiveintervention.Themainproblemisthatincentivesarediluted.Thisisbecausetheoptiont

i t ` b i d b th f d (t t t d t i ) d f b d (t


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