Lecture 10 - Property Rights

Question 1

PRA: Behavioral assumptions

Answer 1

• Bounded rationality
• Opportunistic behavior

Question 2

PRA: Contracts

Answer 2

Incomplete contracts

Question 3

PRA: View of the firm

Answer 3

Firm as the entrepreneur-manager + all owned non-human assets
* Humans cannot be owned

Question 4

Notions of ownership

Answer 4

Residual income perspective
Ownership gives the right to residual income - i.e., an ”owner” is a residual claimant
(finance notion of ownership).

Residual rights perspective
Ownership gives the right to make residual decisions – i.e., decisions over uses of assets that are not stipulated in a contract (“property rights approach”).

Question 5

PRA: Key issues

Answer 5

• Which governance/ownership structure is best? And why?

Question 6

Property rights critique of TCE:

Answer 6

1. Opportunistic:
   Is it consistent & meaningful to assume that people, in an integrated enterprise, do not have opportunistic intentions anymore?
2. Who integrates who?
   But, what if integration affects parties differently?
   E.g., a party invests more as owner than as employee?
   Then, the form of integration matters – i.e., the specific pattern of ownership matters.

Question 7

Governance structures / Ownership patterns

Answer 7

• Forward integration
• Market
• Backward integration

Question 8

Ownership –> bargaining power

Answer 8

Ownership gives the right to pull the assets out of a relation → bargaining power (how much value can you appropriate) → incentives to invest in a relation ↑ → value creation (efficiency).

i.e., if you want people to invest, give them bargaining power

Question 9

Profits in market with 50:50 bargaining power

Answer 9

Ex-post upstream profits:
recoverable costs+1/2 quasi surplus-costs=200-K+1/2 (40+K)-200=220-1/2 K-200
=20-1/2 K

Ex-post downstream profits:
1/2 quasi surplus
=20+1/2 K

Question 10

K influence on efficient governance structure

Answer 10

K = 0 –> all 3 governance structures can realize efficient investment (Coase Theorem)

K = [0,40] (0-surplus) –> both market and forward integration can realize efficient investment

K > 40 (surplus) –> only forward integration can realize efficient investment

Question 11

Failures in governance structures

Answer 11

Backwards integration:
the firm appropriate all the value. Leaving the supplier/U with a loss.

Market:
risk of being held up

Question 12

Opportunism & moral hazard under integration

Answer 12

Contracts and internal legal system necessary because opportunism and moral hazard exist under integration – e.g., supply divisions may not deliver the right amount, quality, etc.

Question 13

Implications

Answer 13

1. A party that invests in relationship specific assets deteriorates its ex post bargaining position. Give her sufficient bargaining strength → confident that the investment will be recouped.
2. The more specific the investment is (K ↑), the more bargaining power a party should get in order to induce her to invest.
3. You can strengthen the incentives of a party by providing more control over assets - but only at the expense of weakening the incentives of other parties (the costs of ownership)
4. Those parties whose investments matter most to value creation should own the assets.

Question 14

Patrons & Coops

Answer 14

Ownership falls to a class of patrons (those who transact with a firm)
- Capital suppliers
- Customers
- Input suppliers
- Workers
- Government
- No one (non-profits)

All ownership structures are really coops

Question 15

Which patrons should own the firm?

Answer 15

• Ownership falls to a class of patrons, i.e., those who transact with a firm
  (capital suppliers, customers, input suppliers, workers, etc.).
• Basic TCE idea: Balance the costs of contracting (with non-owning patrons) and the costs of ownership (for owning patrons).

The patron group for which the sum of these two costs is lowest is the efficient owner-group.

Question 16

Within-group conflict

Answer 16

Relative homogeneity doesn’t imply complete interest alignment.
- Capitalists coop /the corp: Conflicts between owners of preferred versus common stock, owners with more or less diversified portfolios, owners with different preferences over risk and return; etc.
- Agri coops: Conflicts between young and old farmers re e.g. investing in product development.
- Worker coops: Conflicts in professional services firms between young and old partners re e.g. innovation.
Note the time-horizon issue. Is that a problem for the “capitalists coop”?

Question 17

Cost of contracting & cost of ownership

Answer 17

Cost of contracting (with non-owners)
* Monopoly or monopsony.
* Contractual lock-in.
* Relation-specific assets (as in TCE/Williamson; Session 8).
* Asymmetric information.
* One party has specialized knowledge that can be used to exploit the other party (moral hazard etc.).

Cost of ownership (for owning patrons)
* Monitoring (agency) costs.
* All else equal, patrons who are least-cost monitors are most efficient owners.
* Collective decision-making.
* How to aggregate the interests of members of a patron class?
* Are interest homogeneous enough to make good decisions quickly?
* Risk bearing.
* Which patron class is in the best position to bear risk?

Question 18

The public corporation

Answer 18

A “capitalists cooperative” emerges when …
- Lenders are particularly likely to have their capital at risk/appropriated b/c of opportunism/moral hazard from other patrons, particularly when the firm needs to undertake long-term investments, requiring long-term financing.
- Risk diversification benefits of investor ownership.
- Common denominator of profit/max NPV of firm reduces costs of decision-making.