X1.2 - Theories of the Company Flashcards
Classical Theory
-Based on Perfect Market & Perfect Information.
-A company is a functional tool for converting inputs into outputs, and
that is its role in society.
- It is a Black Box, and we don’t really know or care how it operates
internally as long as it works.
- We can therefore ignore the Human Element (decision-making, quality
of management, innovation, determination etc)
Classical Theory
-Based on Perfect Market & Perfect Information.
-A company is a functional tool for converting inputs into outputs, and
that is its role in society.
- It is a Black Box, and we don’t really know or care how it operates
internally as long as it works.
- We can therefore ignore the Human Element (decision-making, quality
of management, innovation, determination etc)
Transaction Cost Theory
Transaction costs- a cost incurred in making an economic exchange.
Examples of transaction costs:
- calculating the value of any product/service
- negotiating contracts
- communicating
- finding the right knowledge to do something
- administration
- supervising
- legal fees
- transportation costs
- stress and time lost.
Agency Theory
An agent is someone who is paid by a principal to do something.
- Different people in a company have different things to offer.
An owner or investor has the capital, but maybe not the knowledge or time to run the company and do everything.
- A manager has the experience and knowledge, but maybe not
the finance or the time or energy to do everything.
- The workers have the energy but not the finance or the experience to manage everything.
- They must cooperate to align
their objectives. (E.g. some
profits go to the owner as
dividends, and some profits go to
workers and managers as pay
increases/bonuses.
Creates additional costs
(control, planning,
communication etc).
Other ways to align objectives
include:
- Company culture
- Sense of being part of a team
- Being a good company that people want to work for
- Long-term growth for everyone
Ownership and Contractual Theory
Business activity carries a lot of uncertainty:
- if we invest money in a company on the stock exchange, we have to feel
safe that company managers will manage the company effectively
- when we work for a company we have to feel save that the company will
pay us at the end of the month
- when a supplier gives materials to a client, it has to see safe that the client
will pay within 90 days
All these issues are controlled by different contracts. So the company is a series of bilateral formal and informal contracts.
Resource Based Theory
Companies are heterogeneous because they have heterogeneous resources,
and mix them in different ways, meaning they can have different strategies.
1) Identify potential key resources.
2) Evaluate how important each resource is
3) Develop, nurture, and protect resources that pass these evaluations.
Resources: a combination of factors and assets owned or controlled by the
company, used to carry out strategies
Capabilities: how we use these resources to achieve objectives, the skills and experience, etc
Examples of Resource
Summary
These different ideas about the role of the company in the economic system
are all important. The reality is that the company must:
1) Consider the economic inputs/outputs of its operations (theory 1),
2) Control transaction costs and choose internal/external ones (theory 2),
3) Align the different objectives (theory 3),
4) Provide a safe legal environment to provide security to business activities
(theory 4),
5) Analyze the unique resources they have and how to use them (theory 5).
