Week 2

Weber’s model of bureaucracy is an ‘ideal type’ (not a literal description of actual bureaucracies)

Rather a simplified account of the central dimensions of a new technology of human control

Earlier, informal methods of control unsuited for an age of unprecedented military and economic competition

Key to success (in both war and business) was not just armies or technology but ability to harness the energies of a group to a common goal

Weber’s famous essay on bureaucracy provides an account of the forms key features, which include…

1. Rules

2. The separation of person and position

3. The proliferation of written communication and formal records

4. Reward

1. Rules

Bureaucracies governed by “calculable rules” - open, widely understood, and fairly applied – rather than by persons

-Rules establishes a hierarchy, proscribing who give orders to whom

-Rules governs admission of people to the organisation (e.g. what accomplishments required for employment) plus standards for promotion

-Rules setting out routines for performance of work

Weber argued these rules beneficial because (what do you think?)

-Prevent employees from using the organisation for their own ends, rather than the employers (i.e. the Agency problem)

-They reduce the costs/ time of deciding, haggling, arranging and coordinating

1. The separation of person and position

The existence of fixed well-defined roles that specify the rights and obligations of every organisational member (except those at the very top)

In an age in which most people regarded the workplace as an extension of their personal domain, it required participants to interact with each other in terms of their formal work roles, rather than their personal identities

This again reduced ‘haggling’ costs as it make duties clear and eliminated the need to members to negotiate with each other.

1. The proliferation of written communication and formal records

Provides a collective memory – which had previously been inseparable from (and thus a source of considerable power to) persons

Enabled many aspects of organisational history and routine to be written down and retained for the use by occupiers of relevant roles – whoever they might be (codification of knowledge)

Enhances calculability and control (of employees whose performance could be explicitly tracked) and expenses (through the use of double entry bookkeeping) which enables firms to spot fraud and control costs more effectively than in the past

1. Rewards

Lifetime security and compensation and advancement dependent on how well each employee fulfilled his or her official role

Weber argued that this gave employees a strong long-term motivation to please their employers

Note: Here Weber was wrong, lifetime job security has been largely limited to government service and a few large market insulated firms

In sum:

Key dimensions of Weber’s formal model of bureaucracy (clear universally applied rules, separation of person and position, formal rules and records, employment and advancement dependent on qualifications and performance) would all now characterise most large modern organisations.

1. Weber does not use the term Bureaucracy as a disparaging term

2. He regarded it as a more modern and efficient means of organising v. earlier orders based on nepotism and class favouritism

3. To Weber bureaucracy was an ideal that did not exist in reality. It was a standard or model.

4. Weber’s model of bureaucracy is based on legal authority. Managers are given authority by virtue of their position. Obedience is not owed to a person. But to the impersonal authority of the office.

5. His analysis was culture free. Today all undertakings of any size in any culture are bureaucratic to some degree

   
   

Disadvantages of Bureaucracy (which Weber acknowledged)

-Rules and controls may become an end in themselves

-Extreme devotion to rules may lead to inflexibility and an inability to adapt

The Equilibrium of the Corporation (Simon, H., 1947) “Administrative Behaviour”

Simon (1947) defines bounded rationality as follows: Individuals are “intendedly rational, but only limitedly so.”

Individuals have limited ability to process information and limited insight into their own preferences.

Individuals satisfice (rather than maximize), because they rely on habitual rules to make heuristic judgments about the world.

Individuals need to rely on on-going patterns of interaction to make decisions entails that they form organizations.

Organizations are the consequence of the reliance by participants upon the heuristic rules provided by the organization.

Each individual participates in the firm as long as the satisfaction received from the net balance of inducements over contributions exceeds the satisfaction obtained by not participating in the firm.

The ToF is the name given to a set of theories that attempt to explain important aspects of the firm, such as its existence, behaviour, structure and relationship to the market.

Note we addressed some of these questions in session 1 from a historical (Chandler) and sociological (Weber) perspective

Here we are looking at the question as economists tried to grapple with it

Two key questions:

1. Why do firms exist – Transaction cost theory (Coase and Williamson)

2. How do firms align the interests of managers and owners (Agency theory – Jensen & Meckling)

In 1937 Coase raised question: if markets are so good at allocating resources, why do we need firms?

(Converse also true: firms cannot always be better at allocating resources, or we would not have markets)

He argued each way of organising economic activity is costly

Most obvious costs of using the market/price mechanism are

-Discovering the relevant prices

-Negotiating a separate contract for each exchange transaction (‘haggling costs’)

-Enforcement of contracts

With relatively simple goods, it might be simple or easy to use the market. But with a complex transaction it might be very difficult

Firms arise because there are costs to using the price mechanism

The boundaries of the firm were defined by the relative costs of two methods of coordination: markets and the price mechanism v central command and managerial hierarchy

At the time, when communications were poor, and economies of scale were vast, this justified keeping a lot of things inside a big firm

Coase's theory explained why companies existed, but it was not specific enough to predict the conditions under which firms, or markets, would be preferred. 

Williamson made two key assumptions:

1. That in the real-world contracts of any complexity are incomplete

2. That humans can be opportunistic!

3. 
   

Given these assumption he noted three important dimensions of transactions:

1. The frequency with which they occur (one off transactions have different properties compared to regular repeat transactions)

2. The nature and amount of uncertainty to which they are subject

3. The specificity of the asset being transferred

   
   

The trade off between whether it is cheaper to transact on the market, or to internalize the transaction will depend on the specificity, frequency, and uncertainty of the transaction.

In general markets will tend to be more efficient when transaction less regular, it is easy to write and enforce the contract and involves standard products.

There is a cost to using a market

But bureaucracy (organising internally) also carries a cost (Williamson: mainly because it reduces individual incentives to perform)

Explains why we see both firms and markets

Implies a natural limit to firm size

Please see appendix

The Agency relationship is where one party (the principal) delegates work to the other party (the agent) who performs that work.

It is concerned with resolving two problems:

1. The problem that arises when the desires or goals of the principal and agent conflict

2. It is difficult or expensive for the principal to verify what the agent is actually doing

   
   

There are many agency relationship, but in particular it has been applied to the relationship between senior managers of the firm (the agents) and the owners/ shareholders of the firm (the principals)