Practice Questions

The most important part about comps is answering the question. To that end, I will be practicing some questions over the next few days. It is not my intention to write out the answers, but rather identify what is needed in order to answer the question.

Practice question 1
Imagine two US firms in the same industry.  In the last five years, both companies have been trying to expand their presence in China.  While one has been very successful in their efforts, the other has not. Agency Theory, Transaction Cost Theory, and theories of Dynamic Capabilities would likely offer some common and several unique explanations for the differences in these firms’ performance in this market.  Develop the unique explanations and design a study that would effectively confirm or eliminate one or more of these explanations.

In order to answer this question, I need to:

• Define how each theory offers different explanations for performance
• Agency Theory
• Management structure
• Transaction Costs
• Vertical Integration, make-or-buy
• Dynamic Capabilities
• Routines of the organization
• Having defined how each theory offers different explanations, I must design a study:
• Structure the previous explanations into testable hypothesis or propositions
• The management controls in one company create the right incentives
• The successful company has integrated key operations in China
• The successful organization is more efficient
• Define the variables
• DVs (outcome - success) 
• IVs (based on the hypotheses)
• Controls (age, funding)
• Discuss sampling and data collection issues
• Selection of the sample
• Archival and survey methods
• Length of the study
• Discuss what data is necessary to confirm or eliminate each hypothesis

• Cites
• Agency: 
• Jensen and Mekling 1976
• Fama 1980
• Demsetz 1983
• Fama and Jensen
• Jensen 1986
• TCE:
• Coase 1937
• Williamson
• Hill 1990
• Jones and Hill  1988
• Teece 1982
• Alchain and Demsetz
• RVB:
• Alchain
• Schumpeter
• Nelson and Winter 1950
• Teece

Creating this outline took me about 25 minutes. I did not recall many of the years of the citations. My goal is to create the outline and the cites in 20 minutes. Furthermore, I should be able to detail one or two words about each paper. I also did not include the critics of TCE.

During the exam, I will have two hours to complete this question. In this case, the key ideas have been detailed and it is a matter of making this into paragraph form.

The End: Putting It All Together

Now that I have finished making a blog post for each of the major ideas for my exam, it is time to put it all together.

I have previously mentioned how I was working on a mindmap in order to accomplish this. My remaining task is not just synthesizing, it is also memorizing. This represents a challenge since I have never memorized anything as a way to prepare for an exam.

I recently linked this article from Mental Floss on my twitter. In it, the author describes 11 different ways to improve my memory. They are:

1. Concentrate For Eight Seconds
2. Don’t Walk Through A Doorway
3. Make A Fist
4. Exercise
5. Sleep
6. Use Crazy Fonts
7. Chew Gum
8. Write Things Out 
9. Know When To Turn The Music On—And Off
10. Visualize
11. Doodle

In an attempt to memorize for the first time ever, I am making flashcards by hand. Making flashcards helps with concentrating for more than eight seconds and writing things out. In addition, it helps me to review. Once I finish a particular theory, I will go to the mindmap to see if I can put things together from memory. This also helps visualize.

This is how I will be spending the rest of the day today. And possibly tomorrow.

The exams are next week...

¡Arriba y adelante!

Strategic Management

I have now written about all the major topics related to the Economic Foundations, Sociological Foundations, and Contemporary Research in Strategic Management.

However, this is not quite enough. I need to understand them together. In other words, I need to synthesize all these theories.

As I begin this process, I will be using a mind-mapping tool. I believe that having everything in a single page will help me begin to see all the similarities and differences.

As with everything else in this blog, the mind-map is a work in progress. I currently have the major theories listed. The next step is to detail the main ideas of each theory, what they predict, and the seminal papers and other researchers.

This mind-map can be found here. I created it using Mind Mup and it is shared via GoogleDrive.

Economic Foundations Conclusion - Part 2

This is the second part of the review of the Economic Foundations of Strategic Management. Part 1 here.

Transaction Cost Theory

• Key idea:
• There are costs associated with having operations inside the firm (hierarchy) or outside the firm (market).
• Assumptions:
• Self-interested behavior, bounded rationality.
• Uncertainty and risks.
• Unit of Analysis:
• Transaction Costs.
• Seminal papers and authors:
• Coase (1937)
• There are costs to use market transactions. 1) costs of discovering what the relevant prices are 2) negotiating and concluding a separate contract for each 3) difficulties of specifying all in a contract. By forming an organization and allowing some authority (entrepreneur) to direct resources, certain costs are saved. 
• Alchain & Demsetz (1972)
• They emphasize measurement problem in team production. They examined the difficulty of metering output in team production in which union or joint use of inputs yields a larger output than the sum of the products of the separately used inputs. They view a firm as a contractual structure arises as a means of efficiently organizing team production.
• Klien, Crawford & Alchain (1978)
• Contracts are open to serious risks. In the presence of appropriable quasi-rents, the possibility of post-contractual opportunistic behavior is real. This can be solved through vertical integration or contracts, with vertical integration being more likely.
• Williamson (1985)
• Unlike Alchain and Demsetz (1972), Williamson highlights the problem of opportunism in the context where executing transaction requires specific investments. According to him, transaction costs refers to negotiating, concluding and enforcement costs associated with transactions taking places in the market place. There are six main factors that produce transaction difficulties. 1) bounded rationality 2) opportunism 3) uncertainty and complexity 4) small number trading relationships 5) asset specificity 6) information impactedness. The joining of the different pairs of the factors generates particular transaction difficulties and they become serious especially when specific investments are required and information asymmetry between two parties is substantial. In theory, it is possible to use the market transaction if a comprehensive contingent claims contract is made; but in practice, it is almost impossible or prohibitively expensive to specify all the conditions, let alone monitoring such complicated contacts. 
• Jones & Hill (1988)
• Transaction costs should be incurred in order to use market transactions and they can be economized if the economic benefits of internalizing the transaction exceeds the bureaucratic costs of organizing transactions using a hierarchy. There are three ways to realize economic benefits from internalization. Economic benefits from vertical integration occurs when concerns about opportunism in small number trading relationships and information asymmetry between two parties is substantial. Economic benefits from related diversification are generated when inputs are shared or utilized in complete congestion. It is very difficult to realize such synergistic gains through market transactions due to transaction costs. Economic benefits from unrelated diversification have to do with the market failure as well as information asymmetry. Compared to external market investors who are at the disadvantage of information asymmetry and control disadvantage, the head office has overcome such weaknesses through its relationship with operating units. By acquiring a firm and exposing it to the discipline of efficient internal market competition, the head office, compared to external market investors, is at advantage of allocating resources more efficiently and thus increases performance. 
• Teece (1982)
• Diversification is driven by excessive capacity and its creation, market imperfection, and the peculiarities of organizational knowledge, particularly its fungibility and tacit nature.
• Hill (1990)
• Even when asset specificity is high, the problems of opportunism may be mitigated by systems of market in which selection favors actors with good reputation concerning trusting and cooperating relationship. However, transaction cost theory ignores a dynamic evolutionary process for such behavioral repertoire, and in this regard, their rationale for vertical integration may be overstated.
• Similarity or relationship to other theories:
• Agency theory makes similar assumptions to human behavior and human limits.
• What kind of predictions can be made:
• Make-or-buy decisions.

Resource-Based View

• Key idea:
• Sustained competitive advantage comes from idiosyncratic resources.
• Assumptions
• Tacit know-how resides in organizational routines.
• Unit of Analysis:
• Resources.
• Seminal papers and authors:
• Lippman & Rumelt (1982)
• Uncertain imitability. This concept allows us to deal with causal ambiguity that exists when a link between resources controlled by a firm and its sustained competitive advantage is not understood perfectly.
• Wernerfelt (1984)
• He introduced the idea of analyzing the firm with a resource-product matrix instead of growth-share matrix. Also, diversification is discussed as a dynamic resource management. Acquisition is seen as a purchase of bundles of resources in a highly imperfect market.
• Barney (1986a, 1986b)
• For a firm’s resources to have sustained competitive advantages, they should have following attributes: 1) Valuable: resources should make the firm to exploit opportunities and/or neutralize threats in a competition. 2) Rare (path dependency assures this) among a firm’s competitors. 3) Inimitable (uncertain imitability Lippman and Rumelt 1992) -valuable and rare resources can be a source of sustained competitive advantage only when they are inimitable by competitors, and this is often true because a firm’s ability to acquire and exploit such resources depend on a firm’s unique historical conditions( place in time and space).
• Conner (1991)
• He argues that RBV provides an alternative rationale for the questions like why a firm exists and what determines a firm’s scale and scope. He maintains that heterogeneous firms continue to exist because the assets with which firms will come be mated are themselves heterogeneous, making each other a better fit than other firms. The theory views a firm as “a creator of unique productive value” instead of “an avoider of negative”. The scale and scope of a firm depends on a degree of to which new projects are specific to a firm’s current resource base. He also compares the RBV with other five traditional industrial organization economics. As the neoclassical view of the firm, RBV views a firm as an input-combiner but it does not include the assumptions of neoclassical views. Like the Bain-type IO, the RBV agrees that it is possible to make above-normal earnings but the profits come from idiosyncratic, immobile resources of a firm, not from the artificial reduction of industry outputs. As Schumpeter, the RBV recognizes the power of creative destruction (innovation) to shift market structure, but the RBV does not need large-scale industry incumbents for such initiative. Finally, like the Chicago school but unlike the Bain-type IO, the RBV sees such rents coming from luck or acumen of entrepreneurs in acquiring, combining and deploying such resources (conduct), not from the structure of the industry in which firms operate. 
• Barney (1991)
• Building on the assumptions that strategic resources are heterogeneously distributed across firms and that these differences are stable over time, this articles examines the link between firm resources and sustained competitive advantage. Four empirical indicators of the potential of firm resources to generate sustained competitive – value, rareness, imitability, and substitutability – are discussed. 
• Reed and DeFillippi (1990)
• Argues that causal ambiguity is a function of tacitness, complexity, and specificity of competency
• Similarity or relationship to other theories:
• Dynamic capabilities - RBV looks at resources, DC looks at capabilities.
• What kind of predictions can be made:
• Impact of resources on firm performance, strategy.

Dynamic Capabilities

• Key idea:
• Sustained competitive advantage comes from capabilities.
• Assumptions:
• Competition as a process (Neo-Austrian economics).
• Unit of Analysis:
• Capabilities.
• Seminal papers and authors:
• Alchain (1950)
• Like the biologists, the economist can predict the effects of environmental changes on the survival class of living organisms.
• Schumpeter (1950)
• The essential character of capitalism is its evolutionary process driven by a perennial gale of creative destruction
• Nelson and Winter (1982)
• Evolutionary relies on a cumulative learning-based view of organizational competence in the face of exogenous changes in the economic subsystem. Evolutionary theory explains how particular organizational forms come to exist in specific kinds of environments. The process is not necessarily efficient and path-dependent process can often lead to an outcome other than those implied by historical efficiency. Capabilities are captured in the organizational routines. Routines are the result of trial and error as organizational learn. Routines reflect the knowledge base of organizations. We can predict how organizations will behave in the future according to their routines, and even a high-level of complex problem solving efforts may fall into a quasi-routine pattern. 
• Nelson & Winter (2002)
• Building on the assumptions that strategic resources are heterogeneously distributed across firms and that these differences are stable over time, this articles examines the link between firm resources and sustained competitive advantage. Four empirical indicators of the potential of firm resources to generate sustained competitive – value, rareness, imitability, and substitutability – are discussed. 
• Teece et al (1997)
• Dynamic capabilities framework (Efficiency-oriented): Stresses exploiting existing internal and external firm-specific competences to address changing environment. Conclusions: 1) Private wealth creation in regimes of rapid technological change depends in large measure on honing internal technological, organizational, and managerial processes. 2) Identifying new opportunities and organizing effectively and efficiently are more important than strategizing.
• Similarity or relationship to other theories:
• RBV looks at resources, DC looks at capabilities.
• What kind of predictions can be made:
• Impact of capabilities on firm performance, strategy.

(Adapted from course notes)

(Flashcards and other resources here)

Economic Foundations Conclusion - Part 1

This week, I spent my time reviewing theories used in strategic management that were derived from economics or grounded in economic concepts.

In one of my classes, we were encouraged to summarize theories by looking at the assumptions they make, how they are similar to other theories, the unit of analysis, and the predictions that can be made.

I will conclude the review of economic foundations by describing the major theories in those terms:

Industrial Organization

• Key idea:
• Builds on the theory of the firm. Looks at the impact of structure (read: boundaries) of firms and markets.
• Assumptions:
• Adds "complications" to perfectly competitive market.
• Unit of Analysis:
• Industry, firm.
• Seminal papers and authors:
• Stigler (1965)
• Collusion is very difficult, even if firms want to do it.
• Caves & Porter (1977) 
• Entry barriers are both due to the structure, and also endogenous to the industry. Entry decisions to an industry depends on a firm's strategic position. 
• Demstez (1973) 
• Industries become concentrated due to their efficiency, not because of collusion.
• Gilbert (1989) 
• Industry structure is not strictly exogenous, but is endogenous as industry incumbents try to influence the behaviors of potential rivals by engaging in strategic entry deterrence behavior (either by forestalling entry or inducing exit).
• Shapiro (1989)  
• Overview of recent IO research that includes game theory; emphasizes the dynamics of strategic actions and the role of commitment in strategic settings, not possible to determine an overall theory of oligopoly.
• Arthur (1989)  
• Examine the dynamics of allocation under increasing returns in a context where agents choose between technologies competing for adoption.
• Similarity or relationship to other theories:
• Since it addresses boundaries of the firm, perhaps TCE can be a complement.
• What kind of predictions can be made:
• The structure of the industry can be used to create strategy for the firm.

Managerial Theories

• Key idea:
• There is a separation of ownership and control of the firm. Managers seek to maximize their own utility.
• Assumptions:
• Managers maximize their own utility.
• Unit of Analysis:
• Firm.
• Seminal papers and authors:
• Bearle & Means (1932)
• Separation of ownership and control of the firm.
• Marris (1963)
• The optimal growth level requires the rate of diversification and profit margin but also a growth-maximizing financial policy. However, because a financial policy is under the hands of managers, an optimal growth level and optimal value of fiscal policy are often set from the point of view of managers, not of shareholders. 
• Penrose (1965)
• Some diversified growth represents efficient use of underutilized firm resources that cannot be separated out for sale. Expansion itself provides an opportunity to further growth, an opportunity that did not exist before the expansion, due to unused resources available at no extra cost. However, due to lack of managerial services (imagination, insight, creativity, experimenting etc), all potential opportunities known and open to a firm are not exploited together. 
• Chandler (1985)
• Vertical integration is driven by a desire to keep firms’ core assets to efficiently employed (assurance of supply) while diversification is the realization of economies of scope
• Similarity or relationship to other theories:
• Since it discusses the separation of ownership and control, agency theory.
• What kind of predictions can be made:
• Features of the firm (diversification or vertical integration) as a result of managers.

Agency Theory

• Key idea
• Because of separation of ownership and control, problems arise aligning priorities of managers with priorities of owners.
• Assumptions
• "Economic man."
• Unit of Analysis
• Principal-agent relationship.
• Seminal papers and authors
• Jensen & Meckling (1976)
• Agency emerges as a response to managerial theory. 
• Fama (1980)
• Market for professional managers ‘disciplines’ managers to work for performance.
• Demsetz (1983)
• Corporate execs, while not often among the largest shareholders, receive incomes that are highly correlated with stock performance, and it forms a strong link between management and owner interests.
• Fama & Jensen (1986)
• Shows how organizations characterized by separation of ownership and control are so common and survive well despite of the agency problems. They show that such organizations control the agency problems by separating management (initiation and implementation) and control (reification and monitoring) of decisions. The common features of decision control system include mutual monitoring system, board of directors consisting of outsiders, decision hierarchies etc. 
• Jensen (1986)
• Debt reduces the agency costs of free cash flow by reducing the cash flow available for spending at the discretion of managers. Debt creation binds managers to keep their promise to pay the debts with future cash flow, in this sense it is an effective substitute of dividend.
• Similarity or relationship to other theories:
• Managerial theories of the firm. Agency theory came about as a direct response to that theory.
• What kind of predictions can be made:
• Behavior of managers based on different control tactics.

(Adapted from course notes)

(Flashcards and other resources here)