Monday, 13 April 2015

Modelling science as a contribution good 2

Continuing on with the Kealey and Ricketts paper, Modelling science as a contribution good we see that in section 7.2 Kealey and Ricketts discuss "Science and the firm". They write,
The contribution good model requires that scientists are able to gain financial rewards from the common pool of science. The institutional mechanisms that enable these rewards to be claimed are not modelled explicitly but are simply assumed to exist. The contribution good model of science has direct relevance, therefore, for research programmes in business structure and organisation. In modern Institutional Economics the firm is seen (i) as a substitute for relatively high costs of transacting in the market, after Coase (1937); (ii) as a means of coping with uninsurable uncertainty and continual change, after Knight (1921); and (iii) as a vehicle for instigating technological innovation, after Schumpeter (1934, 1943). The conversion of scientific knowledge into new tradable goods and services confronts obvious transactional difficulties between scientists and technologists, technologists and entrepreneurs, and entrepreneurs and financiers. Cooperation between these elements entails high costs of transacting and is likely to involve the formation of firms with internal labour markets and specially designed incentive arrangements to mitigate them. Hansmann’s (1996) proposition that ownership rights tend to be assigned to the group that faces the highest transactions costs might suggest, for example, the development of scientist-owned firms or firms with significant control rights in the hands of the knowledge creators and users.
There are a number of reasons for thinking that the development of scientist-owned firms could occur.

Within the property rights (also often referred to as the incomplete contracts approach) approach to the firm Brynjolfsson (1994) and Rabin (1993) show that there are adverse selection and moral hazard reasons why a scientist-entrepreneur may have to form their own firm to develop their ideas. In Rabin (1993) Rabin shows that adverse selection problems can be such that, in some situations, an informed party (the scientist-entrepreneur in this case) has to take over or form a firm to show that their information is indeed useful. For Rabin an informed party has information about how to make a firm more productive but can't reveal the information to the owners of a current firm. If the information is revealed the current firm can produce using it without any payment to the informed party. If the information is not revealed why should the firm believe the information is in fact useful? Within the Rabin framework it is suggested that firms are more likely to trade through markets when informed parties are also superior providers of productive services that are related to their information but if, on the other hand, information is a firm’s only competitive advantage, it is likely to obtain control over assets, possibly by buying firms that currently own those assets or setting up his own firm.

The Brynjolfsson (1994) model on the other hand works within a moral hazard framework. Brynjolfsson considers a situation where an scientist-entrepreneur has some expertise needed to run a firm but no value can be created without both the knowledge asset of the scientist-entrepreneur and the physical assets of a firm. He assumes that no comprehensive contract can be written between the entrepreneur and the firm. If the scientist-entrepreneur does not own the firm and he makes an investment in effort and creates value, he can be subject to hold-up by the other party since he needs the firm's physical assets. If the scientist-entrepreneur owns the firm then clearly the hold-up problem ceases to exist. The most obvious interpretation of Brynjolfsson model is as a model of a labour-owned firm (scientist-owned firm in this case). Brynjolfsson argues that it is optimal to give the entrepreneur ownership of the physical assets of the firm since he has information that is essential to its productivity. This result is obviously just an application of Hart and Moore’s proposition that an agent who is ‘indispensable’ to an asset should own it (Hart and Moore 1990). Here, firms are owned by the indispensable human capital (a scientist), or, as is more usual, by a small section of the human capital, e.g. a partnership between a number of scientists.

The above arguments support the Kealey and Ricketts notion that scientist-owned firms are a viable form of governance to allow the scientists to capture the returns from their work. However we should ask if there are limits to such arguments? Walker (forthcoming) suggests their may be such limits. In this model the reference point approach to contracts (Hart and Moore 2008) is applied to the modelling of a human-capital based firm. First a model of firm scope is offered which argues that the organisation of a human-capital based firm depends on the "types" (a crude interpretation of a "type" in this context could be the kind of scientist involved in the project, e.g. chemist, microbiologist or may be both.) of human capital involved. Having a homogeneous group of human capital leads to a different governance structure for a firm than that of a firm which involves a heterogeneous group of human capital. For a homogeneous group of human capital, say just chemists, a labour (scientist) owned firm is viable but for a heterogeneous group, say chemists, microbiologists and physicists, ownership by the owners of the firm's non-human capital may be optimal (that is an investor-owned firm may develop). This is because the more heterogeneous the human capital, the more likely it is that some groups will be "aggrieved" (a party is aggrieved when they do not receive the payoff they think they should) and will therefore "shade" on their performance (i.e. they put in a low level rather than a high level of performance) thereby creating deadweight losses. A firm which involves heterogeneous human capital will more more unstable due to the greater amount of a aggrievement/shading and will therefore require some "glue"”, in the form of non-human capital of some kind, to keep the human capital together and thus keep the firm viable. Given the importance of this glue to the firm, ownership of the firm by the owner of the non-human capital is likely.

Thus while it is possible that Kealey and Ricketts are right that scientist-owned firms will develop such a governance arrangement is not the only possibility. What is likely is that we would see what we see today in terms of firm's governance structures with a range of different governance structures being utilised depending on the exact circumstances.

  • Brynjolfsson, E. (1994). Information assets, technology, and organization. Management Science, 40, 12, pp. 1645–62.
  • Hart, O.D. and Moore, J. (1990) Property rights and the nature of the firm. Journal of Political Economy 98(6): 1119–1158.
  • Hart, O.D. and Moore, J. (2008). Contracts as reference points, Quarterly Journal of Economics, 123(1), 1–48.
  • Rabin, M. (1993). Information and the control of productive assets, Journal of Law, Economics, and Organization, 9(1), 51–76.
  • Walker, P. (forthcoming). Simple Models of a Human-Capital-Based Firm: a Reference Point Approach, Journal of the Knowledge Economy.

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