Stockholm School of Economics

How should we understand why firms exist? A prevailing view has been that they serve to keep in check the transaction costs arising from the self-interested motivations of individuals. We develop in this article the argument that what firms do better than markets is the sharing and transfer of the knowledge of individuals and groups within an organization. This knowledge consists of information (e.g., who knows what) and of know-how (e.g., how to organize a research team). What is central to our argument is that knowledge is held by individuals, but is also expressed in regularities by which members cooperate in a social community (i.e., group, organization, or network). If knowledge is only held at the individual level, then firms could change simply by employee turnover. Because we know that hiring new workers is not equivalent to changing the skills of a firm, an analysis of what firms can do must understand knowledge as embedded in the organizing principles by which people cooperate within organizations. Based on this discussion, a paradox is identified: efforts by a firm to grow by the replication of its technology enhances the potential for imitation. By considering how firms can deter imitation by innovation, we develop a more dynamic view of how firms create new knowledge. We build up this dynamic perspective by suggesting that firms learn new skills by recombining their current capabilities. Because new ways of cooperating cannot be easily acquired, growth occurs by building on the social relationships that currently exist in a firm. What a firm has done before tends to predict what it can do in the future. In this sense, the cumulative knowledge of the firm provides options to expand in new but uncertain markets in the future. We discuss at length the example of the make/buy decision and propose several testable hypotheses regarding the boundaries of the firm, without appealing to the notion of “opportunism.”

Firms are social communities that specialize in the creation and internal transfer of knowledge. The multinational corporation arises not out of the failure of markets for the buying and selling of knowledge, but out of its superior efficiency as an organizational vehicle by which to transfer this knowledge across borders. We test the claim that firms specialize in the internal transfer of tacit knowledge by empirically examining the decision to transfer the capability to manufacture new products to wholly owned subsidiaries or to other parties. The empirical results show that the less codifiable and the harder to teach is the technology, the more likely the transfer will be to wholly owned operations. This result implies that the choice of transfer mode is determined by the efficiency of the multinational corporation in transferring knowledge relative to other firms, not relative to an abstract market transaction. The notion of the firm as specializing in the transfer and recombination of knowledge is the foundation to an evolutionary theory of the multinational corporation.

The capabilities of a firm, or any organization, lie primarily in the organizing principles by which individual and functional expertise is structured, coordinated, and communicated. Firms are social communities which use their relational structure and shared coding schemes to enhance the transfer and communication of new skills and capabilities. To replicate new knowledge in the absence of a social community is difficult. A classic demonstration is the well-studied problem of the transfer across country borders of manufacturing capabilities that support production of new product innovations. We show in this article that the degree of codification and how easily capabilities are taught has a significant influence on the speed of transfer. What makes the question of knowledge codification particularly interesting is that firms compete not only through the creation, replication, and transfer of their own knowledge, but also through their ability to imitate the product innovations of competitors. The capacity to speed the internal transfer of a production capability to new markets (e.g., those in other countries) is, consequently, of fundamental significance in a competitive environment. In the attempt to speed the internal transfer of knowledge, the dilemma arises that capabilities which can be easily communicated within the firm are more likely to be easily imitated by competitors. This relationship is tested by analyzing the effects of the ease of codifying and communicating a manufacturing capability not only on the time to its transfer, but also on the time to imitation of the new product. ’The determinants of the time to imitation are found to be the extent to which knowledge of the manufacturing processes is “common” among competitors, and the degree of continuous recombination of capabilities leading to improvement of the product or the manufacturing process. We support this interpretation by a discussion of the results from field research. A wider implication of these findings is the proposition that the transfer and recombination of organizational capabilities are the foundation of an evolutionary theory of the firm. A critical element limiting the expansion of a firm is that the competitive value of codifying knowledge leads to the selection of organizing principles that are not functional in all competitive environments. The pressure of speed is of critical importance to understand the evolutionary advantage of nonoptimal rules of coordinated action within a social community.

Firms are organizations that represent social knowledge of coordination and learning. But why should their boundaries demarcate quantitative shifts in the knowledge and capability of their members? Should not knowledge reside also in a network of interacting firms? This line of questioning presents the challenge to state an alternative view to the “theory of the firm,” a theory that has moved from Coase's early treatment of what firms do to a concern with ownership, incentives, and self-interest. We return to Coase's original insight in understanding the cost and benefits of a firm but based on a view that individuals are characterized by an “unsocial sociality.” Does the perception of opportunism generate the need to integrate market transactions into the firm, or do boundaries of the firm lead to the attribution of opportunism? This basic dichotomy between self-interest and the longing to belong is the behavioral underpinning to the superiority of firms over markets in resolving a fundamental dilemma: productivity grows with the division of labor but specialization increases the costs of communication and coordination. The knowledge of the firm has an economic value over market transactions when identity leads to social knowledge that supports coordination and communication. Through identification, procedural rules are learned, and coordination and communication are facilitated across individuals and groups of diverse specialized competence. A firm is distinct from a market because coordination, communication, and learning are situated not only physically in locality, but also mentally in an identity. Since identity implies a moral order as well as rules of exclusion, there are limitations and costs to relying upon a firm for exchange as opposed to the market. These costs are not necessarily those traditionally assigned to the category of decreasing returns to hierarchy. For example, an identity implies that some practices, and businesses, may be notionally inconsistent with each other. Norms of procedural justice that are identified with a firm imply that not all technically feasible complements are permissible within the logic of a shared identity. There is consequently a cost to an identity that offsets the benefits. Because the assemblage of elements that compose an organization are subject to requirements of consistency, identities rule out potentially interesting avenues of innovation and creativity. We illustrate these ideas by returning to the original prisoners’ dilemma game and by an analysis of the coherence of a firm as a search for complements that are consistent with norms of procedural justice. We argue that the underlying dynamic of a prisoners' dilemma game reveals the problems of coordination, communication, and conflicts in norms of justice when players are deprived of social knowledge and shared identity. Similarly, the determination of a firm's coherence arises out of the demand for a moral and notional consistency in the “categorization” of its activities, as opposed to a technological necessity. These ideas are illustrated through an empirical examination of logical complements in high performance work systems.

Abstract While theory suggests that management has discretion in manipulating resources in order to build competitive advantage, resource‐based research has focused on the characteristics of resources, paying less attention to the relationship between those resources and the way firms are organized. In explaining performance, entrepreneurship scholars have focused on a firm's entrepreneurial strategic orientation (EO), leaving its interrelationship with internal characteristics aside. We argue that EO captures an important aspect of the way a firm is organized. Our findings suggest that knowledge‐based resources (applicable to discovery and exploitation of opportunities) are positively related to firm performance and that EO enhances this relationship. Copyright © 2003 John Wiley & Sons, Ltd.

UNLABELLED: This report describes the epidemiology, burden, and treatment of osteoporosis in the 27 countries of the European Union (EU27). INTRODUCTION: Osteoporosis is characterized by reduced bone mass and disruption of bone architecture, resulting in increased risk of fragility fractures which represent the main clinical consequence of the disease. Fragility fractures are associated with substantial pain and suffering, disability and even death for affected patients and substantial costs to society. The aim of this report was to characterize the burden of osteoporosis in the EU27 in 2010 and beyond. METHODS: The literature on fracture incidence and costs of fractures in the EU27 was reviewed and incorporated into a model estimating the clinical and economic burden of osteoporotic fractures in 2010. RESULTS: Twenty-two million women and 5.5 million men were estimated to have osteoporosis; and 3.5 million new fragility fractures were sustained, comprising 610,000 hip fractures, 520,000 vertebral fractures, 560,000 forearm fractures and 1,800,000 other fractures (i.e. fractures of the pelvis, rib, humerus, tibia, fibula, clavicle, scapula, sternum and other femoral fractures). The economic burden of incident and prior fragility fractures was estimated at <euro> 37 billion. Incident fractures represented 66 % of this cost, long-term fracture care 29 % and pharmacological prevention 5 %. Previous and incident fractures also accounted for 1,180,000 quality-adjusted life years lost during 2010. The costs are expected to increase by 25 % in 2025. The majority of individuals who have sustained an osteoporosis-related fracture or who are at high risk of fracture are untreated and the number of patients on treatment is declining. CONCLUSIONS: In spite of the high social and economic cost of osteoporosis, a substantial treatment gap and projected increase of the economic burden driven by the aging populations, the use of pharmacological interventions to prevent fractures has decreased in recent years, suggesting that a change in healthcare policy is warranted.

ABSTRACT We analyze the consequences of the board's dual role as advisor as well as monitor of management. Given this dual role, the CEO faces a trade‐off in disclosing information to the board: If he reveals his information, he receives better advice; however, an informed board will also monitor him more intensively. Since an independent board is a tougher monitor, the CEO may be reluctant to share information with it. Thus, management‐friendly boards can be optimal. Using the insights from the model, we analyze the differences between sole and dual board systems. We highlight several policy implications of our analysis.

The value concept is a basic constituent of relationship marketing. The ability to provide superior value to customers is a prerequisite when trying to establish and maintain long‐term customer relationships. Stresses the fact that the underlying construct of customer satisfaction is more than a perception of the quality received. What must be taken into account as well is the customer’s need of quality improvements and his willingness to pay for it. From a relationship perspective these aspects are fundamental, since they are both related to the costs of the parties involved. Suggests that a reduction in customer‐perceived costs may be a most recommendable method of providing value to the customer, since, done properly, it can improve the internal cost efficiency as well. It is then possible to establish and maintain mutually profitable customer relationships, which is of prime concern in relationship marketing.

Taking three recent business books on artificial intelligence (AI) as a starting point, we explore the automation and augmentation concepts in the management domain. Whereas automation implies that machines take over a human task, augmentation means that humans collaborate closely with machines to perform a task. Taking a normative stance, the three books advise organizations to prioritize augmentation, which they relate to superior performance. Using a more comprehensive paradox theory perspective, we argue that, in the management domain, augmentation cannot be neatly separated from automation. These dual AI applications are interdependent across time and space, creating a paradoxical tension. Overemphasizing either augmentation or automation fuels reinforcing cycles with negative organizational and societal outcomes. However, if organizations adopt a broader perspective comprising both automation and augmentation, they could deal with the tension and achieve complementarities that benefit business and society. Drawing on our insights, we conclude that management scholars need to be involved in research on the use of AI in organizations. We also argue that a substantial change is required in how AI research is currently conducted in order to develop meaningful theory and to provide practice with sound advice.

Executives can only impact firm outcomes if they have influence over crucial decisions. On the basis of this idea, we develop and test the hypothesis that firms whose CEOs have more decision-making power should experience more variability in performance. Focusing primarily on the power the CEO has over the board and other top executives as a consequence of his formal position and titles, status as a founder, and status as the board's sole insider, we find that stock returns are more variable for firms run by powerful CEOs. Our findings suggest that the interaction between executive characteristics and organizational variables has important consequences for firm performance. Copyright 2005, Oxford University Press.

A model of knowledge management is developed. It builds on the interplay between articulated and tacit knowledge at four different levels: the individual, the small group, the organization, and the interorganizational domain. The model is applied on differences between Western and Japanese patterns of knowledge management. These are related to organizational characteristics, such as employment systems, career patterns, and organization structure. Effective knowledge management is argued to require departures from the logic of hierarchical organization and the M-form structure. The alternative N-form is characterized and suggested as more appropriate. It entails combination of knowledge rather than its division, which is the basic principle in the M-form. Other attributes of the N-form are: temporary constellations of people, the importance of personnel at ‘lower levels’, lateral communication, a catalytic and architectural role for top management, strategies aimed at focusing and economies of depth, and heterarchical structures.

We propose that dispersed outside ownership and the resulting managerial discretion come with costs but also with benefits. Even when tight control by shareholders is ex post efficient, it constitutes ex ante an expropriation threat that reduces managerial initiative and noncontractible investments. In addition, we show that equity implements state contingent control, a feature usually associated with debt. Finally, we demonstrate that monitoring, and hence ownership concentration, may conflict with performance-based incentive schemes.

BACKGROUND AND PURPOSE: In 2005, we presented for the first time overall estimates of annual costs for brain disorders (mental and neurologic disorders) in Europe. This new report presents updated, more accurate, and comprehensive 2010 estimates for 30 European countries. METHODS: One-year prevalence and annual cost per person of 19 major groups of disorders are based on 'best estimates' derived from systematic literature reviews by panels of experts in epidemiology and health economics. Our cost estimation model was populated with national statistics from Eurostat to adjust to 2010 values, converting all local currencies to Euros (€), imputing cost for countries where no data were available, and aggregating country estimates to purchasing power parity-adjusted estimates of the total cost of brain disorders in Europe in 2010. RESULTS: Total European 2010 cost of brain disorders was €798 billion, of which direct health care cost 37%, direct non-medical cost 23%, and indirect cost 40%. Average cost per inhabitant was €5.550. The European average cost per person with a disorder of the brain ranged between €285 for headache and €30 000 for neuromuscular disorders. Total annual cost per disorder (in billion € 2010) was as follows: addiction 65.7; anxiety disorders 74.4; brain tumor 5.2; child/adolescent disorders 21.3; dementia 105.2; eating disorders 0.8; epilepsy 13.8; headache 43.5; mental retardation 43.3; mood disorders 113.4; multiple sclerosis 14.6; neuromuscular disorders 7.7; Parkinson's disease 13.9; personality disorders 27.3; psychotic disorders 93.9; sleep disorders 35.4; somatoform disorder 21.2; stroke 64.1; and traumatic brain injury 33.0. CONCLUSION: Our cost model revealed that brain disorders overall are much more costly than previously estimated constituting a major health economic challenge for Europe. Our estimate should be regarded as conservative because many disorders or cost items could not be included because of lack of data.

The global population at risk from mosquito-borne diseases-including dengue, yellow fever, chikungunya and Zika-is expanding in concert with changes in the distribution of two key vectors: Aedes aegypti and Aedes albopictus. The distribution of these species is largely driven by both human movement and the presence of suitable climate. Using statistical mapping techniques, we show that human movement patterns explain the spread of both species in Europe and the United States following their introduction. We find that the spread of Ae. aegypti is characterized by long distance importations, while Ae. albopictus has expanded more along the fringes of its distribution. We describe these processes and predict the future distributions of both species in response to accelerating urbanization, connectivity and climate change. Global surveillance and control efforts that aim to mitigate the spread of chikungunya, dengue, yellow fever and Zika viruses must consider the so far unabated spread of these mosquitos. Our maps and predictions offer an opportunity to strategically target surveillance and control programmes and thereby augment efforts to reduce arbovirus burden in human populations globally.

The replicability of some scientific findings has recently been called into question. To contribute data about replicability in economics, we replicated 18 studies published in the American Economic Review and the Quarterly Journal of Economics between 2011 and 2014. All of these replications followed predefined analysis plans that were made publicly available beforehand, and they all have a statistical power of at least 90% to detect the original effect size at the 5% significance level. We found a significant effect in the same direction as in the original study for 11 replications (61%); on average, the replicated effect size is 66% of the original. The replicability rate varies between 67% and 78% for four additional replicability indicators, including a prediction market measure of peer beliefs.

ABSTRACT Using corporate social responsibility (CSR) ratings for 23,000 companies from 114 countries, we find that a firm's CSR rating and its country's legal origin are strongly correlated. Legal origin is a stronger explanation than “doing good by doing well” factors or firm and country characteristics (ownership concentration, political institutions, and globalization): firms from common law countries have lower CSR than companies from civil law countries, with Scandinavian civil law firms having the highest CSR ratings. Evidence from quasi‐natural experiments such as scandals and natural disasters suggests that civil law firms are more responsive to CSR shocks than common law firms.

Risk perception is a phenomenon in search of an explanation. Several approaches are discussed in this paper. Technical risk estimates are sometimes a potent factor in accounting for perceived risk, but in many important applications it is not. Heuristics and biases, mainly availability, account for only a minor portion of risk perception, and media contents have not been clearly implicated in risk perception. The psychometric model is probably the leading contender in the field, but its explanatory value is only around 20% of the variance of raw data. Adding a factor of “unnatural risk” considerably improves the psychometric model. Cultural Theory, on the other hand, has not been able to explain more than 5–10% of the variance of perceived risk, and other value scales have similarly failed. A model is proposed in which attitude, risk sensitivity, and specific fear are used as explanatory variables; this model seems to explain well over 30–40% of the variance and is thus more promising than previous approaches. The model offers a different type of psychological explanation of risk perception, and it has many implications, e.g., a different approach to the relationship between attitude and perceived risk, as compared with the usual cognitive analysis of attitude.

Abstract This book gives a comprehensive introduction to arbitrage theory for the pricing of contingent claims, such as options, futures, and other financial derivatives. The arbitrage theory for the term structure of interest rates is given particular consideration. Also included is a self‐contained exposition of stochastic optimal control, with applications to portfolio optimisation. The mathematical development is precise but avoids the explicit use of measure theory.

Julian Birkinshaw, Neil Hood, Multinational Subsidiary Evolution: Capability and Charter Change in Foreign-Owned Subsidiary Companies, The Academy of Management Review, Vol. 23, No. 4 (Oct., 1998), pp. 773-795

Abstract This article examines whether firm-level idiosyncratic shocks propagate in production networks. We identify idiosyncratic shocks with the occurrence of natural disasters. We find that affected suppliers impose substantial output losses on their customers, especially when they produce specific inputs. These output losses translate into significant market value losses, and they spill over to other suppliers. Our point estimates are economically large, suggesting that input specificity is an important determinant of the propagation of idiosyncratic shocks in the economy.