Dynamic Explanation of Industry Structure and Performance
Cotterill
1. Introduction
Since its genesis in the 1930s industrial organization
economics has grown as a corpus of scientific
knowledge by two interrelated avenues: deductive
theory and inductive empirical study of markets. Most
work has focused on the definition of an industry or
market, the organization of such markets including the
condition of entry, the strategic conduct of incumbent
and potential entrant firms, and the performance of firms
and the overall market. Work in this area has evolved
from rich comprehensive industry case studies called for
by Mason (1939), such as Nicholls (1941), Hoffman
(1940), and NCFM (1966), to narrowly focused,
complex econometric studies. Ideally these econometric
studies are based upon, new, very large, disaggregate
data sets with great detail on transactions, advances in
econometrics, and extensive computing power. Today
we estimate and test directly market and firm models
first offered in the 1930's, and subsequently refined by
theorists.
Perhaps the overriding issue in horizontal industry
analysis has been the determinants and degree of market
power. Included in this conundrum are alternative
explanations of firm strategic advantage (increased
profits and or market position) such as real economies of
scale and scope, and product quality. Considerably less,
but by no means trivial, work in industrial organization
has examined the vertical organization of the economy
and the internal organization of firms.
Traditionally vertical organization work is classified
into two areas: vertical integration (Perry, 1989) and
vertical contracting or coordination (Katz, 1989). Most
work on vertical integration has been an extension of
horizontal market analysis to determine whether market
power can be transferred via integration to neighboring
stages in a market channel, or whether integration raises
entry barriers and creates power in one or both
industries. Work on vertical coordination has effectively
eschewed neoclassical analysis, opting for either a
Coase-Williamson transaction cost approach or an
agency theory of the firm (Hart 1995, Grossman and
Hart, 1986) framework. Vertical coordination analysis
has typically analyzed exchange between two successive
stages in a market channel, e.g. growers and processors
or manufacturers and retailers, to determine when and
why contract coordination between a particular seller
and buyer replaces arms length transactions in market.
As we will demonstrate in this paper incentives for such
coordination increase with increasing concentration in
the food sector.
Work on the neoclassical "black box", i.e. the firm,
has also eschewed neoclassical analysis and used Coase-
Williamson transaction costs or agency theory to make
significant progress in our understanding of the
demarcation between firm and market as well as the
internal organization of firms. Writing on the
relationship between three different approaches to
analyzing the nexus between firms and markets Demsetz
states:
Neoclassical theory is focused on specialization, not on
managed coordination. Coase's theory is focused on
managed coordination, not on specialization.
Contemporary theory has a still different emphasis. Its
concern is mainly with agency problems, but, it is more
closely related to Coase's theory than to neoclassical
theory because its focus is on optimal mixtures of market-
based incentives and management-based controls.
(Demsetz, 1997, p. 427)
He continues:
The firm in neoclassical theory reflects the imperatives of
the price system, not those of management; if the price
system works well, resources are allocated well.
Imperfect information, in contrast, makes the judgement
of managers and owners a source of productivity
enhancement. The main source of management's
productivity in contemporary theory has been in its
response to agency problems. (Demsetz, 1997, p. 428)
In addition to the analysis of shirking, opportunism,
and reputation effects within a firm's labor force and
with it trading partners in markets, agency theory has
also been used to analyze the relations between top
management, the board of directors, and stockholders.
Building on the classic work by Berle and Means (1935),
Henry Manne (1965), Fama and Jensen (1983), Jensen
(1986) and others have constructed a theory of corporate
control.1 Therein a merger or leveraged buyout are
actions in a market for corporate control that redress the
1 The separation of ownership and control dates to the advent
of the modern, limited liability corporation in England: "In
1837, when the first Limited Liability Act was passed, the
organization of joint-stock companies was regulated and the
personal liability of each shareholder was limited to the
amount of his share. Previously, if the company went
bankrupt, the entire property of each individual shareholder
could be used to pay the company's creditors. The new Act
caused a flood of wealth to pour into limited liability
companies, which provided much of the capital for new
industries, and London became the financial capital of the
world." (Charlot, 1991, p. 337)
Food Marketing Policy Center Research Report No. 53