Since its take-off in the beginning of the 1970s (e.g. Alchian and Demsetz, 1972), organizational economics has been centrally concerned with what is a very recent recognition in the knowledge management literature, namely ‘that social relations and learning processes do not happen in a political vacuum and, on the contrary, take place in a landscape of interests and differential power positions and relations’ (Easterby-Smith et al., 2000: 793). Fundamentally, organizational economics represents a body of theory that allows the theorist to understand the nature of the obstacles to coordination within and between firms, as well as such issues as how the allocation of incentives and property rights influence the actions and investment decisions of individual agents (i.e. their human capital investments). It does so on the basis of precise assumptions about technologies (e.g. team production, complementarities), the distribution of information, the allocation of incentives and property rights, the degree of rationality and foresight possessed by agents, etc. In other words, organizational economics is taken up with the benefits as well as the costs of alternative contractual, organizational, and institutional structures. It puts forward comparative propositions on this basis.
Organizational economics advances research on knowledge management in organizations by allowing the derivation of novel refutable propositions that are of direct relevance for the empirical research on the practice of organizational knowledge creation. We have provided a number of examples. More fundamentally, it provides a micro-foundation (much needed, in our view) that allows focused research regarding the relation between knowledge management, value creation, and value appropriation by the involved stakeholders. We are confident that further research along these lines will continue to be fruitful.
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1von Krogh et al. (2000: 122) further observe that ‘search costs are the total costs incurred by an organization’s efforts to get individual members or a group to act effectively.’ It is not so: search cost is a category that is entirely different from the incentive and coordination costs of getting ‘members or a group to act effectively.’ More on this later.
2We have dealt with the issue of the boundaries of the firm in the context of knowledge management in Foss (2001, 2002) and Mahnke (2001).
3Part of the motivation for the interest in, and growth of, various knowledge-oriented approaches to organizations appears to be the widespread belief that organizational economics approaches to organizations have very little to offer with respect to an understanding of learning processes in firms (Kogut and Zander, 1992; Madhok, 1996). This is, in our view, something of a misunderstanding. It is true that organizational economics approaches do not conceptualize firms as knowledge-based entities per se. However, that does not mean that it has little to offer of the processes whereby knowledge is created in firms.
4For example, incentives need to be provided so that agents are motivated to supply an efficient (i.e. second-best) level of effort, and undertake the required human capital investments; care must be exercised in connection with multi-stage projects where the firm may wish to stop projects at a certain stage and the project leader (who may be better informed) may not; risk-allocation is particularly pertinent here; etc. This is not to say that understanding knowledge creation is trivial in the context of organizational economics—far from it. In fact, because processes of knowledge creation are more uncertain in terms of the variance of the benefit distribution, and because the distribution of those benefits over time is harder to anticipate than in the case of more routine investment projects, analysis is comparatively more complicated.
5This argument holds important lessons for remuneration practices and career paths in consultancies, which employ up-or-out rules. When senior consultants do not make enough investments to be qualified as a partner, they are fired, but their value to the firm may exceed their value in the best alternative due to previously acquired firm-specific skills. Firing thus means that firms waste firm specific investments in human capital. Thus, although up-or-out rules may be better than up-or-stay rules, they are still inefficient compared to the first-best.
6A further complication prevails when intrinsic motivation is an important consideration. In that case, high-powered (extrinsic) incentives may be counter-productive (Kreps, 1997). Moreover, social comparison processes may complicate the situation further. When such processes are strong, team members may be rewarded as a unit, rather than individually because differential individual rewards impede cooperation (Balkin and Gomez-Mejia, 1992; Jones, 1987; Ouchi, 1980). However, sometimes differentiated incentives may be used, particularly when it is up to the team itself to reward performance. Pfeffer and Langton (1993) add that distributive justice relates to individuals’ perception of whether they are receiving a fair share of the available rewards, proportionately to their contribution to the group, personal risk, and responsibility assumed.
7Such exercises can be associated with 360 degree feedback mechanisms. For a review of this vast and specialized literature, see Baron (1988).
8In the words of March (1994: 248): ‘Since returns from exploration are preliminary returns from absorbing ideas generated by others, those returns are insignificant if no one else is engaging in exploration. As long as nobody else is engaging in exploration, there is inadequate incentive for any individual participant—or potential new entrant—to do so.’
9For example, Brown and Duguid (1991) in a study of informal networks among Xerox repair representatives illustrate how informal ‘war stories’ about painstaking customers and unusual repairs helped its members to deal with situations in their daily practices that were nowhere in the official manuals of the company. Learning in communities of practice is task-oriented, in the sense that there is less uncertainty about what should be achieved than about how to achieve it.
10Recent contributions to the knowledge management literature have suggested creating a knowledge-creating atmosphere (Prusak and Davenport, 1998), generating corporate spirit, or enhancing a climate of mutual care based on reciprocity (von Krogh, 1998). Additionally, appeals are made to intrinsic motivation (McGregor, 1960; Deci, 1975), peer recognition, or symbolic rewards such as Texas Instruments’ annual ‘best practice celebration and sharing day’ (O’Dell and Grayson, 1998). We agree. However, while these possibilities play their part in stimulating knowledge creation, explicit forms of incentives may also supplement them.
11There are also several studies on product development that have argued that varying degrees of knowledge integration is conducive to explain firm performance (e.g. Clark and Fuijimoto, 1991; Iansiti, 1997; Henderson, 1994). Others suggest that patterns of common knowledge in the guise of combinative capabilities, routines, or core competencies are conducive in explaining differences in what firms can do well and how they perform (Hoopes and Postrel, 1999; Grant, 1996).
12For a more detailed review on the relation between organizational economic insights and claims associated with a ‘new’ knowledge-based theory of the firm see Foss (1996a, 1996b) and Foss and Foss (2000).