Underappreciated economists: Eric van den Steen

by on October 20, 2010 at 5:54 am in Economics | Permalink

Can a professor at HBS be underappreciated?  I believe so.  Eric van den Steen is in my view one of the best young microeconomists.  He is not a mere technician but rather a dealer in ideas.  Oddly, I don't hear his name mentioned often by ordinary, non-frontier economists.

Here is his page of research papers.  I am most struck by his paper on the theory of the firm.  It is an explicitly Knightian and non-Coasian model of the firm.  Unlike many authors, van den Steen does not require that the "firm mode of organization" lower transactions costs in the traditional sense (ever try to get a favor from your purchasing department?).

Instead his model starts with the Aumann model of disagreement and he suggests that control rights in the firm follow from a (figurative) auction over who gets to rule the cooperative venture.  It's bidding on the basis of relative certainty to break the initial disagreement.  If you bid for the capital goods, and turn the relationship into a "firm," you have greater authority over the other agent, because you can threaten to separate that agent from the capital goods.  The winner then installs low-powered incentives because the loser still disagrees with him, and the winner doesn't want the loser to be too motivated to pursue his own vision, thus subverting the winner's orders and recommendations.  Overall, the firm increases cooperation among agents but lowers motivation for non-ruling agents and that trade-off determines whether or not a firm will displace a market transactions based on decentralized control of separate decisions. 

It's one of the few articles on theory of the firm which make sense to me, the other candidate being Julio Rotemberg's brilliant but poorly explained "A Theory of Inefficient Intrafirm Transactions."  I view the Coasian tradition as somewhat of a dead end in industrial organization.  Internally, firms aren't usually more efficient than markets although there are good non-transactions cost reasons — including rent-seeking — why they exist.

Here is Eric's paper on the costs and benefits of homogeneity.  It's worth reading just about all of his work.  Hail Eric van den Steen!

mpkomara October 20, 2010 at 2:24 am

I think Tyler may be expecting too much from Eric van den Steen.

W October 20, 2010 at 3:25 am

Eric is now at HBS. And still underappreciated.

Kinch October 20, 2010 at 4:12 am

This SMBC comic seems particularly apt: http://www.smbc-comics.com/index.php?db=comics&id

K October 20, 2010 at 5:48 am

Firms can be more efficient than markets…I think you need to separate concerns about the existence of a firm versus the extent of it's boundary. Are you seriously claiming that transaction costs are unimportant?

Frankly I'm shocked that you would think like this. The recent notion of complexity affecting the compensation form (for example) doesn't strike you as being sensible? ?? What???

K October 20, 2010 at 6:20 am

Having gone through the paper briefly it appears that some of it is actually consistent with a bunch of earlier theory.

The possibility of disagreement can be viewed as a transaction cost.

I am concerned that he does not draw upon any real world examples however. In more than a fleeting sense.

Nuveen October 20, 2010 at 10:29 am

To Bill's comment:

While I think that sociologists yield more insight to how firms really work, I'm not sure if they're better at explaining why firms arise in the first place. It seems like that's what the above research is about. I wonder though, are evidences for these theories observable, or we stuck to roughly feeling about for what makes sense?

abel October 20, 2010 at 1:20 pm

This all looks like rehashed Tirole, Gibbons and Cremer. Especially communication and authority… Tirole's "Modes of Communication", "Real and Formal Authority" already do this stuff. This is a good example of how IO models are stylized enough to write over and over, with "new" results that are just tweaks on old ones.

WillJ October 20, 2010 at 2:06 pm

Maybe it's just because I've never actually studied it, but I find the fact that people actually bother spending time coming up with "theories of the firm" to be fascinating in and of itself.

Do sports analysts ever come up with "theories of the team"? Why do sports teams exist? Why don't basketball coaches find five basketball players, and then each person form a separate contract with each of the other five people (5! = 120 contracts), each contract specifying how each player should act on the court in relation to the other players at that given moment, as well as specifying compensation for each of the players' efforts based on the supply and demand of those efforts at that given moment, with these contracts naturally being re-negotiated after each play? That just seems like a perfectly reasonable way of playing basketball! Clearly this is a deep mystery whose solution merits multiple Nobel Prizes!

…If my snarkiness above is more ignorant than clever, where would you recommend I look as a starting point on studying the theory of the firm? (That's a serious question.)

w October 20, 2010 at 4:45 pm

abel: None of those are theories of the firm.

Michael F. Martin October 24, 2010 at 9:45 am

Having read through the paper now, I feel more confident asserting that this is a new and good theory of the firm in bankruptcy, but not necessarily in other contexts. In particular, the assumption of differing priors is one that doesn't fit well with what we observe of startup founders and employees, for example. In fact, the sharing of priors and ownership in the corporation is a characteristic of some of the biggest success stories in Silicon Valley. ESL comes to mind:
http://en.wikipedia.org/wiki/ESL_Incorporated
http://steveblank.com/2009/04/06/story-behind-%E2

In McGregor's terms, I'd call van den Steen's a Theory X
http://en.wikipedia.org/wiki/Theory_X_and_theory_

Theory Y, with its emphasis on reciprocity norms and shared vision, seems more characteristic of the growth stories. But there does seem to be transition from Theory Y to Theory X in some companies. One of the oldest and biggest in Silicon Valley comes to mind.

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