Specific and General Knowledge and Organizational Structure
Michael C. Jensen
Social Science Electronic Publishing (SSEP), Inc.; Harvard Business School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)
William H. Meckling
Simon School, University of Rochester (Deceased)
Michael C. Jensen, FOUNDATIONS OF ORGANIZATIONAL STRATEGY, Harvard University Press, 1998
CONTRACT ECONOMICS, pp. 251-274, Lars Werin and Hans Wijkander, eds., Blackwell, Oxford, 1992
Journal Of Applied Corporate Finance, Vol. 8, No. 2, Summer 1995
This paper analyzes the relations between knowledge, control and organizational structure both in the market system as a whole and in private organizations. Limitations on the mental capacity of the human mind and the costs of producing and transferring knowledge means that knowledge relevant to all decisions can never be collected in the mind of a single individual or a small body of experts. This means that if the knowledge valuable to a particular decision is to be used in making that decision, there must be a system for partitioning out decision rights to individuals who already have the relevant knowledge and abilities or who can acquire or produce them at the lowest cost. Self interest on the part of individual decision-makers means a control system is required to motivate individuals with the decision rights and the relevant knowledge to use those decision rights appropriately. This control problem is solved in a capitalist economy by a system of alienable property rights.
Alienable rights cannot generally solve the control problem in firms, and the assignment of decision rights in firms does not generally include the assignment of alienability. Indeed, this is one of the major distinctions between firms and markets. The inalienability of rights within an organization means control problems must be solved by alternative means. Organizations solve these problems by establishing what we define to be the Organizational Rules of the Game that provide:
(1) a system for partitioning decision rights out to agents in the organization,
(2) a performance measurement and evaluation system, and
(3) a reward and punishment system
The inherent inefficiency of organizational control systems as compared to alienability means firms cannot survive unless they provide other offsetting advantages such as economies of scale, scope or riskbearing.
Note: Sadly, Dr. Meckling, Dean Emeritus of the Simon School, died in May 1998.
Number of Pages in PDF File: 33
JEL Classification: D23, D82, D83
Date posted: September 1, 1995 ; Last revised: January 17, 2011