Malmgren, Harold B. (1961). “Information, Expectations, and the Theory of the Firm,” Quarterly Journal of Economics 75

1. Malmgren, Harold B. (1961). “Information, Expectations, and the Theory of the Firm,” Quarterly Journal of Economics 75: 399-421. Group 3: Jason Franken Prasanna Karhade Hsiao-Ching Lee Jennifer Shen Marko Madunic

2. Information, Expectations, and the Theory of the Firm Goals: • Operationalization of the Coasean approach to the theory of the firm • Combined knowledge-based approach (Penrose, 1959) to the theory of the firm with the contractual approach to the firm • Malmgren analyzed concepts such as “business culture,” previously not acknowledged in 1960s economics research literature

3. Information, Expectations, and the Theory of the Firm • Used market failure to develop a knowledge-based theory of the FIRM • Central question: “Is there any economic reason why individuals could not perform his/her own service in return for a market-determined price without tying into long term contracts?” • Transaction costs in using price mechanisms – costs of collecting information on relevant sets of events • Markets with heterogeneous transactions - incentive to combine events or activities into one bundle by arranging long-term contracts • Producers and purchasers become one market unit by integration (reduction of fluctuations, and stability)

4. Information, Expectations, and the Theory of the Firm • The firm is more adaptive to changes within the boundaries of the firm itself • Firm can control some of its internal information by intentional planning better than what would emerge spontaneously in the market • Impossibility of perfect information (bounded rationality, asymmetric information, and environmental uncertainty) and complexity of interdependencies • Learning from experience- firms do what they have learned to be profitable in the past • Profitable firms successfully communicate information and expectations to investors

5. Information, Expectations, and the Theory of the Firm • There is a great amount of interdependence in a complex system • Firm’s advantage over market: reducing and eliminating the costs of finding out relevant prices • Cost of specialization due to unsolved coordination problems (bottleneck problem) • Innovation in individual activities result in an uneven development of tools, equipment and components

6. Information, Expectations, and the Theory of the Firm • The greater authority of hierarchy facilitates communication and coordination between production stages so that decisions are based upon convergent expectations (when plans are not independent) • Lack of knowledge about the inner workings of complementary products and other forms of transactional complexity can produce a “divergence of expectations” among the producers • Malmgren clarified how knowledge and the boundaries of the firm interact • Aligning the knowledge and expectations of the parties who need to cooperate in production

7. Information, Expectations, and the Theory of the Firm • Within a firm, a wider range of information is gathered and shared; otherwise divergent expectations are supplanted by a common information base from which common projections are made • Fiat can efficiently, if not always optimally, resolve uncertainty about appropriate technological approaches, creating convergent expectations within the firm

8. Information, Expectations, and the Theory of the Firm • The exercise of authority in the form of managerial fiat in response to changes in the environment provides a reason why firms exist • Many contingencies cannot be foreseen, or it is too costly to do so • How exactly contingencies impact on the preferred level of delegation may be difficult to specify ex ante • There is a need for ex post decision-making • Centralized decision-making (discretionary authority) becomes a preferable mechanism of coordination (superior understanding of how contingencies influence interdependencies • Allocation of decisions by central managers to specialists

9. Information, Expectations, and the Theory of the Firm • Corporate culture: • A set of stable firm-specific rules that delimits intra-firm behavior. • Corporate culture may dampen various sorts of proclivities to moral hazard, and thus harmonize incentives