Advancing Organizational Theory in a Complex World

Advancing Research in a Complex World

Jane Qiu, Ben Luo, Chris Jackson, Karin Sanders

• Publisher: Routledge
• Year: 2016
• ISBN:
  9781317387732
• Edition: 1
• Topic: Betriebswirtschaft
• Subtopic: Organizational Behavior

While research in organisational studies has become increasingly rich and complex, organisation researchers are constantly challenged by the growing quest for theoretical advancement and innovation. To conduct theoretically rigorous and innovative research, contemporary researchers and students must develop in-depth understanding of the theoretical traditions and future prospects of their discipline. This book provides a collection of cutting-edge research topics in the field of organisation and management and offers advanced research findings that explore the frontiers of the field.

Advancing Organisational Theory in a Complex World aims to provide deep insights into many influential organisational theories, including, contingency theory, institutional theory, stewardship theory, population ecology theory, ambidexterity, and complexity theory. All these theories have been developed to explain the external and internal factors that influence organisational survival and evolvement. We focus on these theories because they represent some of the most important ways into the modern literature, counter-points to the modern literature, and a breath of fresh air to some theories which should be better known. This book shows the fruitfulness and the continuous vitality of the theoretical field of organisational studies in a critical and innovative way.

Finally, this book is dedicated to Professor Lex Donaldson who is a thought leader in the field. The field owed this to Lex, for his lifelong dedication to organisational studies and for his creation and advancement of theories that have inspired several generations of researchers.

1 Contingency Theory, Dynamic Fit, and Contracts

Richard M. Burton, Børge Obel, and Dorthe D. Håkonsson¹

Introduction

One of the most important concepts in organization theory is the concept of fit. Donaldson (2001) defines fit as a match “between the organization structure and contingency factors that has a positive effect on performance.” (pp. 7–10) Building on the notion of uncertainty and its consequences, Galbraith (1974) describes fit in information processing terms: fit is a match between the demand for information processing and the capacity for information processing. This reasoning derives from Ashby’s Law of Requisite Variety, which states that the variety of the organization must exceed the variety of the environment.

Burton, Obel, and Håkonsson (2015, 64) characterize the environment by its degree of complexity and uncertainty. Environmental complexity is the number of factors in the environment and their interdependency. Environmental uncertainty or unpredictability is lack of understanding or ignorance of the environment in terms of the nature of the factors and their variance.

In the multi-contingency theory (Burton et al. 2015), there are 14 factors that should be in fit, including environment, structure, incentives, and external agreements or contracts. Luo, Donaldson, and Yu (see chapter 3) analyze multiple contingencies in comparison to equifinality. Qiu and Donaldson (see chapter 5) examine the limited advantage of the matrix structure.

Despite the fact that most environments are dynamic, the emphasis has been on static fit in a static equilibrium sense (Burton and Obel 2013). Dynamic fit extends the concept of fit to include time and makes fit path dependent. Dynamic fit is the continual matching of the environment with the organizational design where the shorter the time to adjust is preferred (Nissen and Burton 2011). Klaas and Donaldson (2009), Klaas, Lauridsen, and Håkonsson (2006), and Luo and Donaldson (2013) introduced the concept over-fit and under-fit using information processing as a compensating mechanism. In a dynamic fit perspective, the organization may over time fluctuate between under-fit and over-fit. The organization desires to minimize the opportunity loss of being out of fit over time. With time included, the notion of opportunity loss is defined as the loss in performance over the time the organization is not realizing its goals—the greater the performance deviation, the greater the opportunity loss; the longer the time duration, the greater the opportunity loss (Burton and Obel 2013).

In contingency theory, an organization’s boundary is a statement of what is inside the organization and what is outside. Traditionally, ownership and rent appropriation as well as property rights and derivative authority rights would define the organizational boundary (Gibbons 2005, 207). This definition, however, becomes ambiguous with outsourcing of activities and services and temporary employees. Organizational boundaries have also become more ambiguous with respect to people and activities because of user-driven innovation and similar activities (Baldwin 2012; Burton 2013; Tushman, Lakhani, and Lifshitz-Assaf 2012).

Contracts extend the managerial boundary of organizations beyond the usual property rights concepts. That is, the coordination question of “who is to do what” goes beyond ownership to include activities both inside and outside traditional boundaries to realize high performance (Baligh and Burton 1982). With ambiguous boundaries, management activities and employees often do not follow the rules of the hierarchy, but are more based on contracts that cross the traditional organizational boundary of property rights and authority (Burton et al. 2015). Thus contracts often serve as organizational coordination mechanisms, as they help specify “who is to do what when”—basic questions of organizing. This makes contracts an integral part of contingency theory of organization design.

The chapter proceeds as follows: First, we provide a review and overview of the three main types of contracts that the paper will explore: relational, agile, and formal. Next, we develop that the performance of the organization depends upon the fit of contracts with the organizational environment. We develop this argument based on information processing arguments.

Background Review of Contracts

In their seminal work “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,” Jensen and Meckling (1979) characterize the firm as a nexus of contracts. Jensen and Meckling took their point of departure in the theory of agency, the theory of property rights, and the theory of finance to develop a theory of the ownership structure of the firm. However, Holmström and Roberts (1998, 75) argue that contracts are much more than property rights to establish boundaries; they are also mechanisms for coordination and motivation. Hence contracts are both a mechanism to enhance optimal governance and safeguarding, as well as a mechanism to achieve coordination and adaptation (Schepker, Oh, Martynov, and Poppo 2014).

Contracts are then central to how we organize firms and a basic factor in contingency theory. In particular, contracts and environments are closely related, as contracts specify what is inside and outside the firm. Contracts always involve a quid pro quo between two entities. Contracts are frequently defined in terms of contrast: complete/incomplete, formal/relational, explicit/implicit, formal/informal, agile/non-agile, flexible/rigid, resource based/performance based, blueprint specified/design and build, fixed cost/variable cost, cost plus/fixed cost, fixed outcomes/best effort, standard/unique, and waterfall or planned sequence/one time, among other names and definitions. Each contract could be put on a continuum on these dimensions, e.g., complete to incomplete.

At the fundamental level, contracts have varying degrees of specificity: complete and incomplete. A complete contract defines everything about the exchange between the two contracting parties: what is to be done and what is the payment, both in detail. An incomplete contract is one that does not spell out everything in the exchange, e.g., marriage as the future is not known at the time of the contract. Complete and incomplete can be viewed as discrete and different, but also along a continuum of degree of incompleteness. In this sense, all contracts are incomplete to some extent.

In all contracts, there are three phases: the contract agreement process, the execution of the contracts, and the completion and payment of the contract—the ex ante and ex post, if you will. It is a time-related and path-dependent dynamic process where what is known is different at the various stages.

Grossman and Hart (1986) and Gibbons (2005), among others, divide contracts into formal and relational contracts. Formal contracts involve agreements between two parties, which involve a transaction or exchange that can be adjudicated by a court or third party. Examples include an activity of a new building according to a blueprint for a fixed fee or a professional athlete will play for a given team one year for a fixed amount of money. These contracts are specified ex ante and can be assessed ex post. The building either is in accord with the blueprint or it is not. The professional athlete either plays according to his or her contract or not. A relational contract is a contract whose effect is based upon a relationship of trust between the parties. The explicit terms of the contract are just an outline, as there are implicit terms and understandings that determine the behavior of the parties. Normally, a relational contract does not involve a court or third party for adjudication. These are sometimes called informal contracts, implicit contracts, incomplete contracts, or understood agreements, among others. These contracts can be efficient and self-enforcing and ongoing for years. They can be for minor issues, such as “I agree to watch your desk for the next 15 minutes,” or “high-level diplomatic understanding” following a largely unspecified agreement. Relational contracts are frequently incomplete because of a lack of information about the future and involve trust (Uzzi 1997), but they can also be open to misunderstandings, which can lead to disagreement without recourse. Despite their ubiquity, the “enforcement” of relational contracts is problematic. If there is no enforcement, why not take advantage of the agreement? One approach is to take time into consideration and to think of relational contracts as a repeated game (Baker, Gibbons, and Murphy 2002). That is, the parties are likely to have ongoing relational contracts for which understanding and trust will continue to be important. In the prisoner’s dilemma, there is the self-interest incentive to default if the game is played one time, but if the game is repeated many times, both parties can win by cooperating over time and not defaulting (Axelrod 1987). In our experience in everyday life, we have many continuing relational contracts of understanding and trust.

Macneil’s legal relational contract theory is complementary, but not identical to our development here. In the legal relational contract theory (Macneil 1980), relational contracts are discussed mainly as long-term contracts, often incomplete and more difficult to negotiate—basically they are used for more complex projects and for long-term relationships (e.g., long-term, buyer-supplier contract). They are then contrasted against discreet contracts—short term, one time, complete, easier, or non-negotiated (e.g., buying milk in a supermarket). Except for simple transactions, the complete contract is an end-point fiction; relational contracts rely upon Macneil’s nine behavioral norms: role integrity; mutuality; implementation of planning; effectuation of consent; flexibility; contractual solidarity; linking norms of restitution, reliance, and expectation interest; creation and restraint of power; and harmonization with social matrix (Macneil 1980, 40). We argue that the contracting parties have limited information, are bounded rationally, and are interested in continuing relations also.

Formal and relational contracts deal with dynamic issues in different ways. A formal contract has detailed specification of activities ex ante; e.g., the design specifications for a bridge are detailed. Ex post, the bridge can be assessed to whether it meets the ex ante specifications or not. Further, a third party or court can adjudicate any deficiencies and who is responsible for correction. There can be both real and opportunity losses from non-compliance. Resources are required to fix a bridge that does not meet the specifications; opportunity losses are incurred as the use of the bridge is delayed, and, further, all of these non-contract activities take time.

For a relational contract, ex ante specifications are incomplete and ambiguous because there is uncertainty about the future or the information is not available, e.g., customer needs or demands are not known. Many possible products and services are included here: software and IT projects, research projects, and temporary specialists, among others. Even ex post, the completion of the contract can also lack specificity, which can be resolved through negotiation. However, there can also be a breakdown, and the two parties choose to part ways. For either impossibility or time and cost, no third party or court is utilized. On the other hand, the two parties may agree that the contract was completed successfully. Looking forward, as in a repeated game, the two parties may engage again in a similar contract. This establishes the relational enforcement.

Another type of contractual relationship is the agile contract. Pioneered in IT project management, agile contracts are frequently preferred to traditional contracts, such as fixed-fee contracts. An agile contract is defined in Wikipedia as follows:

In Agile contracts, the supplier and the customer together define their common assumptions in terms of the business value, implementation risks, expenses (effort) and costs. On the basis of these assumptions, an indicative fixed price scope is agreed upon which is not yet contractually binding. This is followed by the test phase (checkpoint phase), during which the actual implementation begins. At the end of this phase, both parties compare the empirical findings with their initial assumptions. Together, they then decide on the implementation of the entire project and fixate the conditions under which changes are allowed to happen.

In short, agile is an organizational process with a series of contracts. It is a way to reduce the uncertainty and risk for both parties (Cyert and March 1963). The agile process begins with an understanding of business value, costs, and risks. Yet there is not sufficient information to specify a formal or complete contract in detail. Uncertainty is dealt with as a sequence of short-term agreements (Cyert and March 1963). A series of fixed contracts is developed to move the project along toward completion. Thus each party is not subject to over-commitment with large risk. In brief, this sequence of short-term contracts requires understanding and perhaps trust to deal with the lack of information and uncertainty. In his relational contract theory, Macneil (1980) emphasizes the need for “flexibility” (p. 50), “implementation of planning and effectuation of consent” (pp. 59–60), and relations norms of role integrity, preservation of the relation, and harmonization of relational conflict (pp. 64–68).

In a relational contract or an agile contract, incentives are a critical issue. First, the issue of what is in each player’s interest has to be considered. Generally, we assume an individual wants to maximize her or his return, which may mean that the other individual is less well off. But it is possible to cooperate and both individuals win. Second, there may be a short-run opportunistic incentive where information distortion can benefit one player without the other player ever knowing (Burton and Obel 1988; Williamson 1975). The agile contracting process is a series of contracts under uncertainty, which limits the possible loss where a longer-term contract may involve greater risk. That is, there is a renewal of contracts, which limits loss and may build trust in the process. In contrast, the relational contract can be subject to opportunism. Relational contracts can evolve over time, much the same way as agile contracts.

Contracts must be considered dynamically in the multi-contingency theory of organizational design (Burton et al. 2015). While traditional coordination mechanisms such as structures are related to task division, task allocation, rewards, and information sharing, we include contracts between and among individuals and firms as elements of the organization’s design and as part of the definition of the environment. Contracts as well create coordination mechanisms to deal with uncertain environments. Further, agile or relational contracts enable the organization to achieve dynamic fit – that is, to retain fit over time despite continuously changing environments.

Fit between the environment and the organization for good performance is fundamental in contingency theory. Along with organizational structure, contracts are part of the organization. The performance of the organization depends upon the fit of its contracts with its environment. In the next section, we develop the fit relationship in more detail using the information processing approach to organizational design.

Contracts under Environmental Complexity and Uncertainty

As stated earlier, the firm itself can be idealized as a nexus of contracts among property owners who control the firm’s activities (Grossman and Hart 1986). Our focus here is not solely on contract...

Table of contents

• Cover
• Title
• Copyright
• Dedication
• Contents
• List of Figures and Tables
• Contributors
• Lex Donaldson, Colleague
• Introduction
• 1 Contingency Theory, Dynamic Fit, and Contracts
• 2 Structural Adaptation to Regain Fit: Multiple Misfits and Structural Complexity
• 3 Fit of Structure to Multiple Contingencies: Equifinality versus the Contingency Imperative
• 4 Getting Started with Ambidexterity
• 5 The MNC Matrix as Only a Partial Multiple Hierarchy: The Limited Advantage of the Matrix
• 6 Building Higher-Level Contingency Theory to Reconcile Contradictions between Lower-Level Theories
• 7 “Managers to the Rescue!”: Evaluating the Legacy of Stewardship Theory from an Institutional Perspective
• 8 Conclusion
• Index