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Penrose (1959) and Coase (1937) Views on the Size and Growth of Firms

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Wordcount: 2885 words Published: 6th Nov 2020

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This essay will include a detailed discussion involving Penrose (1959) and Coase (1937) views on the size and growth of firms by comparing the theoretical and practical implications. This essay will provide a brief description of the context of Coase (1937) and Penrose (1959), the problem or issue need to be discussed. Different types of business are going to be mentioned as an example.


Edith T. Penrose. (1914–1996) Book (1959) lays out the theory of the company's growth, arguing that the binding limitation on the company's growth rate derives from the limited capacity of its current management. This administrative restraint is known as the Penrose effect on the company's growth rate.

Penrose (1959) provides fundamental guidelines for corporate growth and the pace at which companies can grow efficiently. Nonetheless, together with a strong growth process theory, Penrose (1959) offers a philosophy of efficient resource management, competitive incentives, and strategy for diversification.  In particular, Penrose (1959) offers an explanatory framework for unravelling causal links between capital, skills, and competitive advantage, leading to a competitive advantage theory based on resources. Penrose (1959) provides at least three key arguments in connexion with the capital of the firm, competitive incentives, and sustainable growth of the business. On the other hand Barneys 1991 firms Resources theory suggests that a firm has competitive advantage if you can introduce heterogeneous and immobility resources, “This conclusion suggests that search for sources of sustained competitive advantage must focus on firm re-source heterogeneity and immobility” (Journal of Management, Vol, 17, NO 1, 1991).  This is advantageous because its difficult for other firms or competitors to get hold of due to the fact that the costs can be higher as well as acquiring and using that resource. Barney’s theory can relate to Penrose’s as diversification is introduced in both theories.

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Firstly, Penrose (1959) argues that corporations can create economic value not through pure resource ownership, but through efficient and creative resource management (Mahoney, 1995). Penrose (1959) distinguishes between productive and efficient (Loasby, 2002) capital. The' things' that this resource package usually makes will be different depending on idiosyncratic implementations, despite the same set of resources. Due to creative resource deployments, intra-industry heterogeneity spurs differences in productive opportunities and financial performance (Penrose, 1959, p. 78).

Secondly, Penrose (1959) establishes causal links between capital and successful growth and innovation opportunities. The company's managers ' experience with each other and other resources affects their image of their company's unique productive opportunities. By transforming company resources into firm skills and new product implementations, managers act as a catalyst. New combinations of resources lead to innovation and the creation of economic value in the spirit of dynamic capacity. There is a close relationship between the different types of resources a company works with and the growth of its managers and entrepreneurs ' concepts, experience and knowledge, and we have seen how evolving experience and knowledge impact not only the resource-available competitive services, but also the company's' demand.' For the enterprising company, unused efficient resources are simultaneously a threat to develop, an opportunity to grow, and a source of competitive advantage. They make it easier to introduce new ones. The use of agency theory can be introduced as this is a theory used to clarify and resolve problems in the relationship between the managers and their agents. Most generally, it relationship is the partnership between shareholders as directors and the executive of the company as agents. There are many advantages of agency theory such as: Explains various levels of obedience and also it leads to Agentic state where people obey more when more power is granted to the orders. Furthermore this helps to explain unexplained behaviour using the state of Agentic and the autonomous concept.

Thirdly, the drivers of the rate and direction of firm growth are described by Penrose (1959). The availability of top managerial and technical expertise in a given period of time acts as the bottleneck for a company's growth rate. The company's current knowledge bases and underused resources determine the direction of firm growth. Penrose (1959) not only articulates why and how these forces influence growth rate and direction, but also argues that ignorance of these limiting factors results in competitive advantage inefficiencies and loss. Penrose (1959) provides a comprehensive description of the relation between resource-based connectivity and success at the firm level. Choices leading to an optimum growth pattern have a direct impact on economic rents.

Penrose (1959) argues that the experience of managers with their business-level resources creates firm-specific knowledge about the particular competitive opportunities for this organisation. This expertise based on experience is proprietary because it cannot be easily passed to new managers and cannot be bought on the market. Penrose mentions that (1959, p. 53): ‘experience produces increased knowledge about things and contributes to “objective” knowledge in so far as its results can be transmitted to others. But experience itself can never be transmitted; it produces a change – frequently a subtle change – in individuals and cannot be separated from them.’

In order to achieve productive growth, the availability of managers with firm-specific knowledge often affects the efficient expansion rate. The ability of an organisation of proprietary product-specific knowledge possessed by its managers acts as an isolating mechanism and determines the pace at which a company can take advantage of new opportunities in its market domain (Penrose, 1959, p. 23)

Penrose claims that (1959, p. 77) as the resources of a company are in particular specific and productive uses, unused resources are available for further development, where these unused resources influence the direction and nature of the activities of a business. The quality of the historical knowledge bases of companies drives businesses to diversify in ways that use their excess skills.  Put differently, ‘diversification and expansion based primarily on a high degree of competence and technical knowledge in specialized areas of manufacture are characteristic of many of the largest firms in the economy. This type of competence together with the market position it ensures is the strongest and most enduring position a firm can develop’ (1959, p. 119; emphasis added).

The company's growth theory of Penrose (1959) concerns complex and organisational learning based on the direction. The knowledge endowment of the business shapes and restricts the pace and learning pattern that a company can achieve in a certain period of time (Penrose, 1959, pp. 106–7). Thus, the unique ability of a company to learn and diversify both confines its pattern and rate of diversification and functions as an isolating mechanism because rival companies cannot successfully imitate the diversification strategy of another company without similar knowledge endowment and entrepreneurial insight.

Penrose (1959) discusses the structural factors that could influence both development and diversification profitability. Penrose (1959, p. 47) argues that if a business fails to achieve a compromise between its growth rate and its managerial services ability, it will be inefficient and unprofitable to undertake growth by the company. In the theory of Penrose (1959), the potential of a corporation to benefit and remain competitive in a new business determines growth direction:  It is reasonable to assume that if a business plans to expand in markets already dominated by other businesses (whether it is further expansion in its current markets or expansion into new markets), it will do so because it feels it has some competitive advantage that will ensure the competitiveness of the investment that will be connected to the expansion. (Penrose, 1959, p. 165; additional emphasis)

Coase claims it's because of transaction costs that businesses grow. ... Alternatively, according to the organisational structure of the company, individuals offer their services to other entities within the group. It reduces the transaction costs that the free market would otherwise have faced. Because development could be carried out without any organisation, Coase asks, "Why and under what conditions do we expect firms to emerge?" Since modern firms can only emerge when an entrepreneur of some kind starts hiring people, Coase's study continues by considering the conditions under which it makes sense for an entrepreneur to pursue hired help instead of contracting for some kind of help.

The traditional economic theory of the time claimed that since the market is "effective" (i.e., those who are best at delivering any good or service in the cheapest way already do so), contracting out should always be cheaper than hiring.

Nevertheless, Coase noted that there are a variety of transaction costs to use the market; in general, the cost of obtaining a good or service through the market is more than the price of the good. Certain costs, including search and intelligence costs, cost of negotiating, confidentiality of exchange, and cost of policing and compliance, can all theoretically add to the cost of market-based procurement. This suggests firms will emerge when they can arrange in-house to produce what they need and somehow avoid these costs.

Nevertheless, what can be generated internally has a natural limit. Coase mentions " decreasing returns to the entrepreneur function," including increasing overhead costs and the tendency of an exhausted manager to make resource allocation errors. This is a countervailing expense for the company's use.

Coase claims that a company's size (as determined by how many contractual relationships the company is "internal" and how many "external" relationships are) benefits from seeking an optimal balance between the conflicting cost patterns described above. Generally speaking, making the firm larger would initially be beneficial, but ultimately the diminishing returns mentioned above will kick in, preventing the business from expanding indefinitely.

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Other things being equal, a company tends to be bigger: the less organising costs and the slower those costs increase with an increase in organised transactions. The less likely it is for the entrepreneur to make mistakes and the less likely it is to increase errors with an increase in organised transactions. The greater the decrease (or the less the increase) in the supply price of output factors to larger-sized firms.

The first two costs will increase with structured transaction spatial distribution and transaction dissimilarity. It explains why companies tend to perform different functions either in different geographic locations. Additionally, technology changes that reduce the expense of spatially arranging transactions would result in companies being larger— for example, the introduction of telephone and cheap air travel would be expected to increase the size of firms. The use of the internet and associated digital information and communication technology continues to contribute to the development of so-called virtual entities on a related note. Coase does not recognise non-contractual partnerships as friends or family

Coase asks “Why is not all production carried on by one big firm?”  (Coase, 1937, pp.394-95)

First, as a company becomes larger, there may be decreasing returns to the function of the entrepreneur, i.e. the cost of organising additional transactions within the company may increase by 6. Of course, a point must be reached where the cost of organising an extra transaction within the organisation is equal to the cost of carrying out the transaction on the open market or the cost of organising it by another entrepreneur. Secondly, as structured transactions increase, the entrepreneur may fail to position the factors of production in the uses where their value is greatest, i.e., fail to make the best use of production factors. Finally, a point must be reached where the resource loss is equal to the marketing costs of the open market trade transaction or the loss if another entrepreneur arranged the transaction. Finally, the supply price of one or more of the production factors may increase because a small company's' other advantages' are greater than a large company's. Of course, the actual point where the expansion of the firm ceases might be determined by a combination of the factors mentioned above. The first two reasons given most likely correspond to' decreasing returns to management ' phrase of economists.

Coase mentions “a firm will tend to expand until the costs of organising an extra transaction within the firm become equal to the costs of carrying out the same transaction by means of an exchange on the open market or the costs of organising in another firm” (Coase, 1937: 395)

Compare practical implications ad theoretical implications including the views size and growths of firms of them both

It is probable that Penrose's theories can also make a significant contribution to the 'nature of the firm ' problem, namely the question of why firms exist (Coase 1939). Penrose assumed that there were firms. Coase (1937) compared the nature of the firm to the ' employment relationship ' and attributed this to the productivity advantages of the business transaction costs.

The method of Penrose has a detailed consequence for the' nature argument' of Coase. The' job partnership' can be clarified by endogenous innovation (equal) knowledge-growth in terms of efficiency gains, achieved by productivity improvements. To the degree that dynamic transaction costs can also be important, the overall dynamic cost reduction experience of transactions will be productivity advantages that the coasean business may describe. Importantly, it is only through intrafirm information creation that the very understanding of when and how-to which transaction costs can be obtained. The penrosean' insight' takes us further away.

For understand businesses from a situation of no firms at all, it is necessary to try to bring a business idea into action. It can be difficult to sell this concept in the open market for at least two reasons. First, it may be difficult to communicate being covert. Furthermore, if this concept also has features of public goods, communicating it to anyone will contribute to it being expropriate. In the company's unified shell, the autonomy provided to entrepreneurs of their ideas can be an acceptable initial reason for selling the idea in the open market. This is before and complements the notion that businesses will benefit from efficiency vis-a-vis markets, which can also be an adequate explanation of the ‘nature of firms’ dealing with non-transaction costs.



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