The Relevant Theories in the West--Rational Selection of Governance Mechanisms

When should a leader, of either an organization or a government, loosen control, that is, grant powers so that the people can form self-organized units? And when should the control be tightened, that is, strengthen hierarchy-based governance? There are two considerations: Under which circumstance it is suitable for loosened and tightened control respectively? Does excessively loose or tight control likely occur?

The 2009 Nobel Prize in economics were won by Oliver Williamson and Elinor Ostrom, both of whom specialize in governance theories. Williamson studies how external environment and transaction characteristics affect the selection of governance mechanisms, and he has argued that network is also a governance structure, which is the hybrid form of market and hierarchy.

According to Williamson's transaction cost theory (Williamson, 1985), transaction frequency, asset specificity and environmental/behavioral uncertainties will affect the selection of governance structures. When a transaction is highly asset-specified and faces uncertain environment, market-based governance does not apply since transaction costs are too high; and hierarchy-based governance should be employed instead to carry out the transaction inside the organization, as this will reduce environmental hazards and transaction costs. On the other hand, employing the market-based governance structure to obtain resources becomes more economical if all the three factors are low. Williamson first proposed network-based governance structure, such as strategic alliances and outsourcing, in his analysis, but it is only a transitional form between market and hierarchy.

Nonetheless, Powell (Powell, 1990) made it clear that network is not a hybrid form of hierarchy and market, but a third, and new governance mode. It has unique governance mechanisms, internal operating logic and rules, which are different from those of hierarchy or market.

Moreover, Granovetter noted in his embeddedness theory (Granovetter, 1985) that Williamson's analysis overlooked an important factor – real trust in economic transactions. Firstly, mistrust and infighting between employees actually represent a large part of managerial costs; and mistrust between the parties to a market transaction adds much to transaction costs. Interpersonal trust may greatly reduce managerial costs in an organization or transaction costs in a market and thus changes the selection of governance structures. By extending Granovetter's argument, hierarchy-based governance is not necessarily a good choice for replacing market, and that self-organization-based governance is the choice for minimizing transaction costs, when there is sufficient trust.

Secondly, minimum trust is indispensable in the process of any transaction. Otherwise, it is impossible to carry out transactions inside or between organizations however perfect their institutions are. Again by extending Granovetter's argument, there should be governance mechanism involved based on self-organization principles in any transaction, either in or between organizations.

On the basis of the aforementioned studies, trust can be taken as a key variable, which is the precondition for selecting a governance structure, into William's transaction cost model. When environmental uncertainty, hazards of measurement, asset specification and transaction frequency are high, the market-based governance will not be suitable any longer. If the required real trust in a transaction is high, then carrying out transactions by hierarchical mechanisms is not necessarily the preferred governance structure. In this situation, self-organization may be employed to reduce transaction costs through trust-based relationships and the negotiation mechanism.

On the basis of these theories as a whole, I may simply say that self-organization becomes the best governance option if the transaction of a particular ―product‖ demands a high level of real trust between the two trading parties and if there indeed is sufficient trust to supply. To sum up, a transaction requires real trust between the two parties if it has characteristics as follows:

(1) Behavioral uncertainty is high, and it is difficult to use observable measurement tools to collect performance indicators, not to mention explain employees' performance using statistics;

(2) The product is highly differentiated and even on a one-to-one basis. This requires a lot of communication and is prone to cause information blockage or asymmetry. By letting a relatively independent team deal directly with consumers, therefore, it is possible to make quick decisions, depending on the specific situation, to satisfy diversified needs;

(3) The product is about personal feeling. Again, it is difficult to measure performance using objective statistics, on the one hand, and massive information is required, so it is advisable to let a relatively independent team to deal directly with consumers;

(4) The product is cooperation-based. Specifically, cooperation between the supplier and consumers is required for the product to work, such as education, medical care and community security, because the feeling of trust between the two parties is crucial for the result of their cooperation;

(5) The environment is extremely uncertain, so flexibility, quick response, and a relatively independent team that is able to make decisions at any time are needed;

(6) There are no conflicts of interest between the two parties to the transaction. Some financial products on which bets are placed, for example, will damage trust;

(7) Information is highly asymmetrical. Lawyers, accountants and R&D staffs in the knowledge industry all have expertise that is hard for consumers to fully understand. And it is difficult for any transaction to occur without real trust.

Briefly, market-based governance does not apply to the ―product‖ of a transaction if this product is accompanied by high behavioral/environmental uncertainties, asset specificity and transaction frequency, as was analyzed by Williamson (Williamson, 1996). But which should be employed in this situation, hierarchy- or self-organization-based governance? If this ―product‖ meets the aforementioned conditions, then it requires very strong real trust. And if the parties to the transaction happen to trust each other, then self-organization-based governance becomes the best choice. Otherwise, rational transaction parties would prefer hierarchy-based governance.

Sufficient supply of real trust is the base for self-organization mode of governance. Chinese managerial wisdom, including purifying one's mind, cultivating one's characters, managing guanxi, building guanxi circles, and balancing Yin and Yang dynamically, is for maintaining strong real trust, so that it cultivates a good environment for self-organization-based governance.

 
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