What is organisational economics?

Organisational economics is an area of economics that studies an individual company and its operations, transactions, policies, management decisions and organisational structure.

It examines how well a company can coordinate its operations and the areas where it falls short. This branch of applied economics is most relevant in firm structure, policy development, managerial decision-making, risk assessment, and incentive and reward implementation.

Understanding organisational economics

Organisational economics has three subfields: agency theory, transaction cost economics and property rights.

1. Agency theory –  investigates the impact of information gaps between individuals in the entity, such as business owners, managers and employees. It also studies issues that arise from the information gap.

2. Transaction cost economics – transaction costs are all costs that arise from a business activity. They are divided into bargaining, policing, enforcement and research of information costs – economists look at how these transaction costs play a role in organisational structure and decision-making. 

3. Contract/property of rights theory – investigates the distribution of rights within and between organisations based on the incompleteness of contracts.

Organisational economics can identify the shortfalls in a management approach and strategies to change them. In addition, the subfields help decipher the reasons that drive a company to make operational decisions.

An example of organisational economics is using the three subfields to assess the 2010 BP oil spill in the Gulf of Mexico to determine why the oil leak occurred and how a similar event could be avoided in the future. 

The agency theory can be used to assess the incentives that were in place before the oil spill: what drove those choices leading up to the incident, or why the principals at BP may or may not have been aware of the issues and motivations at play with the agents on the oil rig.

Transaction cost economics can assess any transaction costs that may have been made regarding the safe operation of the Deepwater Horizon oil rig and how such choices may have caused the accident.

The property rights theory can investigate how incomplete agreements within BP, and between BP and the contractor operating the rig may have played a role in the accident. Because contracts can be imperfect, someone has to use their discretion to decide on issues that aren’t explicitly covered by the agreement, so residual control and decision rights are essential.