Question

Coase long ago pointed out that diminishing returns to management may be a significant factor in firms encountering limits to their size and scale. Based on our readings, which statement(s) is (are) accurate?

   Size and complexity may increase the metering and monitoring costs or internal transaction and governance costs to the point where they offset physical or technological scale economies.

   Managers may impose invasive control technologies or techniques that enervate (meaning, Drain someone of energy and vitality, not a synonym for energize) and alienate employees.

   We would expect, all other things equal, to see diminishing returns to management earlier in firms and industries where relational contracts are important than in firms where standardized market or classical contracts are the predominant form of governance.

   All of the above are accurate descriptions of factors that may diminish returns to management.

Answer 1

The first point suggesting that size and complexity may increase the metering and monitoring costs or internal transaction and governance cost to the point where they offset physical or technological scale economies is true. This is explained as follows.

In the above graph we can see that in the Long run average cost curve LRAC is initially downward sloping ->>>>flattens out and later->>>> rises again. This is because initially the firm is small in size and in the short run the costs fall as output increases due to economies of scale. The long run average cost curve is a series of short run average cost curves. Then towards the center part of the graph the curve flattens out as a result of constant returns to scale with the cost stabilised and output increasing. But as it time passes, the firm keeps expanding in order to meet the increasing output requirements and its cost rises due to investment in monitoring labor and governance etc that increase the costs. In other words, as the company expands in the long run, the costs will rise due to diseconomies of scale.

As the size of the firm grows, managers would impose invasive control technologies that interfere with the independent functioning of the labor. Studies have shown that in an experimental setting where a group of employees were monitored, the productivity was decreasing, while in a setting where monitoring did not interfere with their work style each employee was motivated by the productivity of his/her coworker. Thus, increased monitoring results in employees losing the sense of a free working environment, which could hamper their productivity and result in increased cost per unit labor.