Theory of the Firm and Scientology

In 1937, the economist Ronald Coase came up with a theory to explain why firms exist. His answer, in short, was that creating a centralized firm cut down on transaction costs between independent contractors. Let's say we have 5 architects working on a project, but none of them works for a firm. In order to have all of the architects contract with one another, we'd need 10 contracts:

But what if we had a centralized firm, and all the architects were employees? Then we'd only need 5 contracts--one employment contract between the firm and each architect:

Because firms cut down on transaction costs, Coase also reasoned that firms existed because they allowed an entrepreneur to specialize in producing only his goods to serve the market. This allowed the entrepreneur to focus on his specialty, and saved people a whole lot of hassle from having to round up an army of workers every time they wanted a loaf of bread produced. (Leonard Read's "I, Pencil" is a beautiful ode to the ability of the market to blindly coordinate production with demand.)

So Coase figured he had discovered the reason why we establish firms. But he didn't have the whole story. His theory underwent a lot of scrutiny in the '60s, but it was Alchian and Demsetz (1972) who best explained the behavioral component of why we make firms.

It has a lot to do with game theory. Suppose we have our 5 architects, and they're assigned to a project. It has some distant deadline, but it stands to reason that the more projects the architects take on, the more money they make, so they should try to get the project done as quickly as possible to maximize their profit.

If you've ever worked on a group project before, you know that one person usually ends up doing 95% of the work, while the rest sit on their thumbs. Here's where game theory comes in--each architect has an incentive to shirk. If one architect can successfully procrastinate on the project while the other four pick up his slack, he's pulled in his share of the cash for no work. But the other four architects are thinking the same thing, and as a result, the project never gets done. There's a carrot to motivate the group, but there needs to be a stick to motivate each member. They need to hire a monitor (this is where we get our everyday boss.)

A few rules apply to the monitor. First, the monitor has to be able to hire and fire people. Otherwise, workers would still shirk their duties, even if their coworkers complained. Second, and most important, the pay of the monitor must be tied to the performance of the workers. Otherwise, the monitor would shirk his duties, and they'd need a monitor for the monitor, etc. Remember the outrage directed at the executives of failed companies who wrote themselves fat bonus checks while their workers were getting laid off? This is where it comes from, and why the ability of workers (and not politicians) to hire their bosses is so important.

Now allow me to play Malcolm Gladwell here for a minute. After I learned about the stuff I just said, I discussed it with a deadbeat stoner friend of mine named Bob. If you want a visual on Bob, he looks a lot like the teacher from Beavis and Butthead Do America:

I drew the diagrams above for Bob when I explained it to him, and he pointed to the green dot (the "firm") in the second one and said, "And now, if we switch over to theology, this is just God." (There were probably a lot of "uh"s and "man"s and "like"s in there too.)

I was blown away, because he was totally right. Instead of the Theory of the Firm, Bob had hit upon the Theory of the Church--the reasons that organized religion was created.

There are two main aspects of organized religion that explain its creation:

1. Money/power

2. Getting everybody to live a moral life by establishing a moral code.

We'll deal with the first one later. By the way, I apologize in advance if any of what I'm about to say offends your moral/religious sensibilities--please be assured that this is meant to be an earnest discussion of these ideas. Although the paragraph on Scientology is a little harsh. Actually, if you're a Scientologist, just stop reading.

Back to bullet 2: Establishing a moral code and getting people to stick to it. The church/synagogue/mosque/etc. functions like the firm. The production goal is not goods, but good (kindness, charity, etc.)--often spelled out in the form of commandments or other religious doctrines. The members are now congregants rather than workers. The middle management that we hire to make sure that we don’t shirk on our moral duties to produce good are our priests/rabbis/imams/etc., but at the head of the church is our CEO, founder, and president, “God.” God has the ultimate say in whether or not we go to heaven or hell, and, depending on your degree of belief in free will, many other aspects of our lives—including our health, and our success in love/work/sports/etc. God is the boss we hire to prevent moral shirking.

Can the monitor (God) hire and fire people? You bet: that's where we get heaven and hell from. Is the performance of the monitor tied to the performance of the members? Sure. If members behave in a fashion that the majority considers to be immoral, their gods become pagan/heathen/etc. On the other hand, if members behave admirably, the righteousness of their God is increased.

Once we’ve established our firm of Good, Inc., we can see a number of applications of industrial organization. Now, we have to consider that our members are not only our producers, but our consumers as well. Specifically, they consume good feelings (joy, spiritual satisfaction, righteousness) for a price in the form of time or money donated, or an explicit monetary payment (see Scientology and/or Middle Ages Christianity “entitlements”).

-Network externalities: 60 years ago, there was not a single person who identified their religion as Scientology. Now, depending on how you count, there are more than 1 million. But there’s a sucker born every minute, and even completely ridiculous bullshit cooked up by a scam artist/opium addict/science fiction writer as a get-rich-quick scheme can eventually gain legitimacy as a real actual religion if enough suckers get their friends and their friends’ friends on board. Of course, Scientology does have some real value—in getting us to think critically about our own religious beliefs.

-Differentiated products and monopolies: One of the nice things about running a religious organization is that you can tell your consumers that your product is the only product that will perform the desired function (getting them to heaven or to feel good). The other products on the market are not just inferior, but evil and blasphemous! (Somewhere, a Coke brand manager just read this and got really jealous.) Scientology, for example, has a strict monopoly on the sale of Scientology products—everything from self-help books and junk instruments that measure your state of mind to actual religious secrets and materials, available only to platinum-level donors (or, as they call them, “OT levels above Clear,” pending a “review of the candidate's character and contribution to the aims of Scientology,” according to Wikipedia.). They have a militaristic copyright/intellectual property regimen to protect their ability to maintain a monopoly on their brand of spiritual salvation.

Any other links between organized religions and firms that relate to IO? Comments are welcome.

Sources: Wikipedia, lectures at Georgetown U., Beavis and Butthead Do America (1996).