1 The Conduct of Economics: The Example of Fisher Body and General Motors RONALD COASE The University of Chicago Law School The University of Chicago Chicago, IL The Question The events leading to the acquisition of Fisher Body by General Motors (GM) were said by Benjamin Klein, in a paper published in 1998, to be [p]erhaps the most extensively discussed example in the economic literature of a hold-up due to the presence of specific investments (Klein, 1998, p. 241). Joel Trachtman, discussing opportunistic behavior in 1997, refers to the classic example of Fisher Body and General Motors (Trachtman, 1997, p. 521). More recently, in 2003, Douglas Baird noted that the merger of Fisher Body and GM had become the paradigmatic example of vertical integration (Baird, 2003, p. 24). Writing in 2004, Hideshi Itoh and Hodaka Morita refer to the famous General Motors- Fisher Body example (Itoh and Morita, 2004, p. 2). And there are many other references of a like nature. Certainly, as Oliver Williamson has correctly said, this example has been widely used (Williamson, 2002, p. 182). The problem with this widely used example is that the events, so minutely described, never happened. In this paper, I will consider what it is about the conduct of economics that led so many able economists to choose error rather than truth. 2. The Tale The first reference I have found to opportunism in the relations of Fisher Body and GM is contained in a paper by Benjamin Klein, Robert Crawford, and Armen Alchian, Vertical Integration, Appropriable Rents and the Competitive Contracting Process (Klein et al., 1978). This paper, as the authors say, is largely devoted to discussing the possibility of post contractual opportunistic behavior (p. 297). They tell us that GM became unhappy with the price they paid for bodies, I am greatly indebted to Dr. Ning Wang without whose able research assistance this paper could never have been written. C 2006, The Author(s) Journal Compilation C 2006 Blackwell Publishing Journal of Economics & Management Strategy, Volume 15, Number 2, Summer 2006,
2 256 Journal of Economics & Management Strategy calculated in accordance with the provisions of the year contract with Fisher Body in which price was set on a cost plus 17.6% basis (where cost was defined exclusive of interest on invested capital) (p. 309). This assertion, even if true, has nothing to do with post contractual opportunistic behavior. However, they then say that Fisher refused to locate their body plants adjacent to GM assembly plants, a move GM claimed was necessary for production efficiency (but which required a very specific and hence possibly appropriable investment on the part of Fisher) (p ). What they apparently had in mind was that, after Fisher Body had constructed the body plants, GM could reduce the price they paid for bodies to a level that would cover the costs of running the plants but would not compensate Fisher Body for their investment in plant and equipment that had no value except for making bodies for GM. Given this possibility, Fisher Body would be reluctant to locate their plants adjacent to GM assembly plants and would locate them elsewhere in order to be available to make bodies for other automobile manufacturers. Klein et al. (1978) concluded that [by] 1924, General Motors had found the Fisher contractual relationship intolerable and began negotiations for purchase of the remaining stock in Fisher Body, culminating in a final merger agreement in 1926 (p. 310). Although the paper by Klein et al. (1978) was much cited (226 times) in the 10 years after publication, the example of Fisher Body and GM attracted little attention. It was referred to on only five occasions in this period. Three articles refer to but do not discuss it (Crocker, 1983; Anderson, 1985; Joskow, 1985). Only in one paper was there any real interest in this example and this only briefly. This is what was said: the more specialized a firm s investments, the more it entraps itself...fostering opportunistic behavior among the customers. For example, in the 1920s, Fisher Body then an independent firm invested large amounts in presses used to stamp parts for General Motors. Once it had committed itself to such specialized equipment, GM was able to opportunistically renegotiate a better contract (Pennings et al., 1984, p. 308). This paper correctly states the argument of Klein et al. (1978) that a supplier to GM that installed specialized equipment for this purpose, laid itself open to subsequent opportunistic actions by GM but it also states, incorrectly, that GM did act opportunistically. The argument of Klein et al. (1978) was that Fisher Body was able to avoid this outcome, at least in part, by not locating their plants close to GM assembly plants. There was, however, one paper that included an extensive discussion of the Fisher Body GM example, but this was by Benjamin Klein, one of the authors, along with Crawford and Alchian, of the original paper on postcontractual opportunistic behavior. In a paper on the subject of why wages are rigid, Klein (1984), to illustrate his argument,
3 The Conduct of Economics 257 uses the example of Fisher Body and GM. Since Fisher Body had to make a highly specific investment in stamping machines and dies...a long term (10-year) fixed formula price contract was negotiated with the price set equal to cost plus 17.6% (pp ). But, he continues, even if the price is effectively fixed, a buyer may be able to hold up a seller who has made a buyer-specific investment by threatening, unless some price adjustment or side payment is made, to vary quantity demanded, including the threat of complete termination. To prevent this, the...contract included an exclusive dealing clause, whereby GM agreed to buy over the period of the contract all their closed bodies from Fisher. This arrangement significantly reduced the possibility of GM acting opportunistically after Fisher made the specific investment in production capacity (p. 335). However, in the GM Fisher case, omissions in the contract were glaring and caused problems almost immediately. First, although the price was set on a cost-plus basis, cost was defined exclusive of interest on invested capital. Given the absence of a capital cost pass through, Fisher shifted toward a lowcapital-intensity form of production with resulting higher prices to GM. In addition, because transportation costs were reimbursable as part of the price formula, Fisher refused to locate their body plants adjacent to GM s assembly plant,...in an attempt to prevent such problems, the contract included provisions that the price charged could not be greater than Fisher charged other automobile manufacturers for similar bodies. However, this...clause proved to be ineffective, apparently because of the difficulty of defining what is similar (id). It is also said in a footnote that there were provisions for compulsory arbitration in any dispute regarding price but these provisions also proved ineffective (id). What is unexpected is that this account differs in an important respect from what was said by Klein in the paper written jointly with Crawford and Alchian (Klein et al., 1978) published seven years earlier. In that paper, Fisher Body located its plants away from GM assembly plants because it was reluctant to locate them where it would be subject to possible opportunistic behavior on the part of GM. In this account, GM incentive to act in this way was reduced because GM agreed to buy all its bodies from Fisher during the 10-year period of the contract. However, omissions in the contract were glaring, and caused problems almost immediately (Klein, 1984, p. 335). They allowed Fisher Body to act opportunistically by locating its plants away from the GM assembly plants, which raised its costs and therefore its profits under the cost plus 17.6% pricing formula. Klein also says, which is not mentioned in the jointly written paper, that Fisher Body acted opportunistically by using a labor-intensive method of production, which raised its costs and, through the operation of the pricing formula, its profits (id). Klein
4 258 Journal of Economics & Management Strategy concludes that these contractual problems in the relations of Fisher Body and GM led in 1926 to their merger (id, p. 336). A puzzling feature of this tale is that during the whole period in which Fisher Body was said to be taking these actions harmful to GM, it owned 60% of the stock of Fisher Body. It is true that up to 1924, this stock was placed in a voting trust, details of which I have discussed elsewhere (Coase, 2000). But the trust ceased to exist in Klein et al. (1978), after noting the purchase in 1919 by GM of 60% of the stock of Fisher Body, state: However, as demonstrated by future events, the Fisher brothers clearly seem to have maintained complete control of their company in spite of this purchase (Klein et al., 1978, p. 308). But the Fisher brothers retained control of their company because, of course, they did not take these actions harmful to GM. This paper by Klein on Rigid Wages was cited six times up to 1988, but in none of these papers in which it was cited was there any mention of the example of Fisher Body and GM. 3. The Yale Conference In the 10 years following the publication of the paper by Klein et al. (1978) on postcontractual opportunistic behavior, as we have seen, the example of Fisher Body and GM excited little interest. What ultimately led to its widespread use seems to have been the result of some remarks I made at a conference held at Yale in 1987 to celebrate the fiftieth anniversary of the publication of my paper, The Nature of the Firm (Coase, 1937). At this conference, I explained that the ideas in that paper had been conceived during a visit to the United States in I had studied at the London School of Economics (LSE) for a Bachelor of Commerce degree. As I had passed the examinations for the first year of university work while still at school (high school as it would be called in the United States), after completing the course work for the degree at LSE, I had a year to spare until I could graduate. I then had a piece of luck. I was awarded a Cassel Travelling Scholarship by the University of London for the year I decided to spend it in the United States studying the problem of vertical and lateral integration in industry. Although I visited some universities, I spent most of my time visiting businesses and industrial plants. What is relevant for this paper is that, while there, I developed essentially the same argument for vertical integration as did Klein et al. (1978) some 46 years later, although without their sophistication. This is understandable because I had not studied economics at LSE and had picked up what I knew 1. The account that follows is largely based on Coase (1991).
5 The Conduct of Economics 259 about economics from discussions with a fellow commerce degree student, Ronald Fowler, with students who were economics specialists and through attendance at a seminar with Arnold Plant, who was a Professor of Commerce. However, having developed the argument that asset specificity would expose a firm to the risk of opportunistic behavior and therefore lead to vertical integration to avoid it, I finally concluded that it was not an important factor influencing the structure of industry. Fortunately, Ronald Fowler preserved some letters that I sent to him in In them I discussed my thoughts as I wrestled with the problems that I was investigating. As Fowler had some difficulty in understanding my argument about asset specificity leading to opportunistic behavior, I set out my argument in different words at different times. Here is what I said in a letter dated March 24, 1932: The case I am considering is this. Suppose the production of a particular product requires a large capital equipment which is, however, specialized insofar that it can only be used for the particular product concerned or can only be readapted at great cost. Then the firm producing such a product for one customer finds itself faced with one great risk that the customer may transfer his demand elsewhere or that he may exercise his monopoly power to force down the price the machinery has no supply price. Now this risk must mean that the rate of interest paid on this capital is that much higher. Now, if the consuming firm decides to make this product this risk is absent and it may well be that the difference in capital costs may well offset the relative inefficiency in actual operating (Coase, 1991, p. 43). However, I ultimately came to reject the existence of this risk as an important reason for vertical integration as a result of discussions I had with businessmen. They were unimpressed by my argument. They pointed out that if equipment was required solely for one particular customer, the cost would normally be reimbursed by that customer. They told me of other contractual devices that could be used to handle the problem, although unfortunately I do not mention in my correspondence with Fowler what they were. At any rate, opportunism in connection with asset specificity did not normally pose any problem and certainly not one that would call for vertical integration. It is not therefore surprising that this argument is not mentioned in my paper, The Nature of the Firm. When I came to write my lectures for the Yale conference, I did not dispute what Klein et al. (1978) said about the example of Fisher Body and GM but I treated it as an exception to what normally happened. Their tale was made more plausible for me because I seemed to remember that an executive at GM in 1932 had told me that they had merged with Fisher Body to make sure that their body plants were
6 260 Journal of Economics & Management Strategy placed adjacent to GM assembly plants. Nonetheless I accepted what the businessmen had told me was the normal practice, and therefore concluded that what Klein et al. (1978) had said had happened in the example of Fisher Body and GM, although no doubt correct, had no general lesson. This view was strengthened by a visit I paid to the A.O. Smith plant in Milwaukee while I was in Chicago. There I saw steel strip converted into automobile frames, mainly for GM, by a completely automated process. Much of the machinery was specific for the GM frames. 2 But the relations of A. O. Smith and GM were harmonious and there was no talk of any merger of GM and A. O. Smith (Coase, 1991, p ). After my return from the United States, I continued to think about the determinants of the structure of production. In some notes of mine, (probably written in Dundee in 1934), can be found a strand of thought which would again strengthen my belief about the unimportance of opportunism as affecting the organization of industry. In a discussion of fraud, I said that a firm committing fraud would have to take into account the future loss of custom that would result. Opportunism is analogous to fraud (and may indeed involve fraud). I concluded that the incentive for opportunistic behavior is usually checked by the need to take account of the effect on future business. In the case of A. O. Smith and GM, it is obvious that neither firm would want to jeopardize their relationship by such behavior and they did not. That Fisher Body engaged in such behavior was not typical. In my Yale lectures I also mentioned an investigation of longterm supply contracts that I made in What surprised me then was finding how incomplete the contracts were. What was obvious was that the relations between what were clearly independent firms were governed, in part, by informal relations outside the formal contract. No one commented on this passage and I mention it now because the information that I received was very reliable and what it disclosed seems to me extremely important. Such incompleteness, as was found in these contracts, would not commonly exist unless opportunism was rare. I did not explain what the circumstances were that led to this investigation. I will now. In 1945, I was employed in the Central Statistical Office, part of the Offices of the (British) War Cabinet. In 1945, the Economic Section of the War Cabinet Office was considering how to implement the White Paper on Employment Policy of James Meade, in the Economic 2. For a detailed discussion of the A. O. Smith plant, see Making Automobile Frames Automatically, Iron Trade Review, August 23, 1928, a paper that appeared four years before my visit. For comments and additional details, see Chase (1930), published two years before my visit.
7 The Conduct of Economics 261 Section, thought that the information in long-term supply contracts might be of assistance in estimating the future demand for labor. A sample of such contracts was obtained. As you can imagine, an office headed by Winston Churchill in 1945 had no difficulty in securing the full cooperation of firms. I was given the job of looking at the contracts to see if they would be helpful for Meade s purpose. I soon found that their incompleteness meant that they would not be helpful. I so reported and went back to my regular job of handling statistics of guns, tanks, ammunition and such like. At the time, I realized the puzzle that this incompleteness presented for the theory of the firm but I am sure that its relevance for an assessment of the importance of opportunistic behavior never occurred to me. However, when I came to prepare my Yale lectures I remembered this episode and it made me more confident in my view that opportunism was not a major factor determining how industry was organized. When the proceedings of the conference were published, first in a journal (in 1988) 3 and later as a book (in 1991), 4 I was surprised to find that a paper by Klein (1991) had been added that had not been presented at the conference and which was devoted to disputing what I had said about opportunism, his argument illustrated by the example of Fisher Body and GM. No example other than that of Fisher Body and GM is referred to or discussed and this example is used continuously. Of the 13 pages that make up Klein s paper, 12 contain a discussion of various aspects of the relations of Fisher Body and GM. The only page without a reference to these relations is the one giving the conclusion of the paper. Klein (1991) did not discuss what I had said. He dismissed it:...coase s rejection of the opportunism analysis is based upon too simplified a view of the market contracting process and too narrow a view of the transaction costs associated with that process. A more complete analysis of how vertical integration solved the opportunistic behavior problem in the Fisher Body GM case provides insight into the nature of the transaction costs that are associated with the market contracting process and how vertical integration reduces these costs. The primary transaction costs saved by vertical integration are not the ink costs associated with the number of contracts written and executed but, rather, are the costs associated with contractually induced hold-ups. The analysis indicates that hold-up potentials are created not solely from the existence of firm-specific investments, but also from the existence of the rigidly set long-term contract terms that are used in the presence 3. Journal of Law, Economics, and Organization (1988). 4. Oliver Williamson and Sidney Winter (eds.), The Nature of the Firm: Origins, Evolution and Development (1991).
8 262 Journal of Economics & Management Strategy of specific investments (Klein, 1991, p ). Later, Klein says that although Fisher could have taken advantage of many imperfectly specified terms of the contractual arrangement, such as delivery time or quality characteristics, Fisher effectively held up GM by adopting a relatively inefficient, highly labor-intensive technology and by refusing to locate the body-producing plants adjacent to GM assembly plant (p ). I did not see Klein s paper until it was published and had therefore no opportunity to correct its errors or to comment on its approach. Klein (1991) says, for example, that Coase in 1937 and again now has incorrectly identified the costs of using the market mechanism with the narrow transaction costs of discovering prices and executing contracts (p. 221). I have never so confined the scope of transaction costs. For example, in my letter to Fowler of March 24, 1932, (reproduced in the lectures on which Klein was commenting), I discussed the example of a supplier who had invested in equipment which exposed him to the risk of subsequent opportunistic action (although I did not use the phrase). I argued that if such a risk existed, it would lead to an increased cost of capital to compensate for its existence. Whether this is the best way of looking at this problem I do not know. But, at any rate, it was not ignored. But the important difference between Klein and me was due to a difference in our perception of the facts. Klein (1991) thought that the primary transaction costs saved by vertical integration...are the costs associated with contractually induced hold-ups (p ). Klein instanced Fisher Body s action in locating its plants away from GM assembly plants and using a more costly labor-intensive method of production. I relied on my discussions with businessmen, the harmonious relations of A. O. Smith and GM, and an investigation of longterm supply contracts in Klein countered my example of A. O. Smith and GM by saying that there appears to be significantly greater economies of scale in producing automobile frames than producing automobile bodies (id, p. 224). Klein does not say on what information he bases this conclusion or why it is relevant. All I could say was that I had seen a plant which, if Klein et al. (1978) were right, would have made opportunistic behavior a likely outcome but there had been none. And there the matter rested. What followed next is not at all what I expected. 4. The Classic Example Emerges My remarks about the limited significance of the Fisher Body GM case were almost totally ignored in the years immediately following the Yale
9 The Conduct of Economics 263 conference. Up to the year 2000, some 22 papers repeated part or all of the account in the original paper by Klein et al. (1978). 5 Many books repeat the original story. Perhaps the most influential of these accounts was that in Williamson s The Economic Institutions of Capitalism: Firms, Markets, and Relations Contracting (1985). In that book, published two years before the Yale Conference, under the heading, A case study, Williamson (1985, p ) repeats, without reservation, the account in the paper by Klein et al. (1978). Among textbooks that use the Fisher Body GM tale were those by Tirole (1988, p. 33), Carlton and Perloff (1990, p ), Milgrom and Roberts (1992, p. 37), Ricketts (1987, p ), and Salanié (2000, p. 181). Probably the most important paper was that by Klein (1998) on The Holdup Problem in the New Palgrave Dictionary of Law and Economics, a source that would be consulted by students for decades to come. The example of Fisher Body and GM is the center piece of that paper and we are told once again that Fisher Body held up GM by locating its plants, in this paper, far away from GM assembly plants and by using an inefficient method of production. It was toward the end of the 1990s, because of its widespread use, that the example came to be called the classic example (Edlin and Reichelstein, 1996, p. 478; Davis, 1998, p. 263; Holmstrom and Roberts, 1998, p. 74), the canonical example (Rajan and Zingales, 1998, p. 419), and the famous example (Che and Hausch, 1996, p. 126; Zingales, 2000, p. 1637). Its truth seemed to be firmly established. As Ramon Casadesus-Masanell and Daniel Spulber, writing in 2000, said, the Fisher Body example has become an essential ingredient in courses on contract theory, industrial organization, the economics of organization, and management strategy (Casadesus-Masanell and Spulber, 2000, p. 72). 5. The Classic Example Examined Armen Alchian was an economist whose work I greatly admired. Benjamin Klein I had known as a very capable student. Robert Crawford I did not know. It never occurred to me that these economists would misstate the facts. Therefore, as I explained earlier, I accepted as correct what they said about the example of Fisher Body and GM. But when I came to give my Yale lectures, I treated it as an exceptional case. However, as we have seen in the previous section, what I had treated as an exceptional case came to be regarded as an important example of what would commonly happen. What I had said in my Yale lectures was disregarded. It was accepted that asset specificity would commonly 5. Detailed citation information about the 22 papers is available on request.
10 264 Journal of Economics & Management Strategy lead to opportunistic behavior, and, to avoid it, to vertical integration. The classic example was the case of Fisher Body and GM. Over the years, the general acceptance of this classic example as correct made me increasingly uneasy and I decided in 1996, with the aid of Richard Brooks, to find out exactly what had happened. It soon became apparent that the generally accepted account gave a completely false picture (Coase, 2000, p. 21). At the meeting in 1997 of the International Society for the New Institutional Economics, I announced that I was making such an investigation. This led to my learning that Robert Freeland of Stanford University had made a similar investigation and had concluded that the standard account was grossly inaccurate and misleading (Freeland, 2000, p. 34). Freeland s view had added weight because he had made a detailed historical study of the administration of GM and was therefore extremely well informed (Freeland, 2001). I submitted a paper to the Journal of Law and Economics, as also did Freeland. When the papers reached the proof stage, we learned that Ramon Casadesus-Masanell and Daniel Spulber of Northwestern University had also written a paper in which they showed that the account of the relations between Fisher Body and GM that constituted the classic example of asset specificity leading to opportunistic actions was largely inaccurate (Casadesus-Masanell and Spulber, 2000, p. 68). It was an extraordinary coincidence that these three independently written papers, appearing in the same issue of the Journal of Law and Economics, all reached the same conclusion: the opportunistic actions supposedly carried out by Fisher Body never happened. The main purpose of the original paper by Klein et al. (1978) was to explore one particular cost of using the market system the possibility of postcontractual opportunistic behavior (p. 297). When they came to interpret the terms of the 1919 contract between Fisher Body and GM as they understood it, their explanation is confined to the problem of handling possible opportunistic behavior by one or the other. After pointing out that General Motors agreed to buy substantially all its closed bodies from Fisher, they say, this exclusive dealing arrangement significantly reduced the possibility of General Motors acting opportunistically by demanding a lower price for the bodies after Fisher made the specific investment in production capacity (p. 309). However, large opportunities were created by this exclusive dealing clause for Fisher to take advantage of General Motors, namely to demand a monopoly price for the bodies. Therefore, the contract attempted to fix the price which Fisher could charge for the bodies (p. 309). They later tell us that these complex contractual pricing provisions did not work out in practice (p. 309). However, it is unnecessary to discuss whether what they say
11 The Conduct of Economics 265 is true. I know of no evidence that the possibility of opportunistic behavior ever entered the minds of those negotiating the contract. What seems to have influenced Durant, the president of GM (the main negotiator), has been described by Chandler and Salsbury (1971): The postwar expansion plans convinced Durant and the Finance Committee [of GM] of the absolute necessity of having an assured control over GM largest and most critical supplier. They simply could not afford to have the Fishers fail to renew their  contract on acceptable terms. Any doubts...were quickly resolved when [it was] learned that automobile manufacturers in Cleveland...had opened negotiations to form a partnership with the Fishers in which they (the Fishers) would control (p. 465). The account by Freeland (2000) and that by Casadesus- Masanell and Spulber (2000) concur that, for GM, the main purpose of the contract was to obtain an assured supply of bodies and to secure the services of the Fisher brothers. The preoccupation of Klein et al. (1978) with opportunism led to a failure on their part to discover the real reasons why the contract took the form it did. The opportunistic actions of Fisher Body were said to be to hold up GM by locating their body plants away from the assembly plants of GM as Klein et al. (1978) claimed, and by using an inefficient laborintensive method of production as Klein (1984) claimed. I decided to investigate whether Fisher Body took these actions. Richard Brooks found that all the body plants built in the period were located near the GM assembly plants (Coase, 2000, p ). Furthermore, in a memorandum recording a discussion with GM executives in 1922, it was Fred Fisher (the senior of the Fisher brothers) who suggested that the body plants be built on Chevrolet property (Coase, 2000, p. 29). Regarding the use by Fisher Body of an inefficient, highly laborintensive production process (Klein, 1991, p. 215), given that Fred Fisher had been made a director of GM in 1921 and in 1922, a member of the executive committee, while in 1924, Charles and Lawrence Fisher were added both to the board of directors and the executive committee of GM, it is inconceivable that Fisher Body acted in this way. Information that came to light after these three papers were published strengthens this conclusion. Benjamin Klein was able to obtain from GM a copy of the 1919 contract they made with Fisher Body that previously had not been available. Freeland had been unable to obtain a copy of the contract. Richard Brooks, acting as my research assistant, was not able to find the contract in the GM archives and Spulber was similarly unsuccessful. However, the terms of the contract are now available and they make it clear that the account by Klein et al. (1978) and in subsequent papers by Klein (1984, 1991, 1998) is extremely inaccurate.
12 266 Journal of Economics & Management Strategy For example, the statement about Fisher Body using inefficient methods of production was without question untrue. The contract stated that Fisher Body will use the most modern, efficient and economical methods, machinery and devices consistent with good workmanship Given the positions occupied by the most senior of the Fisher brothers in the GM organization, there can be no question that this provision of the contract was observed, quite apart from the fact that it was in the interest of Fisher Body to use the most efficient methods because this would reduce the cost of supplying its customers other than GM. Had Fisher Body in fact used an inefficient method of production, GM engineering staff would have detected it and their law department would have taken steps to enforce the terms of the contract. But, of course, Fisher Body never acted in this way. The close relationship that existed between the Fisher brothers who ran Fisher Body and the management of GM also makes nonsense of the claim by Klein et al. (1978) that by 1924 GM found their contractual relations with Fisher Body intolerable (p. 310). Further evidence that the relations were not intolerable was the appointment in 1925 of Lawrence Fisher to be head of Cadillac, one of the most important divisions of GM (Chandler and Salsbury, 1971, p. 577). Fred Fisher, in fact, became the best friend of William Knudsen, the head of the Chevrolet division (Beasley, 1947, p. 141). The high opinion held by GM of the contribution of the Fishers is made clear by the fact that when Sloan retired in 1956, the choice of his successor as president of GM, as Lammot du Pont saw it, was between Lawrence Fisher and William Knudsen (who was in fact chosen) (Freeland, 2001, p. 78). The availability of the contract shows how inaccurate the description by Klein et al. (1978) was of the contractual relationship in other respects. They state that the price was set on a cost plus 17.6% basis (where cost was defined exclusive of interest on invested capital) (p. 309). This led Klein (1984, p. 335) to argue that given the absence of a capital cost pass through, Fisher shifted to a low-capital-intensity form of production with resulting higher prices to General Motors. However, we now know that the contract states that cost includes interest on borrowed money, prorated according to the ratio of gross sales to General Motors to the entire gross sales of the Fisher Company. 7 The clause in the contract about the methods of production would have ruled out the employment of a low-capital-intensity form of production and the fact that cost included interest on borrowed money would have eliminated the motive for doing so. 6. The General Motors Fisher Body 1919 Contract, Article III. 7. The General Motors Fisher Body 1919 Contract, Article VI A(e).
13 The Conduct of Economics 267 Klein at al. (1978) also speak of Fisher Body having to make a specific investment in production capacity (p. 309) and Klein (1991) of Fisher Body having to make an investment highly specific to General Motors in the stamping machines and dies (p. 214). This resulted in Fisher Body being exposed to possible opportunistic behavior by GM. As a consequence, Fisher Body was reluctant to locate its body plants close to the GM assembly plants (Klein et al., 1978, p ). However, a clause in the 1919 contract stated that a die and special tools shall be manufactured for GM at cost plus 17.6% of such cost. The contract makes clear that Fisher Body would be repaid by GM for its specific investments and therefore had no need to take any actions to avoid opportunistic actions by GM. How this ignorance of the terms of the 1919 contract can be reconciled with the footnote found in Klein et al. (1978, p. 308) and in all papers by Klein (1984, 1991, 1998, 2000) on the subject up to 2000, which states that the manufacturing agreement [called contractual agreement in 2000] between General Motors and Fisher Body can be found in the minutes of the Board of Directors of Fisher Body Corporation for November 7, 1919, which statement is correct, I leave unsolved. Freeland (2000), in his paper, confirms, with a wealth of detail, that Fisher Body did not hold up GM. But he contributed more to our understanding than this. Richard Brooks had shown that the Fisher Body plants in the period had not been located away from the GM assembly plants but close to them. This bothered me because I seemed to remember that an executive in GM had told me in 1932 that GM had merged with Fisher Body to make sure that the body plants were located near the GM assembly plants. My puzzle disappeared when I read in Freeland s paper that there had been a serious dispute in 1925 about the location of a body plant. To handle growing Buick sales, GM wanted a new body plant to be built in Flint, Michigan, while Fisher Body wanted to expand production in its Detroit plant. After the merger in 1926, the Flint plant was built and the Detroit plant closed down. It was undoubtedly this episode that had occurred a few years before that the executive had in mind when he spoke to me in 1932 and said that the merger was necessary to make sure that the body plants were located near the assembly plants (Coase, 1991, p. 71). Freeland s (2000) paper also contributed in another way. He investigated what happened after the merger in One episode he described is of great interest (p ). As a result of GM acquiring Fisher Body, the Fisher brothers became extremely wealthy. Using their GM stock as collateral to speculate on the stock market, they became even wealthier. Then the Great Depression came and they found themselves with debt that they could pay off only by selling their GM stock. In 1931,
14 268 Journal of Economics & Management Strategy GM and Opel (a foreign subsidiary) came to their aid and bought their GM stock. When the stock market recovered, the Fisher brothers sought to regain some of their previous wealth. They asked to be given an option to purchase GM stock. Negotiations followed that the Fisher brothers found unsatisfactory. In March 1934, they announced an ultimatum that they were going to leave in a body forthwith if something was not done (id, p. 58). Their action was regarded by officials at GM and Dupont (the main stockholder of GM) as almost a hold-up (id). After difficult negotiations, a compromise was reached and the Fisher brothers continued with GM. This episode warns us against assuming that hold-ups cannot occur within the administrative structure of the firm. On the other hand, the extraordinary circumstances of life in the Great Depression (of which I learned a great deal on my travels in the United States in ) means that how people behaved then may have no general lesson. The paper by Ramon Casadesus-Masanell and Daniel Spulber (2000) examines in great detail the relations of Fisher Body and GM and comes to essentially the same conclusions as had the other two papers. They point out that the contractual arrangements and working relationship prior to the 1926 merger exhibit trust rather than opportunism (p. 67). They state that the merger was directed at improving coordination of production and inventories, assuring GM of adequate supplies of auto bodies, and providing GM with access to the executive talents of the Fisher brothers (id). The executive talents of the Fisher brothers were particularly important in implementing Sloan s organizational reforms in the 1920s. Sloan required managers capable of coordinating complex operations, making decisions in a decentralized organization, and using common resources effectively (id, p. 100). As the Fishers had worked closely with GM, they were perhaps the best-qualified candidates for the posts Sloan had to fill. In addition, the Fishers brought crucial operational and manufacturing experience (id). Casadesus-Masanell and Spulber also undertook an investigation of the location of the Fisher Body plants and came to the same conclusion as had Richard Brooks: contrary to the statement of Klein et al. (1978), Fisher Body plants had been located close to the GM plants prior to the merger in They give many other details about the relations of the managements of Fisher Body and GM, something that Klein et al. (1978) had thought it unnecessary to investigate, and which, had they done so, would have led them to a very different conclusion. What is clear is that all parts of the tale that make up the classic example of asset specificity leading to opportunistic behavior are wrong. The terms of the original contract were not crafted to deal with the possibility of opportunistic behavior. The terms, as stated
15 The Conduct of Economics 269 by Klein et al. (1978) were inaccurate. The opportunistic actions that were supposed to have been taken by Fisher Body, the locating of the body plants away from the GM assembly plants and the use by Fisher Body of inefficient methods of production, never happened. The relations between Fisher Body and GM never became intolerable. The conclusion is inescapable. The classic example was a product of the imagination. 6. The Response Examined Accompanying the three critical papers in the same issue of the Journal of Law and Economics was a reply by Klein (2000), Fisher General Motors and the Nature of the Firm. In this paper, Klein presents a completely different version of the facts from that found in the original paper by Klein et al. (1978) and in Klein s (1984, 1991, 1998) subsequent papers, including that in the New Palgrave Dictionary of Law and Economics, published only two years before. What was true in 1998 became false in In the original paper by Klein et al. (1978), we were told that Fisher Body held up GM by refusing to locate their plants close to the GM plants and that by 1924, General Motors had found the Fisher contractual relationship intolerable... (p. 310). In a later paper, Klein (1984) tells us that omissions in the  contract were glaring and caused problems almost immediately (p. 335). He adds that Fisher Body held up GM not only by locating its plants inappropriately but also by using an inefficient low capital intensity form of production (id). This tale about what happened in the period up to 1924 (or some version of it) was repeated in innumerable papers and books. It became the classic example of asset specificity leading to opportunistic behavior. In 2000, Klein tells a completely different story. He says that the evidence unambiguously demonstrates that while the contract that governed the relationship between Fisher Body and GM initially worked well, the contract broke down in (Klein, 2000, p. 106). Later in his reply, Klein restates this account:... it is crucial to distinguish between the early period of operation, from 1919 to 1924, when the contract functioned well, and the period , when the contract was used by Fisher to hold up GM (p. 110). In his introductory remarks to this paper, Klein says that the facts of the Fisher GM case are shown to be fully consistent with the hold-up description provided in Klein, Crawford, and Alchian (p. 106), although, as we have seen, the statement of the facts has completely changed. Whereas we were told previously that GM found the contractual relations with Fisher Body intolerable by 1924, we are now told that up to 1924 the contract functioned well.
16 270 Journal of Economics & Management Strategy It is not easy to know what to say about a situation like this. Facts are not like clay on a potter s wheel, that can be molded to produce the desired result. They constitute the immutable material that we have to accept. What is clear in Klein s new version of the facts is that the classic example of asset specificity leading to opportunistic behavior has completely disappeared. All that remains of the original tale is the assertion that Fisher Body held up GM. It reminds one of the Cheshire Cat in Lewis Carroll s Alice in Wonderland, whose body vanished, leaving only its grin behind. Freeland (2000), as explained earlier, had disclosed, what Klein had never mentioned and I had not known, that in 1925 there had been a serious dispute between Fisher Body and GM concerning the location of a body plant. GM wanted a new body plant to be built in Flint, Michigan, while Fisher Body wanted to expand production in their Detroit plant. 8 It was a proposal that would have increased the profits of GM and decreased the profits of Fisher Body. What GM was proposing was to change an arrangement that had been in operation for six years (or eight years, if Chandler and Salsbury s (1971) reference to a previous 1917 contract is correct). It was a proposal that Fisher Body would obviously resist, if legally possible, unless it was compensated in some way, particularly as it had large stockholders who, unlike the Fisher brothers, were not concerned with the fortunes of GM and whose interests Fisher Body was under a legal obligation to protect. Klein s view that Fisher Body s response to the GM proposal constituted a holdup seems to me a very strange use of the term. Are the coach passengers who resist the highwayman holding up the highwayman? Klein attempted to bolster his case by pointing to the many errors that he claimed I had made. Consider the following quotation: One cannot examine the record without concluding that from GM s perspective the contract with Fisher Body was not working during and that this motivated vertical integration. Coase brushes over this testimonial evidence by describing the situation in 1925 as one where GM was dissatisfied with the 1919 agreement. In fact, GM was much more than merely dissatisfied....moreover, Coase does not explain why GM was dissatisfied with the 1919 agreement. He only vaguely notes that Fisher paid less attention to the needs of General Motors than General Motors would have liked. Coase tells us neither in what ways Fisher did not consider the needs of GM nor exactly how the contractual arrangement failed in these respects (Klein, 2000, p. 115). 8. Klein (2000, p. 137) states that it is inexplicable that Casadesus-Masanell and Spulber do not mention this 1925 episode. But as Klein had never mentioned this episode in all his writings and as Casadesus-Masanell and Spulber had not seen Freeland s paper, from which I had learned about it, it is not inexplicable at all.
17 The Conduct of Economics 271 This is a complete misrepresentation of what I wrote. The paragraph before the one from which Klein quotes starts, In November 1920 (Coase, 2000, p. 24). The paragraph after it starts In 1921 (id). It is obvious that in the paragraph from which Klein quotes I was not writing about the situation in 1925 but the situation in the early 1920s. Klein complains about my vagueness concerning the character of General Motors dissatisfaction with the situation. I thought I indicated what this was when I said in the next paragraph that Fred Fisher was appointed to the executive committee of General Motors in 1922 and when I quoted Chandler and Salsbury s (1971) statement that this was done to get him further involved in making the broad decisions about production, products design, output and pricing of General Motors products that inevitably affected the work of his own organization (p. 576). Klein (2000) says that Coase also dismisses the Flint plant episode as merely a disagreement over financing (p. 117). This is untrue. While I say that there may have been other reasons for Fisher Body s reluctance to transfer the production of Buick from their Detroit plant to a new plant in Flint, I thought the main reason was that it would have made it more costly to supply their other customers. I also noted that the interests of the minority stockholders had to be considered (Coase, 2000, p. 25). I made no mention of financing. The remark of mine that Klein cites had nothing to do with the 1925 dispute. Klein had given Sloan s testimony in the Dupont antitrust case as his authority for his claim that Fisher Body located its plants away from GM assembly plants. I pointed out that Sloan only spoke about Fisher Body s reluctance to finance the construction of the plants (id, p. 28). Klein (2000) also says in a footnote that Freeland thanks Coase for pointing out to him that Sloan s testimony is subtly ambiguous about whether the cost-plus provisions were in effect after 1924 (p. 120). This is false. It is difficult to understand how Klein came to make this mistake. What Freeland (2000) did was to thank me for pointing out the reference to the cost-plus contract in the Notice to Stockholders of the Fisher Body Corporation of 1926 (p. 48). This had nothing to do with Sloan s testimony. Quite apart from the fact that I do not refer to Sloan s testimony, Klein s remark has the effect of giving an incorrect impression of my position. I believe that the cost-plus contract was in effect in 1924 and, in my view, the 1926 Notice to Stockholders confirms this. Did Fisher Body hold up GM? My answer is that they did not. The original claim in the paper by Klein et al. (1978) stands discredited. The 1925 dispute that Klein substitutes was, in my view, a normal business dispute that was settled amicably in a matter of months. It is true that the resolution of this dispute became part of the negotiations for the acquisition by GM of the 40% of the shares of Fisher Body that it did not
18 272 Journal of Economics & Management Strategy already own. But GM wanted to acquire these shares long before 1925, as is made clear by Pierre du Pont s letter to Fred Fisher in July, 1924: I hope that you and your brothers will feel that Fisher Body and General Motors are really one and...that you will take chances on associating yourselves permanently with the development. I see no trouble from awaiting the development of a contract between the two companies in order to determine relative value of shares... 9 Had the 1925 dispute never happened, I have no doubt that the acquisition would have taken place, although this dispute may well have affected the timing. The three critical papers showed that the generally accepted tale of Fisher Body holding up GM was untrue. The response of Klein to this finding was to abandon this original tale and substitute another, in which Fisher Body in 1925 wanted to expand production in its Detroit plant rather than build a new plant in Flint, Michigan, and, to preserve the theory by treating the dispute as a hold-up. I thought it to be an ordinary business dispute, the reluctance of Fisher Body to build the plant reasonable, indeed, legally obligatory, and the description of Fisher Body s action as a hold-up forced. It certainly will never become the classic example of a hold-up. 7. The Extraordinary Year 2000 I called the appearance in the same issue of the Journal of Law and Economics of three independently written papers, all disputing the accuracy of the generally accepted account of the Fisher Body s actions, an extraordinary coincidence. 10 But the coincidence was even more extraordinary. In the same year, 2000, in two other journals, were also published two independently written papers with the same conclusion. The first of these papers, by Yoshiro Miwa and J. Mark Ramseyer (2000) appeared in the Michigan Law Review. It investigated the role of relationship-specific investments (RSI) in influencing the organizational structure of production, illustrated by a study they made of the Japanese automobile industry. They point out that RSI theory tells us that if production technology is standard and contracting straightforward, firms will solve any problems by contracts (p. 2667). As this is exactly what happened in the Japanese automobile industry, they conclude, modestly, that perhaps RIS theory explains a narrower band of phenomena than we had thought (p. 2667). 9. Letter from Pierre du Pont to Fred Fisher (July 28, 1924) (Longwood Manuscripts, Group 10, Series A, Papers of Pierre S. du Pont, Hagley Museum & Library, Greenville, Del.) 10. This paper, p. 264.
19 The Conduct of Economics 273 Miwa and Ramseyer (2000, p. 2638) note the major influence of Klein et al. (1978) and Williamson in the formation of RSI theory, and this leads them to examine the example of Fisher Body and GM. They describe what happened according to Klein et al. (1978): After 1919, car makers started to make standardized coaches out of steel. Fashioning these steel coaches required dies. In turn, these dies cost large sums, and could be used only for specific models. Now, the assembler and coachmaker faced little prospect of investing in an asset that paid off only within the relationship. As such, the asset generated appropriable quasirents: if the coachmaker bought the die, the assembler could threaten to end the relationship in order to shift terms of the deal in its favor. Rather than risk this opportunism, reason Klein et al., assemblers and coachmakers integrate vertically (p ). Miwa and Ramseyer (2000) point out that there are problems with this account: If relation-specific dies were the problem, GM could have mitigated it contractually by owning the dies a tactic modern car companies routinely use (p. 2642). In fact, as I learned in 1932, this was the usual practice in all industries (Coase, 2000, p. 18). And as we now know, GM did own the dies. Furthermore, Miwa and Ramseyer (2000) note that GM owned 60% of the stock of Fisher Body and could have prevented Fisher Body from taking these harmful actions. They also note that GM seems to have done perfectly well with independent suppliers for other specialized products (p. 2642) and here they instance my account of A.O. Smith relations with GM (p. 2643). The account of Klein et al. (1978) was not credible. The second of these papers published in 2000 that also rejected the generally accepted tale about Fisher Body and GM was written by Helper, MacDuffie, and Sabel (2000). They demonstrate its weakness by showing its inconsistency with what was happening generally in the American automobile industry. They start with the observation that firms are increasingly engaging in collaboration with their suppliers, even as they are reducing the extent to which they are vertically integrated with them (Helper et al., 2000, p. 443). They note that this is incompatible with the standard theory of the firm, which argues that integration is necessary to avoid the potential for holdups created when noncontractible investments are made (id). By standard theory, they mean the theory enunciated by Klein et al. (1978), which had come to dominate the economics literature. As Helper et al. (2000, p. 452) say: The takeover by General Motors of the Fisher Body Corporation in 1926 has become the canonical example of the logic of the standard argument. This tale, they point out, does not accord with what was happening in the American automobile industry or the part that Fisher Body played
20 274 Journal of Economics & Management Strategy in it. The actions supposedly carried out by Fisher Body occurred at a time when the major automobile manufacturers...were building collaborative relations with suppliers...fisher Body was a pioneer and master of such relations (p. 448). They instance the collaboration between Fisher Body and Hudson during World War I to produce the first cost-effective closed automobile body (p. 457). Later, in 1923 Fisher Body collaborated with the Chrysler design team to produce the curved fenders and bumpers that would eventually come to be associated with the idea of streamlining (id). They also note that Fisher Body even collaborated with a competitor, Briggs Body (p ). What made the Fisher brothers so valuable to GM, apart from their design and engineering expertise, was that they helped GM adopt inside the corporation the collaborative style that Chrysler was using with outside suppliers...the Fishers contributed greatly to the multidivisional corporate structure and system of coordinating committees that Alfred Sloan so masterfully developed to manage GM...This analysis stands the standard account on its head. Instead of seeing the takeover as a response to the threat of opportunism, it presents the amalgamation as an effort to construct a variant, suited to the conditions of GM, of a collaborative supplier system (id, p. 459). They conclude: This is a very different account from the opportunism story: instead of buying Fisher Body because they did not trust the Fisher Brothers, GM bought Fisher Body because they trusted the Fisher Brothers so much that they wanted them intimately involved in managing all of GM s assets (id). With these observations, the destruction of the classical example is complete. 8. The Explanation What has to be explained is why so many able economists in discussing the relations of Fisher Body and GM propagated or treated as true, in papers, books, and in class, statements about them that were inherently implausible and demonstrably false? An easy answer would be to treat it as another case of scientific fraud, similar to the many cases discussed in Judson s (2004) book, The Great Betrayal: Fraud in Science. In these, data were invented or manipulated to support a particular theory. One reviewer, Alan Price (2005), did not find Judson s account surprising: The conclusion is obvious: a few scientists are likely no better and no worse than the few members of the general population who are crooks and charlatans (p. 198). But Price s comment does not answer the question posed at the beginning of this section. In the cases discussed by Judson, the scientists committing the frauds knew what they were doing. They knew that the data they presented as true were, in fact,
The Fable of Fisher Body Revisited Ramon Casadesus-Masanell Daniel Spulber Working Paper 10-081 Copyright 2010 by Ramon Casadesus-Masanell and Daniel Spulber Working papers are in draft form. This working
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