The economic organization of the English East India Company

Liournal of bnomic

Behavior and Organization 4 (1963) 4 (1983) 221-LIB. North-Holland

Gary M. ANIXRSOFZ Auburn Unfumiiry, .&t&um AL 36849, V SA

Robert B. McCORMICK and Robert D. TOILISON Clemson Vniwrsii:y, Clemson, SC 29531, USA Received March 1382, final version received July 1983

Alfred Chandler and Oliver Williamrron pioneered the argument that the invention of the multidivisianal firm in the 1820’9 in the U.S. was a rra@r organizational innovation. In this paper we argue that the organktion~ principles unde$iag the multidivisional firm appear& mu& earl& in history, sp&ifically, in tke organization of the English East India Company. We document the present of multidivisional principles in the l&t India Company, and we argue that, m’ost likely, the Company evolved to a divisional&&i basis because of its monopoly sturus with respect to the sale of Asian goods in Englxxi

1. In&odllction

Ghandier (1966, :‘977) and Williamsc ‘M(1975) are the primary exponents of the argument that the invention of the rlu1tidivisiona.l firm ia the early 1920% in the United States was a rnqior organizational innovation. The multidivisional firm functions as a kiud of miniature capital market. Resources are abcated to divisions c,n a competitive hasis by the firm’s corporate headquarters, which also makes long-range, strategic deciisioqs for the firm as a wholq for example, de&ions concerning future areas for and the product development, location of overall plant qeratidns, appropriate response to government ano’ competitors. Ci4pkll ailocation is ri. function of the compar&.ive profit performance of the valeious divisions. Day.. to-day or operational decisior, making remains ehe responsibility of managers of the divisions of the firm. The multidivisional srgati:ation represents an e&ient adaptation by the firm to the cssts of recourse try the nubside capital market, abwing the: Esm to undertake many 04 the “Jnctiens the capital market is unable to per?orzn as &Gently.

‘l~~i~s~~~ argue llaat the ~~~~~~t~o~ 0,i’the ~~~~~:~d~v~si~t~~~ km in the LJtite.d States was an ~~lrg~.~~~~~~~~~~~~ brea~~~ro~g~ in busyness &story. It is our purpose in this paper to chdfeuge thi:s claim. ‘We believe that ~~~~~ns~~~s account of the nature an,3 functions of the muktidivisional firm k.Bers a us&I anaigrtjGa! tool fix ~~~~~~~~~ the ~~~~~~~~~~~ of a least one firm in the sc:vateeath ard ~gh.t~~n~ zsr;ntuGes,w’bicb would seem to have almost nothing in c4XrmWu F&h Ge%eral Motors or Dupont -- the En~%h East India Company. I here is considerable evidence that this early joint-stock firm displayed ati of the essential characteristics of a mu1tidivisionJ organizatioq ~~hich developed in response TV econsrrticalfy ticaictg&us prcsblems faceu by firms which adopted the same organizationaE f0rm in the We&&3 century. The pqer pr& as fooiIows.In section 2, the Cklandler-Wiltliamson thesis il- eudked. fn se&on 3, some general information on the East India f rrmpany is presen?ed aS nD_ ba&gIoun& In sections 4 the case for the Y1astIndia Company as a mu&division& firm is yreseoted. l;n ration 5, a ~Wory expkning, why the xnuittidivisiocal firm made ifs appearance at thic point in history is developed. A particular problem for the theory will be to ex@n Why hoiders of the ~OIlO$Klfy charter in the Company chose to pursue rents throlagb a verticafly inte-ted fkm rather than ;hrough other contractual arrangements, for exazzple, fr:anchise contracts Finally, some concluding remarks are offered in section 6. Chamdler aad

Bnid tiPI the seniorexecutives ircreased te such an extent that they were utable to handle thek eghtreprelleurial responsibilities efficiently. This situation c;rose when the qxrutiorrs qr tfre enterprise became too m~pfex and too iatricate fir smutl number qf top oflcers to haridle both loqwun, entrepeneurial, and short-mq operc:io~~I activities ’ (Emphasis added.) C%andfer and Williamson argue that ihese problems were overcome to a large: extent by the multidivisiona.1 firm. This innovation came to the fore in Ihe early 192Q’s at General Motors and Dupont. Williamsor, (1975, p. 237) summarizes the characteris:& of the 1~:oitidivisional firm iu this way: (1) The responsibility for operating decisions is assigned to (essentially selfcontained) operati:lg divisions or quasi-firms. a,F,.,” L-.&L nmnPnl VPII~~ .TFF;.-,o~GLLVIIIIJ (3) ThP t,= t&m 1 -..a. dire= .I...” staff at,t&& SXXL&~,2,, uwu ,.-I..:--_-. auv~sui y aiid auditing functions. Both have the effect of securing great:r control over operating division behavior. (3) The general office is principally concerned with straiegic decisions, involving planning, appraisal, and control, includ+g thl: allocation of resources amorg the (competing) operating divisions. (4) The separation of the general ofGce from operations provides general office executives with the psychological commitment to be corcerned with the over311 performance of the organization rather than become absorbed in ttie agair:; of the functional ports. in Williamson’s approach divisional organization reduces costs in tne fir&m. Information problems and the potential for opportunistic beha%r are delimited in this organizational framework. Operating decisions are roade at the divisional level, where managers possess the requisite inforra;ion 10 make day-to-clay decisions. Strategic decisions kre made in a cctntra! ofice, kvhich embodies a planning-coordination m-chanism for resource allocation within the fiLm. This (entral offlice has access, moreover, to an internal auditing and control sq item which allow. s it to monitor and evaluaie thl: perfQnm.tn633 of the various operating units.

As we stress& the C~an~~r-W~~j~so~ studies d’ economic org~~a~o~ are drawn prim&y from Ametim business history kl this pager we seek to demonstmte that the EQ$.s~ East India company! or~e of the Iargest and ino~t far&mg bushiness orgukations in history paior to the nineteenth f;~ltury, is also ant example 01 a mpkx mtitidivi&& organiz~.fion from Sts very founding in MOO.rsased on Williamson’s criteria, .the Eaglish East la&a Compa,.ny was a mu&idivisionaJ enterprise antedating thr: modem agrn;arance of this orgaGz&ion~ form by over 200 yc.ars. Our argument wilt ilot be that the &st k& Co,wpalmy and General Motors are comparable wesibrespect trr:,fines of business or scales of operation. We will argue: that the Ef SW& ~&s&zr~~~of the organizational forms adopted by the two a.mpmks wdasfunction&y t! e same, ad more importantly, that the East India Company’s organization evolved in response to the sam.e type .>f wa’nomic ~robkms that conf%,nted more modern firms who have turned to multidivisional operations.

fin rhc darter of the London East India Company (l&30), two irnporf.ant aspeeta of the Compaq+ organktion were set nut. These were the Court of Csrex3~ttees, c33mposed of twenty-four members of the Company, and the Gen& Couz-& composed of aY shareholders. The Court of Coz~~Gttees eozt&ted of a Governor, a BQJUQ, and ‘ordinary’ members, and served as the main exz&ive organ of the Company.’ The Gener,al Court exc;:rcised a supervk~y role in pdicy-mabe, and possessed &al control in that it could either ratify or alter p&icy throq# majority voting. The members of the COM d Committees were tity merchants, who were directly engaged in sales at honte or reexport of C~mpauy commodities to foreign count:ries. The Gepneri1 Cow% was cxmped of individcafs, who hzid investecl! in thr: Colony but &d not active’byparticipate in itla tradiq operations.

is charar:teristic

of m’~&rh corporations, the Company had what was, intents and purposes, 2 full-time staff of managerial executives in London, Each, week, the Court of Directors met at least once a,ld. often three times. IFinal dsecisions regarding the reports of subcommittees and the contents of dispatches to India were made as the result sf a ballot (a quorum of thirteen directors was required). As many as forty or fifty bal!o!s were taken at a normal meeting [Philips (1940, p. S)]. Zn the eighteenth century a complicated system or committees of directors was maintamed in order to facilitate an efficient division of labor in policy-making; each crlmmittee had its chief clar, who in turn had a slaff of officers (alI full-t&m employees) to conduct committee business. In 1784, the regula; o~fficersemployed at the India House numbered about ‘850[Phih,ps (1940, p. 1(;)I. The Court of Directors, usually in the form of the +rarit)uscommittees, was chiefly responsible for strategic decision making in the firn. For example, the Directors decided where new factories in Asia were to be deweloped, and whether already established factories were to be maintained cr expanded. The Court determined the general pattern of irvestment to be 1.ndertaken by the presidencies in Asia, for example, whether a particular presidency should expand investmsnt in cloth goods or procure agrJ1culture exports of a certain kind, and allocated capital to the presidencies in Asia in the fob,rn of specie for operating expenses and goods for trading capital. The Directors also allocated military protection and decided policy in response to threats from Asian competitors. Basically, the Court oi Directors was responsible for evaluating operational decision making by the presidencies, but did not run the operations in Asia on a day-by-day basis. Beginning in 1683, the Directors organtisd a Secrst Committee (usually composed of three or four members) to d?al with ‘extraordinary political matters’ [Philips (19409 p. 9)j. These include1 the direction of the Company’s naval and milita:ry operai:ions in time of war with native rulers or other European trading powers, the conduct of negotiations with Indian powers. anli the representation of the Company i;r its dealings with Ministers of the British government. The Secret Committee was in charge of the negotiations for the Treaty of Paris .in l”63 at the COAC~USIOA of the Seven Year‘s War insofar as it concerned the Company’s Indian interests. Hn other words! a consititirable proportion of the strategic decision maki ~g As

for

311

um&rtak:n by tfne Cow! of Directon involved the piianning2nd corr~~1 ,jf military operations -- that is, str,~teg~ in 2s original and l!:erai sense. Thg: value of centfaked polizy-making in this, domain is obvious: a ci:hW ii: strat+SFCplaapis a most SmpOp”aYfi j,gl-&le?M,elf S~CCZSS in w.iir.zBut ir is 3.h~

For the reader’s inspection the Company’s organizational chart o\‘er this period., as de~~ibec! by Chaudhuri (1978, p. Xi), is given in fig. I. The Irophisticntion of the Company’s organization is apparent. The c:entral management was divsrced from the day-to-day operations of the presiclencies (discussed below), and WBSprovide? with ample staff support to carry ou’t a planning-c ontroI missios for the company.

Fig. 1

4. The East hdia Company as a mhidivisiona~ firm In analyzing the economic organization

of the East India Company, ‘we f,Alow Williamson’s definitional criteria for 2. multidivisional firm. First, we d :monstrate that the Company was divisir,nJized. d.1. Divisionalization In the early history of the Compaq,

the two principal factories in the Indies trade, Surat and Bantam, functio?ied as separate competing divisions. Ehipping and cash fiow were ilfocated between the factories by the Court of Commikees in London ac$:ording to their relative expected profits. Beginning in 1643, the ovf:rseas adnGnist.ration of the Company was divided. into three presidencies, tlnose at Bengal, Madras, and Bombay. as well a,s a trading establishment in Chi ra iGardner (6972, p. 42,2]. EL& presidnrcy administered a number of separate factories. The scparatpresidencies cormsponded dlrec?ly with the Court of Directors in Lc9nk11 irs well a: &3eloped their own military force:; and kbeir O’+VP c2kds of emplo:izes [F’urber (1976, p. 199)J. Each presidency in Siala was allowed to direct iis countq trading independently.

bndon were also made un the presidency ls~el. The Lendon 1ndi.a. 13[0use was able to nS&e the WJian qxrations ecmcerning future general ~~~~t~eut str~egks, but es~~t~~y restricted itself to evaluating ex cast the speeifie invL%tment ckxiskons undertaken by the presidencies [see letters fern Court of IXreetors, 19 13x~mber 1755 and 13 February 1756, for example, Datta (1958, pp. 129 and. Ml)]. Gaius and fesses OY/patieufar prr=t;iRcnoies were carefklly separated in thr: C~rn~a~y’s accotmts, (nrtldthe perf~rmsn~ of thy: presidencies was evaluated ti xxxdiog to their profitabiky [Chaudhuri (1978, 57--59)‘J.The type of goods ( :-~~~~ ~~ ‘~ YLA;~~ i5~ ~~~~ &~jQ& a ~~&~~~uqj [email protected]~~n~ ;l~iscreti~n as to the precise quality of the goods involved. The actual qxxa*&u 4 the country trade was not contr&xi by the Court sf Dtixtors. Day-to-day operations were left for the separate divisions to manage autonx~~4y [Chaudhuri (1978, p. 208)-J? Tn sum, the Court of Directors was nf?t concerned with day-to-day qxratig de&ions, but with estatblishing a set of consistent decision rules within which 2%zsx-vtits in India could opemte and with making long-bran strategic deckions_ The presidencies were not merely providing funet;.~nally distkt inputs iuts a single output process, but were generatmg separable outputs on a prc¢er basis.. In short, the separate presidexies fuunetirsnedas separate ditisi~ns within the firm subject to an internal cox:rol apparatus maint&exI by the cer&xd management in London.

The East India .EIxqany’s factors iu Asia were the Company’s trading rq.~~~~tatks. One possxb$e means te provide the necessary inventive: for t servants ta pursue the C~mpan~y’s interests wa%to provide them with a. &ry, whkh in&&d a rent paymem over and above their opportumty cesf er and St$$er (1974)$ In this appreaeh facto). shirking wotald be L cmasmti by the ti& 02’ loss of rents through dismiss& Basically, however the Comfy r~yer pursued this course. Even as late as the 17Ws, the ~~rn~~~~~~ wvztats +xe paid very hxv salaries [Datta (4i9%, p. xx)$

‘!‘he primary ~~d~~rn~~t o@eied factors uvas the freedom ‘ro engage in private trade. Private trading wzs a means to solve an information-incentive problem in the Company. The Company’s agents in india possessed information regarding local exchanges and kythr:r Company activities, and private trading represented a system of dec?:ntralized property rights., whereby the agents could be induced to act effectively on the basis of this information. The system &f Flrivate trading was simple in design. The Court of Directors in London would allocate additional shipping and trading capital to Inclian factories, which zhowed relatively high rates of return. This allot&& the trading operations of the factory to expand. In step with this expansion of trading operation!; was an expansion in the private opportunities available to the Compaay’s agents. The Company would allocate space aboard East Indiamen on a pr;ority basis to servants as a reward for effective efforts on the Company’s bhalf, and would reduce the allocation of those whose had proven less effective. In such a way a system of decentralized property rigr,ts evolved, and under this system the Company was able t,> tailor rewards more closely to th: productivity of its agents in India. 4.3. Internal control Bookkeeping for the Company was centralized through an ‘~count current, London’, made up from books annually sent from overseas, tiilowing for an extensive central alldit. ‘Fhe Company employed accountants; :qrilo examined the books sent home. Fasten (19241, Stevens [196?), a.ctd WFGGand Zimmerman (1981) detail the auditing procedures used by the Company in its earl.1 years. Auditors, for exam.ple, were appointed at each scssicn of the General Court (the shareholders’ meeting). There are numerous other examples of the workifig of the audirmg and internal control processes in the Company. On March 9, 1720, Mr. 3. Fletcher wrote from the East India house in London to the Governor arid council at Bombay: L . . .

your laombay journal and lcger, letter Q: are the - ~st acd most erroneously copii;d that cvcr the company receivect fro?nl any gait of India . . . If we had the time to have copied them we would have sent them b&k to you to let ytiu see what sbamefu1 pair of books tixy are. lPri%y let the same persons copj us over another pair.’ [I‘urtxx ( 1976. . 200).-j

London, and this resulted in a stern warn ng to i;ut costs and run a tdghter ship or else. Continuing inefficiency in the Bombay presidency resulted in the decline of cash investment there by the central office and also in a diminished shipping allocation. [Chaudhnri (1978, pp. 6F66)]. Resource allocar:ion in the form of cash investment as well as shipping provision was not mere!:! dependent on tht evaluation of r;ie relative effkiency of the various factories and presidencies, but was also determined by the expcted demand fat the imported goods, which would not arrive for approximately two years. ‘I’hus, not only recent profit performance, but efficiency and expected future demands for particular goods all influenced strategic decisions by the Directors in, London pertaining t.u resource allocation to the factories in Asia. In sum, the mass of the evidence suggests to us that the day-b-day operations of the East India Company were much the same as any modern muitidivisional company although on a :;liauchsmallel; scale. Albert Sloan or Harold Geneen would have felt right at hoFle at the helm of the English East India Company.

5. U’hy did the East hdia Cornpaap have a deeatralized

internal

section we propcse an explanation for the economic organization of India Company. There were two primary aspects of the Company’s organization, which, as we sh,all argue, were interrelated.’ First, the Company held a moncpoiy charter for the Indian .trade. This meant that t?\c East India Company was the only English Company licensed to do business in India and t;, sell Indian goods in England. The Company did not possess a monopoly in its re-export business to the Continent, nor in its port-to-port trac9e in Asia. In both these spheres the Company competed with other national trading companies, especially the Dutch, and to some degee with interlopers and smngglers. Second, the (Company was vertically integrated in the fcllowing sense. Company trading operations in India IMere conducted through a factory system in which Cniripang agents purchased goods with bullion for shipment to England, ‘Ihe:r, agents were the first stage of the Company’s internal operations. The goods a’en: transport& to England ir! Cornparty ships, built by the Company and nranrsed by Comllany employees, and sold at auction at the East lndia Mouse in London. These auctions represented the upper end of the Compaff,y’s vertical 3pe-ail;ions. In other words, Jne Company was integrated from the pu~cka~seof goods i,ti 1ndna to their sale in London.

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isted. Wirfiout 81monop4y compties would have perhaps consisted of sing!e ships; :&h a monopoly the d~~~~~~prne~tof separate. speciahred and competirtg ti,rlmswas ma& more cosdy. Vertical ~~te~~~~on srf purchas;:, shipping, and sales in the case of East In&a Company did not. represent PLY efkient ada~~a~o~ to free market forces, but would appear to have result :d frum a legal &struetkm to these f~rces.~ In ah probabiliiy the Engbsh E:,st Xndiia ~~~~~ as a l~u~ti~~s~o~al &m was an artifact of government ~~g~~a~on. Witti this interpretation of the Company’s organkation, there remains I& issue of wlay other seemingly viable alternatives for exploiting its ~~o~o~~y status were not employed. In particular-~ why couid not the owners %if the trading rights have collected their monopoly rents through a system of kanchismg voyag,es or Eicensing importers? After fist estabhshiug the Eink ktween the Company’s organization and its monopoly charter, we return to tltis issue and c:jrsider why franchising or licensing was not a viable way for the owners of the Company to csllect monopoly rents. Consider the conditions under which the Company operated. Central mana~eement kt London, was basically two years away fron its operatives in India and on ships in between. These distances represented a significant span of control nrobkm. The incentive to act rested with residual claimants in LondoiF the infcsmatian tt, act rested with Cornparry operatives in the field. Resoiting this divergence of incentives and information was the rfrobkr 1 facing the Company. As we noted above, this probfem ~ufth ~~obabiy not have arisen without the monopoly status of the g.rm in the context of poorly developed Asian markets. Otherwise, ~kcentrah& :Iwnersh.ip in the form of separate fkms specializing in tne

Asian trade would likely have prevailed. The degree of verticsl integra:ion fostered by these difficulties required the East India Company to solve b complex organizationall problem. Consider the issue in terms of the example of shipping between LdAdon and India. Ship captains wc:re not owner-operators. Had they been, the fact that they were cut of touch with London for eight months or more would have been immaterial. Bemg residual claimants, the decisions they made during the course of a voyage - should they turn back in the face o”l’a storm, work their crews harder, and so on - would have been pr~fi;-. maximizing decisions. There would have been no divergence of incenrives and information to act. But as a Company employee, the ship captain posed a control problem for the firm. As we stressed in our discussion of the factors, one alternative was to offer ship capta& a wage in excess of their opportunity cost with the implication being that dismissal on grounds of kcompetence would constitute an opportunity loss of rents for captains. This solution works fine for gross acts of aakasance, but not so well in other circumstances. For example, how are the captain’s decisions in the face of uncertainty (did he choose the best route given weather conditions) to be evah&ed? A competent, alert captain might experience delays due to chance c,ircumstances beyond his coi:.trol (thf: converse of this proposition is also true). Simple monitoring c;:n insure formal compliance with regulations, but cannot dj=tinguish reliabl; between competent, dedicated effort and its absence. As c”.result, self-moniLoring hy the employee is more efficient, but requires an incentive szucture based on residual. claimancy or some form of self-enforcing contract. To generate effective entrepreneurship on the part of the ship’s captain, it was necessary for him to exptirience either profit or loss as the result of the qua3ty of his efforts. IR the case of sh@piag there developed a system of trading in which the Company and ~,hecaptain had a mutuality of interests. This developed- in the form of the privilege trade: the captain of an East lndiarnan was aliotted fifty-six tons (at most twenty feet CCdeck space) for his private carpro, which was sold at the Company auction ‘71London.’ This is cot to argue that decentralized property rights led to :a perf@-‘f ‘The allowance for privilege trade wa: only a partial solution to the problem. hov.ee\er. in that it sometimes gave rise to perverse incentive efiects. Captains wouid sometimes divert the return voyage of an East Indiaman from, say, Bengal to a port in Western India or P?ruia. before continuing their vo,vage to England if some momentary profit opportunity so prescribz~. Such diversions created delays, which could involbs signiiicanr cost 10 the Comparer %c mannc: m in stratrgc and operational which this problem was addressed illustrates the speds!ization decision making by the London Office and the Presidencies. Periodically, the Court of Directors offered programs of gratuities for captains who made their return vn\age:; i’7 a suflic ei>t!v timeI:\ fashion :Datta (19%. p. 1 W\l_ The D~WCi:tr~ resend thi: rnsht tc>‘ 5r? captams a5kn faiird it’ en!cWx3nt:tt. ,inJ dkx3sio3, rzg.irdlng respond to these grati%ie>. However. monitoring. 7tirt’\i’ rels\~!tl::t.?:r, !iW i~T”.4,h?L!C\ particula” CBAZ?~ v:ew St,

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feasihh to provide factors and ship eaptti?; with ~~~o~at~c,~ ~rta~r~~g to CURED:prices in London, the fortunes of other ships in transit, and so forth. It most also be noted *at ikit trade by fzactors was a contim4ng problem for the Cckmpany, and there wert: various c~~~~~ts czf int3est ov3 the years ktw~ n the Company’s business and the private trade of factors. Gradually, after :Bc addle of tbe ~ve~t~~~tb century factors became increasingly &vok.d in 14 Indian trading operations to the point th& purchases and sa&esfor the Cumpar~y sometimes; stiered.8 The Compaq novashy no means able to resoh,: its i~~o!~~~~o~-~r~c~~~eproblem in a comprcbensive mam~r. Rather the Company erzolved s workahk system of decentraiiznd property rig&s, which mitig&d some lolr the more important cost3 in the [email protected]~~hlem that it faced. Our ,~urpose is not to &er a normative ~,:valuation of these arrannements, but to suggest the economic forces that Ied 1.otheir adoption by the ?!ompao y. We note that there are additional possible explanations for the emergence of the East India Company into a vertkal3tyGntegrated form, which are related to our argument that the Company’s monopofy oharter wan important for its organization and which merit further r-arch. First, there as the issue of the secm-ity of the firm’s mo~zopofy right. While tl:e monarcn> had a clear inc+~ti~e not to renege on sates of such rights hecause of the 30s~ of revenue on Future s&s, such behavior was not t&ally impiamsible. I$ forming a kuge firm with ma-ny powerful merchazts as investors 2f)ci managers, the company clearly strengthened 2:s poStica1 effectiveness rekls c to what it might have heea under alternative, more independeD* arrangements. Second, it may seem farfetched, but there is the possibility &at ihe Company designed its organizational arrangements such that if i;; monopoly sI.at%ts was zver revoked, it would continue to maintak 3 Cominaart Fition in the innrins~&y. This point relates to modern theoric: o:’ kkstrial orgakttim such ils the welt known Iimit-pricing theorem. A Enal point is that the v&calty integrated nature of the East Ind Company camx-t k -taken br pin&c! in terms of economic analysis. Ir; par&uiar, why dif the firer wet evolve i_rtthe direction of some other set TPI contracrlral .ar:!angements RI& as franchising [Rubin (19X)] or imi,r>ri ; rT_&y-&g$; -r&e titarlerd ~~~~~~~~~ of th. p &mpany may noa provid:. ri uq$ete answer to this question, hezat~zz ol,;her chartered monopolies ~>ver &is eM developed a fraochise form of c,rgaGzation [the Mia,es Royal, for e-Pamp!e: the domestic cuaiarrg msnopofy &I Englaad; ::eft 8,:cLwstfaneand Kearte (f969pJ? -4--P** ‘$*~ir_‘T< .,.‘J,i 14&$j!&!_ ‘.$_ &“:”3h a$13. I& (‘&-qcn,

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in the case of the East India Company, the deveiopmenl ol parallel of factors in Asia is an example of a franchise form. Th,: factors were technically salaried employees, but participated through private trading and other means in profit-sharing. It IS interesting to note that according to Farber (1976, p. 195), ‘At the dose of his career a captain expected to have the disposal of his command, so that he could ‘self’ it for &6900 01’more to om: of the many ma’ltes who hoped to apply the profits of private trade to acquiring such an opportunity. We are not arguin.g that these examples serve as evidence of full-fledsed franchise contracts. The main ;-eason for tke interpretation of the Company as a vertically integrated firm is that the marketing of output was centrally directed at the Company’s London auction.“’ To understand our argument on this point, comider the evolution of Company practices over time. The case can be made that the system of terminable joint stcckc, which characterized the 31d East India Company until the amalgamation with the New company at the beginning of the eighteenth century, also had fr,lnchise characteristics. The different jomt stocks +.-epresenteddifferent trading oodie:: within the Company, each of which hcid its own separate factors in Asia who competed with ezch other for the country-trade [Sc,stt (1968. p. 109)]. To quote Scott (1968, p. 462), ‘It follcNs thar., while from the legal point of view, there was only one company, from the financial stardpoint there had been intereds

many.’ ’ 1 We hypothesize that given its legal monopoly on marketmg, the coinpany was in a position to appropriate quasi-rents from the participants in the franchise-like terminable joint stocks. ‘The economic fcrxs which undermined the argument for franchising can be described in the f.Alowing manner. The holders cf the monopoly charter could have authorized individual firms to go to India and obtain goods for trade. Monopoly profits could have beea collected by pricing franchises appropriately OF by putting a tax on the right to se!] at the London auction. Why was this organizational coursz not

pursued? One hypothesis is tha!: franchising was not a viable organizational or;tion for the Company due to the potcntiad for opportunistic behavior b> the holders of the monopoly charter. An eliample of such ‘3&avior 3dd have been selling the franchisee’s goods fo r a Iow price :\t auiti0,n in thi; face

Of rbe d~s~~ss~~~~ in t&e ~~%eraiure about of ipping %G5r of the ret~r~s a%~Iu~t~~~leo the various the tern?jna$ie jOi~i\ sto&s suggests the potential for

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~~~~~~isti~ behaYiur of tbi.r tgp: [Scott fM8, PI?. K@--I13)j* fi~us, the OId ~‘~ompany”skgdQ chartered competitor in the I@U’s, the +WW East h&h Compmy’, was ~~~~~~~~ on the basis ol’ a body of pcmanmt st~khd&i~, md pw mpidly WI&S the Oid COZYII~MIY staguated. After the two compames w+re merged into the timted East India Cumpany, the separate ter~~able ~oivat stock system was permanently abandoned, of quasi-rents ~~~~sti~g a competitive ~5ostrabint on the appropriation through the Company3 msrketi~1g monopoly. I-Iowever, we hasten to add &at the potential for opportunistic behavior is E,c. a general exp!zrkatic~n of beha1 :or irk a repeat purchase, continuous &z&ng environment. As Kkia &w&d and M&an (1978) have discussed, t.k exmti bs of rents on future business acts as a bonding device against ai ,c a-w~q&&~~u

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does not occur, It does, and the poteutial for rent appropriation may ho a satisfactory expIatnation Ebs tble verti~d integration of the East India Comipany. We si,+aply do uot know the relevant data with respect to imdividti discount rates, the annual diow of voyages, the probability of return -voyages,,and so forth, It co&d weIll have been the cs.se that the quasirents and the releraut probabihties infiueucing behavior became such as to swamp the bonding value of repetitive dealing. Our point is simplv that the rem appropriaGioa argument is not a generaI explanation for the vertical integration of the Conrpa~y.~~ Another ezpknation for thtk absertm of franchist: contracts in this c&se i: the Cost of contracting. w‘it-,A monopoly, efficient. vertial disintegration rquires t&at the monopofy right be exercised with respect to final output demami. To p-revent distortion of factor proportions it may have been n~sary to write compkated franchise contracts, whi~b dule to the nature of the buskss ;a this GSS (ships at sea) would have beea difli~ul t to enforce. The fk&ii fie, fm example, would have caused the shipping firms’ tinimum average cost to sh%t up and to the rig&t aad resulted in larger ships and mire fr%cqtzeuttrips than optimai. Presumably. tfre c&s of writing and ez%for&rg a contra4 .: p xsvent this type of input distorlion among frztu&isors were ; ;i.>&jPjve_ ‘rertical integration could thus have been Edopted u-:r”rfranch-tig on -en! -maximizing grounds. 13 P&S

“‘P+xhaps t&-zfcwcz of oppcuti~,ti~ t ,:hztiior was symmettic. It is pLrlb!e that the company f;icec a quaw+xmi-o: pmbkm wi!th j sps :O t&e gmds it si% 3n %gfrznd waist was wt SO~~Eti by dom&C C4l.art.tmd mrm ~&w~~Sts. WitJl impti tioenses 3r frsnchtising there Csy Saw been a @&m of mm siting the #low of kferior goods to the market which mull not srr~umtly k &a& IQ iu~ -ndivldual st4kr. By integrating fomwd md cmzollia~r tiic ibai szic c: ~a&& iI-4 karidori, tk compzap intemaEsd this qudiQ co&r01fsrob% Y Ihe !&maad

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Both, the r~~t~~~~ro~~at~~~ and the ~::ostof contracting argurnenl.s provide r,>ossibleexpla-latitiocs of the vertical integration of the Company. Moreover, the evjdeace noted above that other contemporary monopolists succ~sftilly employed franchise contracts may mean that the East India Company was a com,7arativeiy in&icient firm that was somehow shielded from takeover. Such Gompeting explanations provide grist for future research on the evolu?ion on this and othe? carl;~ companies. In any event the East India Company evolved in the fax of such problems into z m;lltidivisional firm with a vertically integrated s tructure.14 The piain truth is that we do not have enough infofmatlon to reject any ol‘ these explanations for the ,organization of the Company. We do observe this, however. Many modern firms have chosen to exploit monopoly rights, quch as patents, through vertical integration and producsdon in the marketplace rather than through licensirlg or franchising. While we do not know atl t!ic reason:%that some firms behave this way, WCdo know that the behavior of the Ea.st india Company, for tivhatever reas03s, was analogous. , 6. Cot&ding

remarks

The foregoing discussion represents the basis cf an explanation for :he emergence c>f the principles of a multidivisional firm in the East In&a Company. In essence, the organizational form of the East India Company was an anachroniem. IQ virtlle of its trading mor.opoly, the Company was necessarily large in a time when the costs of c-mmunication, crganization. and control dictated that efficient firm-size be sm:A This YAnt is bolstered by the fact that the Company’s shareholder-to-director ratio was increaibly small by modern standards. For example, in 1600 there were 24 directors out developing its trade in Asia, also evolved the means to defend tt!s trade and the internation& relations activity that greased the trade. While these services could have been sold t I franchisers as a par.1 0,’ ‘he fee that they paid for the privilege, there would hatie been char incentive problems on ?he Comp,;ny’s part n provid:‘qg these services if the franchise fee here paid up front. On the other hand, if the fe: were pi:id periodically, the cost of contractin! co;lld :ha:e swamped the gains from such arrar,gements. Perhaps for these reasons the t’ompa::g: was kge. vertica!ly integrated, and provided I s own defense and diplomatic service?;. 14We hnve emphasized the imrxtance of decentraiized property rights rn thr Compaq!‘\ operations. However, malfeasance 9n the >r, t of the Compzny employees renaainea a persistent problem, which could be controllet-, but no 0 ao&ualIly eliminated. The C’omp;ny’s attempt5 :C establish a mutuality of interests wth its sc~vartts ir, A.zia were remarkably sucrx3~:ifu!,all things considered,, even if they neve- frznctioned perfectly. A fundam:ntak ,:bange oorurrzd titer lqSY. which mqnified the monk ricp and coxtrol problem the C’ompan~ faced. The trallinp caperation~ of the Company bic:ime subord Kttc id ris goVeF!!mUlid func+i,ins in India. d&d ttic main source of its revenues s’-i!‘kedfr.?m trz,cdeto extidnnate taxation. !-Bugc fottl9ss becm3e available to Company servants in India associated wirh the exercise of force. ‘The incent!vcs lor malfeasance were greatly increased, wfhile the costs to malfeeas~s decreased dl’c to it3< efkci I\+’ corruption in the Court rmf Prirp;ietc.rs. Bill uniil the unique S:rcd~nStanfek Ii! hd:an ,i,Tr.!i!!\, C;vq?ai?~ tj; l<‘T\ Gas\ . produced this aberrant sit, &. in;lifG&%n!ce ei;3 dlirk‘np .. .w .inJ Tc>Hi~rw I iWZ. !I_ i :‘2<: __x!: !:I: j. ,j[s;:;_..i;i. c j, ., manapbk problem. SW Am* i ‘\ t;E’PTit,?‘/. /II I!I<_.;$ ,, ,, ‘. ,, ;,;<: ! --i -