Evidences on a Positive Link between Structure and Performance

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CHAPTER TWO THEORY AND LITERATURE REVIEW

Introduction

The literature review begins with an outline on the definition and historical evolvement of the field of industrial organization up to its current state. In particular, a review on the shift in the field’s emphasis over time from the endeavor to address measures across industries towards more individual industry related studies. The second part of the review highlights key ideas on the focus of the industrial organization. The detail model of the structure-conduct-performance paradigm is also reviewed in the subsequent section. This is followed by a review of the alternative structural and non-structural models of industry structure evaluation.

Industrial Organization- Defining the concept

Industrial Organization (IO) is known by several names in the literature such as ‘Economics of Industries’, ‘Industry and Trade’, ‘Industrial Organization and Policy’, ‘Commerce’ and ‘Business Economics’ etc. However, several authors (Stigler, 1968, Carbal, 2000) have used ‘Industrial Organization’ as an appropriate title of the subject. Despite the diversity of naming, there seems a consensus on the definition and scope of IO. On much broader sense, authors consider IO to have concern on three areas: the firm, markets and industries. For instance, the most illustrious definition of IO by Stigler contains all three elements. He defined industrial organization as ‘the application of microeconomic theory to the analysis of firms, markets and industries’ (Stigler,1968, p. 1).
Another definition with similar contextual meaning is from (Cabral, 2000) ‘Industrial organization is concerned with the workings of markets and industries, and in particular the way firms compete with each other’ (Cabral, , p.9). This definition provided more prominence to IO’s focus on the competition among firms in the industry. A rather more specific definition of IO is also forwarded by Church and Ware (2000). They defined IO as ‘the study of the operation and performance of imperfectly competitive markets and the behavior of firms in these markets’ (Church and Ware, 2000, p.7). The definition interestingly defined the type of market the IO study basically provides greater attention i.e. imperfect competitive market. The existence of imperfect competition or the degree of existence of all the stated factors is a reflection of the differences in market power of firms in the industry. In such regard, Church and Ware (2000) provided an alternative and very specific definition to IO, i.e. ‘it is the study of the creation, exercise, maintenance, and effects of market power’ (Church and Ware, 2000, p.31).
The other dimension of IO definition is related to explaining the root of the field. Barthwal (2010) argues that ‘IO as a field developed from microeconomics and is concerned with economic aspects of firms and industries seeking to analyze their behavior and draw normative implications’ (Barthwal, 2010, p. 15). He explained that there are differences between those two theories. Microeconomics is formal and deductive, whereas, Industrial economics is less formal and more inductive. Furthermore, microeconomics is a passive approach with the aim of profit maximization of a company, without concerning operational aspects of the company. Industrial economics’ emphasis is on the operational aspect and tries to explain the working and changes in the existing system. His argument also get support from other authors like Ramsey (2001) who suggested that the focus of IO theory is on the market a company operates in, rather than the company itself . Ramsey (2001) supports the market focus of IO being reflected in the structure-conduct-performance model, which claims that there is a causal link between the structure of a market in which a company operates, the organization’s conduct and in turn the organization’s performance in terms of profitability. Thus, the industrial organization theory focuses on the whole industry and market conditions of a company.
Shepherd (1972) further explained the difference as microeconomics typically focuses on the extreme cases of monopoly and perfect competition while industrial organization focuses primarily on the case of oligopoly. That is to mean, a competition between few firms in an industry whose number is more than one unlike in monopoly, but not as many as in competitive markets.
Some authors also provided a strategy or conduct focused definition of IO. For instance, Salinger (2000) explained IO as the field that tries to understand the behavior of companies and what that behavior means for the well-being of consumers. This appears to be the area where the overlap between strategy management and economics was apparent. For instance Porter (1981) has used the SCP model to design its industry analysis model. He claimed that the central analytical aspect of IO can be used to identify strategic choices which firms have in their respective industry. More specifically, IO has offered strategic management a systematic model for assessing competition with in an industry (Porter, 1981). Church and Ware (2005) support the close association of the two fields of the study. The focus of the new industrial organization on the behavior /conduct of firms in imperfectly competitive industries involves determining the firms’ strategies to win a competitive advantage in the market. Therefore, IO that has a bearing on industry and firm level study appears as a theory of business strategy.

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History of Industrial Organization

Literature shows that it is difficult to identify the exact beginnings of IO because of limited historical records on the field (Hamphrey, 1940). There appear, however, some evidences according to which monopolistic practices and other elements of the industrial economics were in operation as far back as 2100 BC (Trucker, 2010) However, written records revealed that the foundation of economic theory was the book of Adam Smith in 1776 named ‘’Wealth of Nations’’. In his economic theory, Smith (1776) discussed the principles of division of labor and analysis of pricing which were described by some authors like (Barthwal, 2010)) to represent the concept of IO.
Corley (1990) in his article, ‘Emergence of the Theory of Industrial Organization, 1890-1990’, classified the history of IO into eras and referred to Marshal as pioneer to present ideas about IO. The eras incorporate: Alfred Marshall Era, Cournot Legacy (1890-1933), Era of Controversy (1933-1951), The Emergence of Industrial Organization Studies (1950s) and developments after 1960 onwards. Corley associated Marshal to the theory of IO due to his focus on competition and being a pioneer to integrate the concept of entrepreneur into analysis of firm value. ‘Marshal’s basic ideas on the firm centered around competition which he saw in terms of an activity or a process rather than in modern structural terms’ (Corley, 1990, p.88).
Following Marshal (1889), Cournot formulated an economic model used to describe an industry structure in which companies compete on the amount of output they will produce (Hal, 2006). He began with the monopolistic case and progressively extended the number of producers in the market until he reached the opposite pole of unlimited competition. At this pole, each firm contributed too small a proportion of the whole to affect the going industry price. Cournot discussed duopoly, suggesting that self-interest would induce the two rivals concerned to reach a determinate and mutually advantageous solution. However, he failed to analyze the commonest market form in advanced economies, namely oligopoly (Corley, 1990). This makes it the model to diverge from the current attention area of the IO and the facts in the real world which is the imperfect market and mainly of the oligopoly.
The developments up to 1933 were the gradual realization of the existence of an entirely new academic subject, the theory of the firm. Coase (1937) set out his transaction cost theory of the firm which is one of the first attempts to define the firm theoretically in relation to the market. His work is followed by a number of economic theories that explain and predict the nature of the firm and including its existence, behavior, structure, and relationship to the market (Demetri, 2007). Therefore, the period has diverted attention of earlier economists’ work on corporate topics to clarify aspects of value theory. Corley (1990) named this period as ‘an interlude before the pace of constructive work accelerated in the 1950s’.

The Modern Theory of Industrial Organization

By the end of the 1930s, the field of IO started to come together and take shape (Schmalensee ,2012). Partly this was due to the influence of Edward Mason at Harvard (Mason 1939, 1957) and partly due to the industrial data collection and analyses practice. Schmalensee (2012) considers that in the modern era, IO economist have played an important role in industry studies in support of broad assertions regarding market conduct and performance. The modern era can also be further classified into three groups based on the dominating school of thought (Kovacic and Shapiro, 2000).
 

Harvard School

After the 1930s, scholars from the Harvard school began to focus on the structure of both firms and industry (Schmalensee, 2012). A notable influence from this school was from Mason (1939) who pointed out that the size of a firm has an impact on its competitive polices in the market. Mason (1939, p.73) explained that:
‘‘The relative size of a selling unit, to recapitulate is one element-doubtless a very important one-in the structure of a firm’s market. As such it exerts an influence on the policies and practices of the firm. But firms of given size, relative to the extent of their markets, will follow very different price and production policies in different market situations.’’
Another significant influence is from the school has been from Bain (1951) who has assembled a sample of census industries and linked them to profitability data. He has found that industries in his sample with four-firm concentration ratios above 70 percent had distinctly high accounting profit rates than did the others (Bain,1951) Bain (1956) has improved such concept further in his book, ‘Industrial Organization’. He laid out the Structure – Conduct – Performance (SCP) which is used as an analytical framework to make relations among market structure, conduct and performance. Bain (1956) established that the market structure of an industry determines its conduct and thereby impacting firm performances. The SCP paradigm, with some further economics based supplements, became the basis for much of the modern version of ‘Merger Guidelines’ (White, 2006).
As implications of all this, Harvard School, recognizes market power as being a factor to be controlled and establishes a relation between the concentration ratio and its harmful effects on social welfare (Weiss,1971). The 1960s and early 1970s saw further elaborations of the SCP paradigm and more extensive testing of the profitability-concentration relationship with the inclusion of entry conditions (Mann, 1966; Weiss, 1971), advertising (Comanor and Wilson, 1967, 1974), foreign trade (Esposito F. and Esposito L.,1971), the structural conditions on the buyers’ side of the market (Lustgarten, 1975), risk (Bothwell and Keeler, 1975), and the presence of a critical concentration ratio (White, 1976). The concept of efficiency has also started to grow from this school. Harbison (1956) drew on the concept of entrepreneur and suggested that so called inefficiency could be due to entrepreneurs behaving rationally in pursuing other goals than profit maximization such as social advancement. Furthermore, he remarked that efficiency could also be reduced by inadequate knowledge and inappropriate organizational structure which could lead to loss of effective control over subordinates. These important ideas were further developed later (Leibenstein, 1966). He stated that ‘…the amount to be gained by increasing allocative efficiency is trivial while the amount to be gained by increasing X-efficiency is frequently significant.’ (Leibenstein, 1966, P. 45)

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Chicago School

The Chicago School counter upheaval focused on SCP, which argued that high concentration might be causing high profit rates, because of economies of scale (Goldschmid, 1974). A further attack to the profit-concentration relationship also aroused on the use and reliability of the accounting data that were used to measure the profit rates (Anthony, 1986; Salmon, 1985). In addition, there were critics on whether relative profit rates were even the appropriate indicators of market power (Fisher and McGowan, 1983). Profit-based tests of the SCP paradigm quickly tailed off, but were soon replaced by price-based studies drawn from individual industries (Weiss, 1989; Bresnahan and Schmalensee,1987). Results, however, tended to show a similar positive relationship between prices and market concentration. There was a general consensus among this school’s scholars that the relationship between market structure and performance is a reflection of the efficiency of big firms which allowed them to be prominent from the market (Simrlock, 1985). In other front, Demsetz (1974) argued that the pragmatic relationship between profitability and concentration could be due to the large market shares of firms in highly concentrated industries. Therefore, the emphasis of the school seems changed in regard to price and efficiency theory.

Abstract 
Acknowledgements 
CHAPTER ONE  INTRODUCTION AND BACKGROUND OF THE INDUSTRY 
1.1. Introduction
1.2. Background of the Industry (the Structure of the Ethiopian Banking Sector)
1.3. Problem Statement
1.4. Objectives of the Study
1.5. Hypotheses
1.6. Rationale
1.7. Delimitation and Scope of the Study
1.8. Organization of the Study
CHAPTER TWO THEORY AND LITERATURE REVIEW 
2.1. Introduction
2.2. Industrial Organization- Defining the concept
2.3. History of Industrial Organization
2.4. The Modern Theory of Industrial Organization
2.5. Focus areas of Industrial Organization
2.6. The Structure-Conduct-Performances (SCP) Hypothesis
2.7. Competing Hypotheses
2.8. Efficiency
CHAPTER THREE  EMPIRICAL EVIDENCES AND CONCEPTUAL FRAMEWORK 
3.1. Introduction
3.2. Evidences on a Positive Link between Structure and Performance
3.3. Studies Supporting the Efficient Market Hypothesis
3.4. Methodology and Approaches
3.5. Critics on the Approach/Methodologies
3.6. Variables Used
3.7. Studies by Region
3.8. Studies Conducted in the Ethiopian Banking Sector
3.9. Snapshot on the Recent Trends of the Empirical Studies
3.10. Summary
CHAPTER FOUR PROPOSED CONCEPTUAL FRAMEWORK AND VARIABLE CHOICES 
4.1. Conceptual Framework
CHAPTER FIVE  RESEARCH DESIGN AND METHODOLOGY 
5.1. Introduction
5.2. Research Design .
5.3. Research Design in this Study
5.4. Research Approach
5.5. Research Methods
5.6. Reliability and Validity in Quantitative Research
5.7. Qualitative Data Collection and Analysis
5.8. Procedural Issues in the Study
5.9. Ethical Issues
5.10. Summary
CHAPTER SIX  QUANTITATIVE ANALYSIS 
6.1. Introduction
6.2. Testing the Impact of Industry Concentration on Bank Performance
6.3. Summary
6.4. Testing the Efficiency Variation and its Determinants
6.5. Testing the Impact of Internal Factors on Bank Performance
6.6. Testing the Impact of External Factors on Bank Performance
6.7. Testing the Impact of Regulation on Performances
6.8. Combined Model/Integrating the Quantitative Study
CHAPTER SEVEN  QUALITATIVE RESEARCH RESULT 
7.1. Introduction
7.2. Market Structure
7.3. Efficiency Determinants and Impact of Efficiency on Performances
7.4. Bank Conduct
7.5. Impact of Bank Specific Factors on Performances
7.6. Impact of External Factors on Performances
7.7. Impact of Regulation on Bank Performances
7.8. Summary
CHAPTER EIGHT  DISCUSSION, CONCLUSIONS AND RECOMMENDATIONS 
8.1. Introduction
8.2. The Integration of Qualitative and Quantitative Approaches
8.3. Summary of Empirical Results
8.4. Conclusions
8.5. Recommendations and Policy Directions
8.6. Contribution of the Study
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