This paper applies the principles of organization economics (an offshoot of organization theory and a cousin of the New Institutional Economics) to a variety of organizations, mainly public ones. Organization economics seeks to understand and improve the ways in which organizations overcome agency costs, information costs, and other obstacles to efficiency. The private organization discussed in the paper is the modern publicly held (that is, dispersed ownership) business corporation, and the particular problem on which I focus is excessive executive compensation as a symptom of weaknesses in corporate governance. I then discuss two public organizations involved in national security – the US intelligence ‘community’ (a kind of mega-organization) and the Federal Bureau of Investigation in its role as the nation's principal domestic intelligence service. Both exhibit significant dysfunction that organization economics can help us to understand and overcome. I then discuss two types of public organization that have been more successful in overcoming obstacles to organizational efficiency: the judiciary of common law nations, such as the United States, and the very differently structured judiciary of civil law nations, such as France, Germany, and Japan.

Judge Posner (2010) identifies organizational economics with the principal-agent problem and offers no definition of the crucial term organization, which leads him to force the principal-agent template on social formations that are not organizations and to neglect aspects of their operation that might be illuminated by alternative conceptions of organizational economics. This response offers an explicit characterization of organizations as central planning agencies, considers Posner's examples in light of the problems of purpose, information, and control faced by all central planners, and draws upon an emerging capabilities theory of organizations to extend the scope of Posner's analysis and suggest insights beyond those that flow from the principal-agent approach.

The agency problem at the core of corporate law stems from a chronic potential conflict of interest between directors’ self-interest and that of shareholders. Corporate law views directors’ self-interest in terms of diverting welfare to directors at the expense of shareholders. Another component of directors’ self-interest – being perceived as maximizing shareholders’ welfare – is seen not as part of the agency problem, but as part of the solution (aligning directors’ incentives with shareholders’).

This is true only if taking actions that maximize shareholders’ welfare is also the optimal manner for a director to be perceived as maximizing welfare. However, directors have more appealing ways to be positively perceived. In conducting bias arbitrage, directors identify risks that shareholders over-estimate, take action to address the risk, and then take credit for the ‘lowered’ risk (i.e., shareholders’ corrected assessment of the risk).

Bias arbitrage is more attractive as shareholders’ misperception of a risk increases. The opportunity to bias arbitrage thus leads directors to address highly misperceived risks instead of highly remediable risks.

The intellectual roots of law and economics, institutional economics, and the possible science of organization economics are here explored for a better understanding of what Posner is pushing for. The purpose is, of course, to gain better acceptance of his proposal. As it turns out, organization economics comes close to what has come to be called ‘the science of State’, i.e. treating law, economics, sociology, and political science as approaches to one and the same subject always to be taken together.

Posner's economics of organization yields an unconventional view that private organizations operating in the market, the publicly held US business corporation, despite the profit motive, ends up being inefficient, paying excessive compensation to CEOs, while some public organizations, the US federal judicial system (and the judicial system of Continental Europe and Japan), despite the insulation of judges from most of incentives and the near complete autonomy afforded to them, works reasonably well. Unfortunately, Posner does not state clearly the criteria by which he judges one ‘excessive’ and the others ‘works reasonably well’, nor does he explain well why professional norms of judges that play a crucial role in public organizations are not a factor in business organizations.

Posner's (2010) analysis offers many exciting insights into the principal-agent problem, particularly with respect to the secret service. I argue that it would be useful to consider a broader model of human behaviour, which includes awards as extrinsic incentives beyond pay, as well as intrinsic motivation. A more comparative stance that goes beyond the United States would be a useful check of how general the results are. Scholars should not forget that while the US is the dominant economy today, there are 195 nations in the world that offer many fascinating institutional variations, which are useful to take into account.

Judge Posner (2010) has identified an important lacuna in law and economics, namely a tendency to ignore organization theory. I will apply the tools of organization theory to an area almost completely neglected in law and economics, forensic science. Posner points us to tools we should make use of; I am pointing to an application we have neglected. Forensic science today is characterized by a twofold monopoly. First, evidence is typically examined by one crime lab only. Second, that same lab will normally be the only one to offer an interpretation of the results of the examination it performs. Crime labs today are typically organized under law enforcement agencies, which may create conscious and unconscious biases in favor of police and prosecution. These organizational features of forensic science today encourage errors and wrongful convictions.

Judge Posner (2010) offers a substantial agenda for organization economics. He advises us on how organization economics can shed substantial light on some of the most pressing social problems of the day. I comment on two of the areas he selects for discussion and offer some comments on the relationship of organization economics to new institutional economics. Judge Posner surely is right to argue that organization economics can help us understand the failures of corporate governance in regulating executive pay. Moreover, with additional and more institutionally nuanced theorizing, organizational economics should further our understanding of the work of judiciaries in the civilian and common law traditions. Judge Posner tells us that organization economics and new institutional economics are related fields. I make a plea for economic holism. Organizations are institutions. While getting clear on disciplinary boundaries and the differing kinds and concepts of institutions is important, logical differences in concepts like ‘organization’ and ‘institution’ may be less important than what to emphasize in theory construction and what to test for with those theories. The success of organization economics will be in whether the different emphases produce new insights. Judge Posner is right to tell us that new insights are coming and will continue to come from organization economics. This is true however we conceptualize the field as a school of thought.

The different role played by case law and the historical and conceptual differences between the doctrines of precedent in common law and civil law traditions are important determinants of judicial creativity. In this article, we consider a hybrid version of stare decisis, called by the French name of jurisprudence constante, adopted by mixed jurisdictions. Unlike stare decisis, which allows a single precedent to establish case law, the doctrine of jurisprudence constante links the recognition of a judge-made rule to the existence of a consecutive line of decisions affirming the same legal principle. We develop a model to consider the effects of this doctrine on the social costs arising from judicial error and uncertainty in case law. We further consider the effects of these alternative doctrines of precedent on judicial creativity and ideological bias in judge-made law.

Recent writings by Richard Posner in this Journal and elsewhere appear to mark a departure from the Chicago price theory tradition with which Posner long has been associated. This paper picks up on one facet of this: the similarity of Posner's views of the corporation, and of executive compensation in particular, to the perspective laid out by Adolf Berle and Gardiner Means in The Modern Corporation and Private Property – a perspective that has for decades been harshly rejected by the Chicago school.

This comment relates to Richard Posner (2010), the lead article for this issue. Posner applies ‘the principles of organization economics’ to the study of diverse types of organizations. His study comparing the FBI to other types of police organization is important and compatible with the study of urban policing in American metropolitan areas. Many policy prescriptions are based on an inadequate understanding of the diversity of urban public good production functions and a lumping together of every type of police service. A brief review of research related to the concept of polycentricity as related to urban services in metropolitan areas is provided as a way of further illustrating Posner's concern that finer distinctions need to be made in the way scholars analyze organizational economics.

Posner considers purposeful organisations. Legal persons are fictitious non-mortal species whose evolution has played a major role in economic development. In what sense can they be said to have a purpose? Thanks to several important mutations, the status of legal persons was transferred from public bodies to business corporations. This evolutionary journey is complementary to the Coasian view, which, moving in the opposite direction, explains the firm as a centralization of market transactions. If the corporation emerged also from a process of decentralization of public attributes, some features of public legal persons, are lacking in its business mutation. Also some ways of motivating people are only available to the original species.

The design of incentive systems is a central issue in the economics of organization. This paper argues that very often the ideal incentive systems to use within firms will involve low-powered incentives. Five particular circumstances leading to weak incentives being optimal are examined.

In order for organizations to adopt procedures and structures that efficiently serve their goals, they need to overcome predictable errors in individual and group judgment and decisionmaking and to distinguish ephemeral from significant environmental changes. I seek to identify factors internal and external to the organization that contribute to overcoming these two problems. I suggest the modern US research university as a case study of a successful organization.

The 13 responses to my article are of high quality and suggest many fascinating directions for further research in the economics of organizations. I will not try to reply to all of them, in view of their number, but omissions should not be taken as criticism or that I think the response is not a contribution. I shall strive for brevity.