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The Conduct of Economics: The Example of Fisher Body and General Motors
The Conduct of Economics: The Example of Fisher Body and General Motors
1. 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 lit-
erature 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, 255–278
256 Journal of Economics & Management Strategy
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. 334–335). 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 low-
capital-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
258 Journal of Economics & Management Strategy
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.
The Conduct of Economics 261
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. 114–115) 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. 15–
16), Milgrom and Roberts (1992, p. 37), Ricketts (1987, p. 221–222), 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).
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 1931–1932) 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 work-
ing 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 1926. 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
The Conduct of Economics 269
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 1925–
26 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).
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.
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.
The Conduct of Economics 273
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 Conduct of Economics 275
predicted they would. As their theory was not based on the result of
investigations into how firms did in fact act, it is not surprising that, as
we have seen, the conclusion reached was completely wrong. What is
needed is a change in the way economics is conducted. If our discussions
are to have any value, our theories must have an empirical basis. As it is,
the investigations by the economics profession of the relations of Fisher
Body and GM stand as a glaring example of how economic research
should not be conducted.
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