Merger Between Fisher Body And General Motors Media Essay

The debate about the merger between Fisher Body and General Motors (GM) in 1926 has been going on for over 30 years, between the original author (Klein, et al., 1978) and his main critic (Coase, 2000), each responding to one another’s papers. Set up initially (Klein, et al., 1978) in the paper only as a three paragraph example showing vertical integration, then further worked on (Klein, 1988), Klein’s view was considered valid until Coase (2000) later published his debunk on Klein’s analysis of the example. Coase’s knowledge and specific experience in the industry gave weight to the argument and therefore provided fuel for the debate to continue.

For this literature review the four most relevant and prevailing papers will be discussed [1] : Klein et al. (1978), Coase (2000), Coase (2006) and Klein (2007), with supporting period relevant papers being used to further each line of argument from the original authors and contributing studies from other sources. The basis of the debate revolved around the contractual obligations and the relationship between the two firms.

Klein et al. (1978)

In the original paper, Klein used Fisher Body’s take over by GM as an example of vertical integration. Fisher Body produced car bodies for GM, specifically open wooden and closed metal bodies. As closed metal bodies were seen as the future, GM entered into a 10 year contract with Fisher Body from 1919. The specifics of the contract were that GM would only buy from Fisher Body at a price fixed at cost + 17.6% (GM – Fisher Body contract, 1919, pp. 4). In return, Fisher Body committed to make specific investments in production capacity.

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Fisher Body made the investment in production capacity, therefore abiding by the contract with GM for a “fixed price” per unit. With demand for closed metal bodies significantly increasing, Fisher Body was able to take advantage of the fixed price element in the contract due to their output per unit of capital dramatically decreasing as production increased. GM made a request in 1924, for Fisher Body to relocate their production adjacent to the GM factory, Fisher Body refused the request. For this reason Klein argues that Fisher Body ‘held up’ GM.

The fixed prices coupled with the relocation refusal had made the Fisher Body – GM relationship “intolerable” (Klein, et al., 1978, pp. 310) according to Klein. In 1924 GM started negotiating a merger with Fisher Body to overcome the situation, which was finally completed in 1926.

In Klein’s footnotes, he mentions that GM, when entering into the 10 year contract with Fisher Body effectively purchased a 60% interest into the company. Klein states that the Fisher brothers “maintained complete control” (Klein, et al., 1978, pp. 308) despite this purchase, hence the longstanding contract continued to be in place until the merger in 1926.

In Klein’s original (Klein, et al., 1978) article he argued that the market pressure of having an inflexible contract forced the hand of GM to merge with Fisher Body. Over the long term, this merger benefitted GM as they regained competiveness, through supply of bodies at lower costs.

In Klein’s (1988) follow up paper, he furthers his work on the hold ups that Fisher Body used against GM; this was in response to Coase’s speech (1988). Klein described how Fisher Body took advantage of constraints built into the original long term contract. Klein states that Fisher Body’s costs were intentionally based on labour intensive processes as they were able to profit from the cost plus element in the contract, and since GM bought exclusively from Fisher Body, there was little GM could do. Klein then reiterates the point that GM merged with Fisher Body so that any potential threats of holdups were removed.

Langlois & Robertson (1989) agreed with Klein’s view that GM merged with Fisher Body to “protect its interest” (Langlois & Robertson, 1989, pp. 372). Their discussion on the merger reinforces the same point as Klein, describing how the vertical integration occurred due to the high prices and the enforced contract. These sentiments were echoed by others, including Crocker and Masten (1996), with the phrase ‘The Hold-Up Problem’ being used to describe the consensus views. While each of the authors had independently reviewed the GM – Fisher Body merger, all came to similar conclusions. It is not until the late 1990’s that questions about the validity of the research appears.

Coase (2000)

Coase (2000) describes Klein’s work on GM – Fisher Body, from the first example (1978) to the latter expansion of his ideas (1986 & 1988), as a “tale [that is] is factually incorrect” (Coase, 2000, pp. 15). In fact Coase discredits Klein’s work completely:

“I believe that the prevailing view gives a completely false picture of the events leading to the acquisition of Fisher Body by General Motors. There was no ‘holdup’. The situation never became “intolerable.”” (Coase 2000)

Coase, having firsthand experience of the car manufacturing industry in the 1930’s, initially questioned the validity of the much revered argument that GM merged with Fisher Body to create a body plant adjacent to the GM factory. He based this argument on the situation with another manufacturer of bodies, A. O. Smith, who were shipping their bodies hundreds of miles to the customer.

Coase’s analysis focused more on the relationship of the Fisher brothers, the founders of Fisher Body, with GM, something that Klein had not referred to in his assessment. In 1919, after complex negotiations, Fisher body agreed that GM would buy 60% of its stock. Klein briefly covered this part with a footnote stating that Fisher Body maintained the control, but failed to explain the full details of the agreement. Coase however, explicitly describes the agreement which left the control of Fisher Body to the Fisher brothers for 5 years, with additional clauses giving the potential for longer retention of control. The agreement also entitled one of the brothers to take a director’s position on the GM board, therefore bring the GM – Fisher Body relationship closer together.

Coase’s thoughts were that Fisher Body was efficient – I.e. not using labour intensive operations – but the need to satisfy GM specific needs was low. Coase’s argument revolves around the Fisher brother’s involvement in GM;

“It is ludicrous to suppose that the Fisher brothers, occupying the most senior positions in the General Motors organization, would have engaged in the practices injurious to General Motors that are described by Klein” (Coase, 2000, pp. 26)

Coase also argues that Fisher Body was supplying to other car manufacturers and the GM contract stated that GM should get the bodies for the same price or less than those manufacturers. Therefore Fisher Body needed to maintain and improve cost and efficiency to remain competitive in the market when seeking other business. Fisher Body would be unable to sell an overpriced closed metal car body to other car manufacturers.

With regard to the issue of their factory placement, Coase uses the work of Freeland (2000). Freeland, separately to Coase, was looking at Klein’s work and came to many of the same conclusions as Coase. Freeland indicates that there never was a hold-up and that GM’s merger with Fisher Body was to “acquire and retain the specialised knowledge” (Freeland, 2000 pp. 35) of the Fisher brothers.

Freeland’s work echoes Coase’s (2000) work and analysis. Freeland argues that in the 1924-1926 period, the hold-ups that Klein describes were in fact simply contract re-negotiations with GM who wanted to retain the Fisher brother’s expertise. Klein dispels the idea that the Fisher brothers were the main driving force behind Fisher Body, whereas Freeland suggest that this is the key aspect in GM’s merger ambitions. Freeland describes how GM saw the rise in closed metal bodies and that keeping Fisher Body, along with the Fisher Brothers, was key in remaining competitive. Also, the contract that was drawn up in 1919 demonstrated the true value of Fisher Body to GM. Due to potential risk of losing the Fisher brothers and their knowledge after 5 years (1924), GM started to negotiate the merger, with GM explicitly requesting the services of the Fisher brothers.

Klein’s argument (2000) that the vertical integration occurred due to inefficient labour intensive activities and the unwillingness of Fisher Body to relocate next to GM’s main factory does not agree with Freeland’s (2000) and Coase’s (2000) ideas. Klein’s argument was that Fisher Body’s location of plant was due to there being more potential profit from the transportation element because of the fixed price being paid for the bodies. However Freeland argued, and Coase agreed, that it would have been counter intuitive for Fisher Body to move their plant, as they already had a large factory which could be expanded to meet additional demand, instead of building a new one from scratch. Also GM was exclusive to Fisher Body but Fisher Body was not exclusive to GM; Fisher Body could and did sell to other manufacturers, including having a large contract with Ford. It made no sense for Fisher Body to relocate while these other contracts were in place as doing so could potentially lose business.

Coase and Freeland come to similar conclusions; while discussing Klein’s work, both negate any possibility of holdups and, due to the way the Fisher Body – GM relationship was, argue that Fisher Body was not exploiting the fixed price contract set in 1919.

An analysis (Helper, MacDuffie et al. 2000) of the state of the car industry, in the same period of the GM – Fisher Body merger, sides with Coase (2000). They oppose the arguments of Klein (1978) by showing that the industry was growing into “collaborative relationships” (Helper, et al. 2000 pp. 448); whereby vertical integration was not a pre-requisite because of the inter-relationships of firms involved. They cite Fisher Body as a “master of such relations” and the work from Coase (2000), on the intertwined relationships, bolstered this argument.

Helper et al. (2000) conclude, in line with Coase’s work (2000), that the merger was due to GM valuing the Fisher brothers’ insight and expertise so highly that they wanted them to work for GM. Also the opportunistic behaviour (Klein, 1996) cited as one of the reasons for the merger was a non-issue; with GM’s vertical integration occurring due to suitable conditions in their relationship with Fisher Body.

Coase (2006)

In 2000, the Journal of Law and Economics published the article discussed above (Coase, 2000) and also a response from Klein on the critique of Coase’s work. Klein reinforced his position and explained where Coase fails in his argument. Klein also attacks the methodology of Coase, citing missing data which contributed to an inaccurate picture of the whole situation.

In 2006, Klein sent Coase a copy of the contract between GM and Fisher Body; the complete contract was not available prior to this. Klein also drafted a new paper, to address the issues that Coase raised in 2000 and supplemented his work with the proof of the contract. Klein’s paper was not published until 2007 but Coase had prepared a paper (2006) on the subjects and specifics Klein raised in his 2000 article.

Coase’s 2006 article began by assessing the situation of the ‘hold-ups’; Klein’s new suggestion (2000) is that between 1919 and 1924, the holdups were not apparent but when demand increased from1924 onwards, and Fisher Body was unable to meet GM’s increased schedules, it slowed down GM’s production. Coase argues that this assessment was incorrect, owing to the fact that after 1924 GM actually controlled the majority share in Fisher Body and if they were finding the relationship “intolerable” (Klein, et al., 1978, pp. 310) then they could have rectified the situation.

Coase then elaborates on how Klein’s work (1996) does not take into consideration the actual relationship between GM and Fisher Body. Klein stressed that Fisher Body had used opportunistic behaviour in the placement of their plants as they had a monopoly over GM’s supply of closed metal bodies. Coase, through the research of his assistant (Brooks), found that the expansion of Fisher Body’s plants all took place around GM’s plants prior to the merger; completely discrediting Klein’s argument of a hold-up existing.

In support of Coase’s argument, Freeland (2001) had also focused on the good relationship between Fisher Body and GM – something that Coase had originally stressed in 2000 – stating that it was never “intolerable” (Klein, et al., 1978, pp. 310). In fact GM valued the Fisher brothers so highly that when it came to finding a new president of GM one of the Fisher brothers was poised to succeed. This good relationship was demonstrated in the work of Chandler and Salsbur (1971), whose research, predating Klein’s work, shows that the same brother, prior to being shortlisted for the presidency of GM, was named head of Cadillac – “The most important division for GM” (Chandler and Salsbury, 1971, pp. 577).

Coase (2006) leans on Casadesus-Masanell’s and Spulber’s work (2000) to discredit Klein’s assessment of the reasons behind the vertical integration. Casadesus-Masanell and Spulber discuss the merits of the merger for GM, suggesting that GM required the skill set that the Fisher Brothers provided while also Fisher Body would be able service the needs of GM’s closed bodies more effectively.

Coase (2006) reiterates his work (2000) and that of Freeland (2000, 2001), questioning Klein’s suggestion of a hold up due to Fisher Body not locating a plant next to GM:

“Are the coach passengers who resist the highwayman holding up the highwayman?” (Coase, 2006, p270)

It was argued that Fisher Body was acting as a separate entity to GM and moving their operations next to GM’s plant would hamper their wider operations and damage their profitability with other clients. What may therefore be seen as a hold up for GM was a valid business decision for Fisher Body.

Coase summarizes his 2006 paper by “Did Fisher Body hold up GM? My answer is that they did not” (Coase, 2006, pp. 271). Explaining that it was a “normal business dispute” (Coase, 2006, pp.271) as the two firms were acting as separate entities at the time; there would be no reason for Fisher Body to relocate to lose profits while GM increased profits. Coase also explains that the merger was likely to take place even if this dispute had never existed due the relationships between the Fisher brothers and GM, and the lack of GM’s experience in car body manufacturing.

Klein (2007)

Klein’s 2007 work was mainly in response to Coase’s 2000 article and with the aforementioned contract now available. It is significant because although he concedes some points to the work of Coase (2000), he uses the contract details to reinforce some of his original statements (1978).

Klein now accepted that Fisher Body did not use inefficient processes in its production as, the contract impeded such actions – this is contrary to what Klein (1978, 1996 & 2000) had said previously. He also accepts Coase’s (2000) research on the location of Fisher Body’s factories, but insists that there was still a holdup. This holdup justification was different from that originally outlined in his initial work (1978) but what he still thinks this is the reason for the merger.

What Fisher Body did holdup on, and Klein insists upon, is the resistance to locate the plants close to GM’s. Klein states that Fisher Body was reluctant to put up the capital for the new plants as they had had little to gain from the investment.

The proposed plant next to GM would service GM solely; therefore limit Fisher Body’s opportunities and competitiveness with other manufacturers. If the plant was constructed, Fisher Body would also be unable to maintain profit from transportation costs – Transportation costs fell under the fixed price (Cost + 17.6%) – although Coase (2000) disputed these costs, as Fisher Body serviced other manufacturers from a distance. Therefore the cost of building a new plant and losing the transportation cost would decrease Fisher Body’s profitability. This coupled with the 10 year contract meant that Fisher Body did not have to provide a co-located plant that ultimately only benefitted GM.

Klein argues that subsequently, Fisher Body was in a considerably stronger bargaining position, with GM contractually unable to do anything about it. Therefore GM was forced to invest in the construction of 3 of the 6 factories that Fisher Body would utilise. Klein then goes on to explain that due to GM’s later investment, Fisher Body greatly benefitted for the fixed price contract of 1919 which was still valid. The 17.6% up-charge was initially created to compensate Fisher Body for their investments, however with GM now providing half of their investment Fisher Body stood to be more profitable.

Klein now, and this is where he strays from his original assessment, argues that the power of Fisher Body is the main holdup for GM; with Fisher Body being in a position whereby it can exploit the 19i9 contract. Although Klein himself, now questions if it was a holdup in the conventional sense:

“Perhaps ‘post-contractual opportunism’ is a less charged description of what is taking place than ‘holdup’.”(Klein, 2007, pp. 17)

Klein is still convinced that a holdup was taking place; wherein, Fisher Body was able to negotiate a more profitable settlement due to prior contracts.

Also Klein clarifies GM’s position on holding 60% shares in Fisher Body, whereby GM was contractually obliged to act for Fisher Body’s best interests rather than their own. As the two firms were separate entities, it would not have been in Fisher Body’s interest to negotiate towards a better settlement for GM.

Klein concluded that vertical integration occurred to prevent miss-location of future plant and ease future coordination. The merger was beneficial to GM as they would not be susceptible to the opportunism that Fisher Body was previously able to exert over them.

Conclusion

It is accepted that, even by the author himself (Klein, 2007). Klein’s first article on the General Motors – Fisher Body merger has some factual inaccuracies, Klein’s final article twists his original work to suit a better matched scenario in which Fisher Body is able to extract benefit from contractual constraints and GM’s need.

Coase’s work, proven mostly correct over Klein’s original (1978), focuses more on the relationship of GM and Fisher Body; how the Fisher brothers became integrated into GM, post merger. Coase negates any possibility of a holdup existing and any contractual problems were just normal business issues.

Coase’s work is supported by that of Freeland (2000, 2001), and Helper, MacDuffie and Sabel (2000); who were all working separately on the analysis of the GM – Fisher Body merger around the same time. Their work came to the same conclusion to that of Coase.

Ultimately Coase is Klein’s biggest critic and there are more economists siding with Coase over Klein’s original writing. However as for Coase:

“It is ironic that Coase criticizes economists who accept Fisher Body-General Motors as an example of holdup behaviour for relying too heavily on theoretical analysis independent of the facts when his landmark article on ‘The Nature of the Firm’ (1937) was essentially pure theory.” (Klein, 2007, pp.4)

In my opinion, Klein’s initial assessment was inaccurate; perhaps because of the limited data available and his assessment at the time fitted. However, once more information surfaced, Klein vehemently defended his initial position, and it was only until the original contract was found that Klein refreshed his argument. The U-turn that Klein made undermines his whole argument and his new conclusion, which to all intensive purposes is a compromise.

Coase’s work holds a more concise and researched view; with more support – from the economic community – to his work than Klein’s. Coase’s firsthand experience and his previous accolades add weight to his argument.

For myself, Coase’s argument fits well into the situation; I have large doubts about the nature of the hold ups and whether they weren’t just normal business practices.