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Uncertainty and the nature of the firm: From Frank Knight and Ronald Coase to an evolutionary approach

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Abstract

In his article ‘The Nature of the Firm’ Coase Economica 4:386-405, (1937), Ronald Coase enquired why organisations such as firms exist in a specialised exchange economy. He concluded that the main reason to establish and grow a firm is to avoid some of the transaction costs of using the price mechanism. Earlier, a similar issue was considered, albeit not so explicitly, by Frank Knight in his book, ‘Risk, Uncertainty, and Profit’ Knight, (1921). According to Knight, the emergence and growth of a modern enterprise is associated with ‘the fact of uncertainty’. In this paper, we address the seminal Coasian question regarding the firm and compare his and Knight’s views on the nature of the firm in its relation to uncertainty.

We argue in favour of conceiving of the firm as an institution of a dynamic economy and explain the relationship between the firm and the market in terms of their complementarity, coevolution, increasing complexity and order. We also examine the notion of transaction costs and outline the concept of Coasian uncertainty. Toward the end, we demonstrate the advantages of the firm from the perspective of its complexity, evolutionary adaptability and its viability in the face of uncertainty. We suggest that both Knight and Coase came close to perceiving the nature of the firm in terms of complex systems, but from fundamentally different angles. Thus, we formulate the criteria to determine the boundaries of the firm with regard to the problem of complexity and the system's viability, considering both Knight’s and Coase’s uncertainties.

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We did not analyse or generate any datasets because our work proceeds within a theoretical approach.

Notes

  1. Boudreaux and Holcombe also believe that the dominant contemporary theories of the firm (e.g. Alchian and Demsetz 1972; Williamson 1985) remain in the Coasian tradition too, since they assume given technical production processes with given inputs and given outputs (Boudreaux and Holcombe 1989, 149). The latter statement, however, has drawn the sharp criticism from some researchers. For example, in the opinion of Nicolai Tuul Foss (1993), Boudreaux and Holcombe misrepresented at least some important segments of the modern theory of the firm (Foss 1993, 274). If we were to consider the theory of the firm as a nexus of contracts (e.g. Jensen and Meckling 1976), this view would correspond with the general-equilibrium framework (Foss 1993, 271). But the central categories in Williamson’s analysis (asset specificity, uncertainty, complexity, bounded rationality frequency) describe “a complex and changing economic reality, rather than the dull picture of eternally given inputs and outputs” painted by Boudreaux and Holcombe (Foss 1993, 272).

  2. See, e.g. Nelson and Winter 1982.

  3. For example, in his (Robé 2011) article, Robé illustrates, how to economize on the costs of transacting with third parties by using a separate fictitious’ legal person, and asserts that creating a legal entity ‘greatly reduces the transaction costs of operating the business by making the drafting and enforcement of the contracts much simpler’ (Robé 2011, 18).

  4. As an example of such a nexus can be the exchange rate fluctuations. About their effect on transaction costs and firm boundaries see, e.g. Balcells 2022.

  5. This assumption is coherent with different theories and research areas, such as: institutional analysis (e.g. Hodgson 2015), social identity and group cohesion theories (e.g. Stets and Burke 2000; Ellemers et al. 1997; Obschonka et al. 2012), the theories of social capital and collective actions (e.g. Ostrom and Ahn 2003), behavioural and experimental economics (e.g. Frey and Bohnet 1996; Fehr and Fischbacher 2003), evolutionary anthropology (e.g. Henrich 2016), and some others. For example, Geoffrey M. Hodgson notes that “for millions of years, rivalry between human groups has given the advantage to those communities that cohere and cooperate” (Hodgson 2015, 242; see also Henrich 2016). The capitalist firm, thus, “harnesses our genetically and culturally inherited impulses to cooperate and respect authority” and “capitalism is obliged to use, and marginally adapt, our evolved human nature” (Hodgson 2015, 241).

  6. See e.g.: “Complex activities require a deeper division of knowledge”, and “this division of knowledge creates high coordination costs” (Balland et al. 2022, 7).

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Acknowledgements

The authors would like to thank the anonymous reviewers for their substantive and inspiring comments, which significantly helped to improve the article. The authors are also grateful to Agnieszka Wincewicz-Price, Casimiro Antonio Nigro, Tetiana Botsian, and Stefano Calvani for their valuable suggestions, discussions and support.

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  1. Independent researcher, Zhytomyr, Ukraine

    Liudmyla Vozna

  2. Warsaw School of Economics, Warsaw, Poland

    Anna Horodecka

  3. Zhytomyr Polytechnic State University, Zhytomyr, Ukraine

    Vitalii Travin

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Correspondence to Liudmyla Vozna.

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Vozna, L., Horodecka, A. & Travin, V. Uncertainty and the nature of the firm: From Frank Knight and Ronald Coase to an evolutionary approach. J Evol Econ 33, 1397–1425 (2023). https://doi.org/10.1007/s00191-023-00842-6

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