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Economic Theories of the Firm

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Abstract

Economic theories of the firm have provided much of the language and concepts of modern corporate governance and corporate law discourse. Alternative mechanism. According to economic theories of the firm, the default form of economic exchanges is through the market. The mechanism of market prices is assumed to allocate resources to their most effective uses. The firm is an alternative mechanism.

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Notes

  1. 1.

    See, in particular, Bratton WW, The New Economic Theory of the Firm: Critical Perspectives from History, Stanford L Rev 41 (1989) pp 1471–1527.

  2. 2.

    Demsetz H, The Structure of Ownership and the Theory of the Firm, J Law Econ 26(2) (1983) p 377: “It is a mistake to confuse the firm of economic theory with its real-world namesake. The chief mission of neoclassical economics is to understand how the price system coordinates the use of resources, not the inner workings of real firms.”

  3. 3.

    Foss NJ, Lando H, Thomsen S, 5610 The Theory of the Firm. In: Bouckaert B, De Geest G (eds), Encyclopedia of Law and Economics. Volume III. The Regulation of Contracts. Edward Elgar, Cheltenham (2000) pp 631–658.

  4. 4.

    See, for example, Williamson OE, The Modern Corporation: Origins, Evolution, Attributes, J Econ Lit 19 (1981) p 1539.

  5. 5.

    See Wernerfelt B, The Resource-Based View of the Firm, Strat Man J 5(2) (1984) pp 171–180; Barney JB, Firm Resources and Sustained Competitive Advantage, J Man 17 (1991) pp 99–120; Peteraf MA, The Cornerstones of Competitive Advantage: A Resource-Based View, Strat Man J 14 (1993) pp 179–191.

  6. 6.

    Jensen MC, Meckling WH, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, J Fin Econ 3 (1976) pp 305–360.

  7. 7.

    Smith A, The Wealth of Nations (1776).

  8. 8.

    Coase RH, The Nature of the Firm, Economica, New Series 4(14) (1937) pp 386–405.

  9. 9.

    Alchian AA, Demsetz H, Production, Information Costs, and Economic Organization, Am Econ Rev 62 (1972) pp 777–795; Jensen MC, Meckling WH, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, J Fin Econ 3 (1976) pp 305–360.

  10. 10.

    Ostrom E, Governing the Commons. Cambridge U P, Cambridge (1990) pp 25 and 40.

  11. 11.

    Williamson OE, The Lens of Contract: Private Ordering, Am Econ Rev 92(2) (2002) pp 438–443; Williamson OE, The Theory of the Firm as Governance Structure: From Choice to Contract. Journal of Economic Perspectives 16(3) (2002) pp 171–195.

  12. 12.

    Arrow KJ, The Limits of Organization. Fels Lectures on Public Policy Analysis. Norton, New York (1974); Grossman SJ, Hart OD, The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration, J Pol Econ 94 (1986) pp 691–719; Holmström B, Tirole J, The Theory of the Firm. In: Schmalensee R, Willig RD (eds), The Handbook of Industrial Organization. Volume 1. North-Holland, Amsterdam (1989) pp 61–133; Holmström B, Roberts J, The Boundaries of the Firm Revisited, J Econ Persp 12(4) (1998) pp 73–94.

  13. 13.

    Williamson OE, The Incentive Limits of Firms, Rev World Econ 120(4) (1984) p 741; Williamson OE, The Economic Institutions of Capitalism. The Free Press, New York (1985) p 137.

  14. 14.

    See also Arrow K, The Limits of Organization. W. W. Norton & Company, New York (1974) pp 68–70 (on consensus and authority).

  15. 15.

    Alchian AA, Demsetz H, Production, information costs, and economic organization, Am Econ Rev 62(5) (1972) p 794: “The essence of the classical firm is identified here as a contractual structure with: 1) joint input production; 2) several input owners; 3) one party who is common to all the contracts of the joint inputs; 4) who has rights to renegotiate any input’s contract independently of contracts with other input owners, 5) who holds the residual claim; and 6) who has the right to sell his contractual residual status. The central agent is called the firm’s owner and the employer.”

  16. 16.

    Jensen MC, Meckling WH, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, J Fin Econ 3 (1976) p 311: “The firm is not an individual. It is a legal fiction …”.

  17. 17.

    Ibid, p 312. For a critical view, see Fama EF, Agency Problems and the Theory of the Firm, J Pol Econ 88(2) (1980) pp 290–291.

  18. 18.

    Alchian AA, Demsetz H, Production, Information Costs, and Economic Organization, Am Econ Rev 62 (1972) p 778. See also Jensen MC, Meckling WH, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, op cit, pp 309–310; Simon HA, Organizations and Markets, J Econ Persp 5(2) (1991) p 36.

  19. 19.

    Jensen MC, Meckling WH, op cit, p 310: “It is important to recognize that most organizations are simply legal fictions which serve as a nexus for a set of contracting relationships among individuals. This includes firms …” The authors define legal fiction in footnote 12: “By legal fiction we mean the artificial construct under the law which allows certain organizations to be treated as individuals.”

  20. 20.

    See Rajan RG, Zingales L, The Governance of the New Enterprise. In: Vives X (ed), Corporate Governance, Theoretical & Empirical Perspectives. Cambridge U P, Cambridge (2000) pp 201–227: “Summarizing, there are three main features of [what Chandler (1977) calls the modern business Enterprise (MBE)] that shaped the ensuing debate on corporate governance. First, the MBE was well defined by the ownership of assets. The legal boundaries of the corporation could be drawn around these assets and also coincided with its economic boundaries. Moreover, these boundaries did not change unless ownership changed. Since the boundaries were well defined, the main issue in corporate governance was how the surplus generated within these boundaries was to be allocated, and not on how to preserve and protect the boundaries. Second … outsiders could obtain power by virtue of their ownership of the crucial assets. As a result, the MBE came to be owned by outsiders. Finally, the concentration of power at the top of the organizational pyramid, together with the separation between ownership and control, made the agency problem between top managers and shareholders the corporate governance problem.”

  21. 21.

    Simon HA, Organizations and Markets, Journal of Economic Perspectives 5(2) (1991) p 30.

  22. 22.

    Williamson OE, Transaction Cost Economics: How It Works; Where It Is Headed, De Economist 146 (1998) pp 23–58; Williamson OE, Transaction Cost Economics. In: Menard C, Shirley MM (eds), Handbook of New Institutional Economics. Springer, Dordrecht (2005) pp 41–65.

  23. 23.

    Fama EF, Agency Problems and the Theory of the Firm, J Pol Econ 88(2) (1980) p 290.

  24. 24.

    Hardin G, The Tragedy of the Commons, Science 162 (1968) pp 1243–1248.

  25. 25.

    Ostrom E, Governing the Commons. Cambridge U P, Cambridge (1990) pp 24–25.

  26. 26.

    Wilson R, On the Theory of Syndicates, Econometrica 36 (1968) pp 119–132; Arrow KJ, Essays in the Theory of Risk Bearing. Markham Publishing Co., Chicago (1971); Jensen MC, Meckling WH, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, J Fin Econ 3 (1976) pp 305–360. For an overview, see Eisenhardt KM, Agency Theory: An Assessment and Review, Acad Man Rev 14 (1989) pp 57–74.

  27. 27.

    Fama EF, Agency Problems and the Theory of the Firm, J Pol Econ 88(2) (1980) p 291.

  28. 28.

    Jensen MC, Meckling WH, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, J Fin Econ 3 (1976) p 312. See also Fama EF, Agency Problems and the Theory of the Firm, J Pol Econ 88(2) (1980) p 290–291.

  29. 29.

    For a discussion of the role of constituencies, see Williamson OE, The Economic Institutions of Capitalism. The Free Press, New York (1985) pp 298–312.

  30. 30.

    Coase RH, The Nature of the Firm, Economica, New Series 4(14) (1937) p 392.

  31. 31.

    Alchian AA, Demsetz H, Production, Information Costs, and Economic Organization, Am Econ Rev 62 (1972) p 777; Jensen MC, Meckling WH, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, J Fin Econ 3 (1976) p 310.

  32. 32.

    This approach was pioneered by Grossman SJ, Hart OD, The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration, J Pol Econ 94 (1986) pp 691–719.

  33. 33.

    Ostrom E, Governing the Commons. Cambridge U P, Cambridge (1990) pp 25 and 40.

  34. 34.

    Baumol WJ, Business Behavior, Value and Growth. Macmillan, New York (1959); Simon HA, Theories of decision-making in economics and behavioral science, Am Econ Rev 49 (1959) pp 253–283; Cyert RM, March JG, A Behavioral Theory of the Firm. Prentice-Hall, Inc., Englewood Cliffs, NJ (1963); Williamson OE, The Economics of Discretionary Behavior: Managerial Objectives in a Theory of the Firm. Prentice-Hall, Englewood Cliffs, NJ (1964). See also Fama EF, Agency Problems and the Theory of the Firm, J Pol Econ 88(2) (1980) p 289.

  35. 35.

    Simon HA, Organizations and Markets, J Econ Persp 5(2) (1991) pp 25–44.

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  1. Department of Accounting and Commercial Law, Hanken School of Economics, Handelsesplanaden 2, 65100, Vaasa, Finland

    Prof. Dr. Petri Mäntysaari

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Mäntysaari, P. (2012). Economic Theories of the Firm. In: Organising the Firm. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-22197-2_2

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