Theory of the firm
The need for a revised theory of the firm was emphasized by empirical studies by Adolf Berle and Gardiner Means, who made it clear that ownership of a typical American corporation is spread over a wide number of shareholders, leaving control in the hands of managers who own very little equity themselves.
Coase begins from the standpoint that markets could in theory carry out all production and that what needs to be explained is the existence of the firm, with its "distinguishing mark … [of] the supersession of the price mechanism."
These include discovering relevant prices (which can be reduced but not eliminated by purchasing this information through specialists), as well as the costs of negotiating and writing enforceable contracts for each transaction (which can be large if there is uncertainty).
[16] According to Louis Putterman, most economists accept distinction between intra-firm and interfirm transaction but also that the two shade into each other; the extent of a firm is not simply defined by its capital stock.
[17] George Barclay Richardson for example, notes that a rigid distinction fails because of the existence of intermediate forms between firm and market such as inter-firm co-operation.
(Baumol suggested that managers’ interests are best served by maximising sales after achieving a minimum level of profit which satisfies shareholders.)
More recently this has developed into ‘principal–agent’ analysis (e.g., Spence and Zeckhauser[20] and Ross (1973)[21] on problems of contracting with asymmetric information) which models a widely applicable case where a principal (a shareholder or firm for example) cannot costlessly infer how an agent (a manager or supplier, say) is behaving.
The behavioural approach, as developed in particular by Richard Cyert and James G. March of the Carnegie School places emphasis on explaining how decisions are taken within the firm, and goes well beyond neoclassical economics.
[23] Thus according to them the firm emerges because extra output is provided by team production, but the success of this depends on being able to manage the team so that metering problems (it is costly to measure the marginal outputs of the co-operating inputs for reward purposes) and attendant shirking (the moral hazard problem) can be overcome, by estimating marginal productivity by observing or specifying input behaviour.
For Alchian and Demsetz, the firm, therefore, is an entity that brings together a team that is more productive working together than at arm's length through the market, because of informational problems associated with monitoring of effort.
[citation needed] The weakness in Alchian and Demsetz's argument, according to Williamson, is that their concept of team production has quite a narrow range of applications, as it assumes outputs cannot be related to individual inputs.
[30] Vertically deep firms leverage capabilities such as production and process expertise, including technology selection, asset utilisation, and supply chain management.
Vertical depth often improves a firm's governance of activities, and contributes to a beneficial exploitation of internal capabilities, but is limited by the costs of hierarchical management, such as monitoring and coordination.
[31] In economic theory, the pros and cons of outsourcing have been discussed since Ronald Coase (1937) asked the famous question: Why is not all production carried on by one big firm?
[33] According to the property rights approach to the theory of the firm based on incomplete contracting, the ownership structure (i.e., integration or non-integration) determines how the returns to non-contractible investments will be divided in future negotiations.
It delves into the interplay between the human and technological elements within organizations, emphasizing the interconnectedness and interdependence between the social structure—comprising people, relationships, and interactions—and the technical system—encompassing tools, processes, and resources.
[38] Evolutionary approaches to understanding firms arose as a parallel branch to classical theories, stemming from the pioneering work of Joseph A. Schumpeter.
Both the system's structure and the environment spontaneously change congruently and complementarily as the firm strives to maintain its organization and operational coherence.
In this context, the exchanges it conducts with its supra-systems merely represent disturbances and residues allowing it to capture from the environment the necessary order for its survival and sustenance of its identity.
[40][42] The viability of the firm, as a self-referential entity enclosed within operational closure, is linked to the rate of regeneration of its sociotechnical systems and the flow of resources and information traversing it.
The flow of resources and information also places the firm in a situation of constant threat since such structures rely on relationships with the environment to sustain their dynamics.
This underscores the necessity for an adjustment field that compensates for environmental disturbances—a crucial factor in preventing the system from reaching thermodynamic equilibrium, which ultimately signifies the demise of the structure.
This grants leaders a crucial role in the growth and regeneration of structures since their control capacity directly impacts the organization's viable boundary.
Simultaneously, such restructuring in relationships and social attraction basins can also promote innovation, akin to DNA mutations, creating new dynamics and altering the variety and redundancy within organizations.
This suggests that mechanisms specialized in reconstructing the organization's social network topology, even in simplified forms, are vital to ensure the longevity of such structures.
[citation needed] George Akerlof (1982) develops a gift exchange model of reciprocity, in which employers offer wages unrelated to variations in output and above the market level, and workers have developed a concern for each other's welfare, such that all put in effort above the minimum required, but the more able workers are not rewarded for their extra productivity; again, size here depends not on rationality or efficiency but on social factors.
Recently, Yochai Benkler further questioned the rigid distinction between firms and markets based on the increasing salience of “commons-based peer production” systems such as open source software (e.g., Linux), Wikipedia, Creative Commons, etc.
He put forth this argument in The Wealth of Networks: How Social Production Transforms Markets and Freedom, which was released in 2006 under a Creative Commons share-alike license.
[48] Chiu (1998) and DeMeza and Lockwood (1998) have extended the model by considering different bargaining games that the parties may play ex post (which can explain ownership by the less important investor).
[10] Schmitz (2006) has studied a variant of the Grossman–Hart–Moore model in which a party may have or acquire private information about its disagreement payoff, which can explain ex post inefficiencies and ownership by the less important investor.
