The firm as a subeconomy
Author: Holmstrom, B
Source: Journal of Law, Economics, and Organization, Volume 15, Number 1, March 1999 , pp. 74-102(29)
Publisher: Oxford University Press
Abstract:This article explores the economic role of the firm in a market economy. The analysis begins with a discussion and critique of the property rights approach to the theory of the firm as exposited in the recent work by Hart and Moore ('Property Rights and the Nature of the Firm'). It is argued that the Hart-Moore model, taken literally, can only explain why individuals own assets, but not why firms own assets. In particular, the logic of the model suggests that each asset should be free standing in order to provide maximal flexibility for the design of individual incentives. These implications run counter to fact. One of the key features of the modern firm is that it owns essentially all the productive assets that it employs. Employees rarely own any assets; they only contribute human capital. Why is the ownership of assets clustered in firms? This article outlines an answer based on the notion that control over physical assets gives control over contracting rights to those assets. Metaphorically, the firm is viewed as a miniature economy, an 'island' economy, in which asset ownership conveys the CEO the power to define the 'rules of the game', that is, the ability to restructure the incentives of those that accept to do business on (or with) the island. The desire to regulate trade in this fashion stems from contractual externalities characteristic of imperfect information environments. The inability to regulate all trade through a single firm stems from the value of exit rights as an incentive instrument and a tool to discipline the abuse of power.
Document Type: Research Article
Publication date: 1999-03-01
- The Journal of Law, Economics, and Organization is an interdisciplinary exercise. It seeks to promote an understanding of many complex phenomena by examining such matters from a combined law, economics, and organization perspective (or a two-way combination thereof). In this connection, we use the term organization broadly - to include scholarship drawing on political science, psychology and sociology, among other fields. It also holds the study of institutions - especially economic, legal, and political institutions - to be specifically important and greatly in need of careful analytic study.