Abstract

http://ssrn.com/abstract=227638
 
 

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The Visible Hand, the Invisible Hand and Efficiency


Eitan Goldman


Indiana University - Kelley School of Business - Department of Finance

Gary B. Gorton


Yale School of Management; National Bureau of Economic Research (NBER)

March 2000

NBER Working Paper No. w7587

Abstract:     
When a firm forms a market closes. Resources that were previously allocated via the price system are allocated by managerial authority within the firm. We explore this choice of organizational form using a model of price formation in which agents negotiate prices on behalf of their principals when there is trade in a market. Principals motivate agents to make efforts and form prices by writing contracts contingent on the prices that the agents themselves negotiate. Admitting agency issues into price formation introduces a need for a principal to have the authority to coordinate economic activity. This can be achieved by closing a market and forming a firm, thereby contracting directly with both agents, and centrally directing trade. Closing a market, however, results in a loss of information from market prices, information that can be used to reduce the cost of contracting. This information cannot be replicated by internally generated transfer prices.' Hence, when the market is internalized within the firm, information from market prices is lost. Choice of organizational form, a market or a firm, is then determined by the relative value of central authority over agents (the visible' hand) versus information from market prices (the invisible' hand).

Number of Pages in PDF File: 53

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Date posted: June 11, 2000  

Suggested Citation

Goldman, Eitan and Gorton, Gary B., The Visible Hand, the Invisible Hand and Efficiency (March 2000). NBER Working Paper No. w7587. Available at SSRN: http://ssrn.com/abstract=227638

Contact Information

Eitan Goldman (Contact Author)
Indiana University - Kelley School of Business - Department of Finance ( email )
1309 E. 10th St.
Bloomington, IN 47405
United States
812-856-0749 (Phone)

Gary B. Gorton
Yale School of Management ( email )
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
203 432-8931 (Fax)
HOME PAGE: http://mba.yale.edu/faculty/profiles/gorton.shtml
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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