Reconceiving the Firm

Abstract:     
Despite their seemingly sophisticated economics, existing theories of the firm have made for poor public policy, as witnessed by recurrent crises in corporate governance. This Article identifies and begins to remedy this gap. It argues that to make sense of organizational behavior, the firm needs to be reconceptualized as an entity that evolves norms within a social construct.

Orthodox economic models of the firm remain focused on microanalytic equilibria drawn from assumptions of rationality. Institutional economics persists in erroneously modeling the firm as a series of efficient contracts. Behavioral economics treats the individual, not the firm, as the unit of analysis. Organizational behavioral economics has yet to emerge.

The path forward requires recognition that firms can evolve norms dangerous not only to those outside the organization, but ironically also to those within it. Not only does a norms-based theory of the firm better accord with actual firm behavior, but it pushes law and economics in new directions. Understanding norms as responses to high contracting costs gives institutional economics new tools to address the problem of incomplete contracts; framing norms as collective heuristics helps extend the insights of behavioral economics to organizational entities.

Finally, the Article argues that public law must be deployed as a countervailing force to these dangerous organizational norms. It addresses possible objections that might emerge from contractarians, as well as from scholars who suggest that administrative hierarchy runs counter to the ideals of a participatory democracy. The piece concludes by offering suggestions to begin reform in criminal and corporate law, securities regulation, and antitrust.

Number of Pages in PDF File: 76

Keywords: Theory of the firm, law and economics, norms, institutional economics, transaction cost economics, agency theory, game theory

JEL Classification: C70, D21, D70, K22, I20

Accepted Paper Series