Interpersonal Authority in a Theory of the Firm
40 Pages Posted: 26 Jul 2007 Last revised: 14 Feb 2008
Date Written: July 1, 2007
This paper develops a theory of the firm in which a firm's centralized asset ownership and low-powered incentives give a manager 'interpersonal authority' over employees (in a world with differing priors). The paper derives such interpersonal authority as an equilibrium phenomenon. One key result is that a manager's control over critical assets - through its effect on the level of outside options - allows the manager to order employees what to do. The paper thus provides micro-foundations for the idea that bringing a project inside a firm gives the manager authority over that project, while - in the process - explaining concentrated asset ownership, low-powered incentives, and centralized authority as typical characteristics of firms. It also leads to a new perspective on the firm as a legal entity and, building on the insights of a parallel paper, to a new theory for firm boundaries based on the idea of break-up. A key feature of the latter theory is that firm boundaries matter even though both ex-ante investments and ex-post actions are perfectly contractible.
Keywords: theory of the firm, authority, interpersonal authority, differing priors, heterogeneous priors, asset ownership
JEL Classification: L22, D23, D81
Suggested Citation: Suggested Citation