Interpersonal Authority in a Theory of the Firm

40 Pages Posted: 26 Jul 2007 Last revised: 14 Feb 2008

Eric Van den Steen

Harvard Business School - Strategy Unit

Date Written: July 1, 2007

Abstract

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

Van den Steen, Eric, Interpersonal Authority in a Theory of the Firm (July 1, 2007). MIT Sloan Research Paper No. 4667-07. Available at SSRN: https://ssrn.com/abstract=1002789 or http://dx.doi.org/10.2139/ssrn.1002789

Eric Van den Steen (Contact Author)

Harvard Business School - Strategy Unit ( email )

Harvard Business School
Soldiers Field Road
Boston, MA 02163
United States

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