Coase, Knight, and the Nexus-of-Contracts Theory of the Firm: A Reflection on Reification, Reality, and the Corporation as Entrepreneur Surrogate

Abstract

Scholars routinely credit R.H Coase and his first seminal work — The Nature of the Firm — as the progenitor of the nexus-of-contracts theory of the corporation. This account, which has dominated legal scholarship for four decades, describes a corporation as a nexus of contracts between the various claimants to the earnings of the business — shareholders, directors, officers, employees, customers, suppliers and other factors of production. In this article I argue for a different understanding of Coase’s theory of the firm and its implications for legal research into the nature of the modern corporation. I argue that nexus-of-contracts scholar’s claims to Coase’s lineage are based on a misapplication of Coase’s central insights and the pursuit of a very different research project than underlay The Nature of the Firm. I suggest that Coase’s insights must be understood as an extension of Frank Knight’s grand opus — Risk, Uncertainty and Profit — and as an extension of Knight’s theory of the entrepreneur. So understood, Coase’s theory of the firm, properly understood, supports a very different contractarian account of the corporation than the currently dominant nexus-of-contracts version, and a very different research agenda. Properly interpreted, the firm has boundaries and a center. Properly understood, the corporation and the firm are different phenomenon. Properly understood, the corporation and corporation law must be seen as serving the purpose of providing the corporation with a substitute for the entrepreneur who owns and directs the classic firm.

Keywords: Theory of the firm, nexus of contracts, corporate governance, institutional economics, law and economics, Ronald Coase, Frank Knight, Entrepreneur, Adolf Berle, reification, corporations, intellectual history, transaction cost economics, director primacy, shareholder primacy, mediating hierarchy

JEL Classification: A14, B10, B13, B15, B20, B25, B30, B31, K00, K22, D23, N00, N81