Power in a Theory of the Firm

Abstract

What determines the boundaries of a firm? Is a firm defined solely by the ownership of physical assets as suggested by the property rights theory? This paper presents a theory of the firm based on the well-known idea that the firm improves over the market because it uses ex ante mechanisms to enhance specific investments. Maintaining the contractability assumptions of the property rights view, however, we identify not one but two such mechanisms. One is, of course, the ownership of property rights. Our contribution here is to highlight the costs of this mechanism which has been underemphasized. The second is the access agents have to the scarce resources, be they physical assets or human capital, that are needed for the production process. The theory enables us to address a number of issues including the separation of ownership and control, the importance of organizational design, and the rationale for the division of labor.

JEL Classification: G30