Partner Uncertainty and the Dynamic Boundary of the Firm
33 Pages Posted: 29 Aug 2012 Last revised: 20 Feb 2017
Date Written: March 15, 2015
We develop a new theory of the dynamic boundary of the firm where asset owners may want to change partners ex-post. The model identifies a fundamental trade-off between (i) a "displacement externality" under non-integration, where a partner leaves a relationship even though his benefit is worth less than the loss to the displaced partner, and (ii) a "retention externality" under integration, where a partner inefficiently retains the other. With more asset specificity, displacement externalities matter more and retention externalities less, so that integration becomes more attractive. Our model also shows that wealthy partners would want to commit to ex-post wealth constraints.
Keywords: Asset ownership, control rights, firm boundaries, asset specificity, specific investments, wealth constraints
JEL Classification: D23, D82, D86
Suggested Citation: Suggested Citation