Employment, Markets, Contracts, and the Scope of the Firm

25 Pages Posted: 19 Dec 2013 Last revised: 6 Jan 2015

See all articles by Birger Wernerfelt

Birger Wernerfelt

Massachusetts Institute of Technology (MIT) - Sloan School of Management

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Date Written: January 6, 2015

Abstract

We look at the economic functions of firms, contracts, and markets and characterize the optimal scope of the firm. Governance structures appear as equilibria and are compared in terms of production costs - determined by a tradeoff between standardization and adaptation - and adjustment costs - sometimes incurred when new prices have to be agreed upon. Under natural conditions, employment, markets, or sequential contracting weakly dominate all other equilibria. As firms become larger, gains from standardization come at the cost of increasingly poor adaptation, ultimately bounding their scope. The model rests on standard assumptions, is consistent with the managerial literature on the scope of the firm, and makes predictions based on factors that do not play a role in contemporary theories of the firm.

Keywords: organization, institutions, labor

JEL Classification: D02, D23, L23

Suggested Citation

Wernerfelt, Birger, Employment, Markets, Contracts, and the Scope of the Firm (January 6, 2015). Available at SSRN: https://ssrn.com/abstract=2369048 or http://dx.doi.org/10.2139/ssrn.2369048

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