The Theory of Irrelevance of the Size of the Firm

Abstract

This paper formalizes Cheung, Coase, Stigler, and Young's theory of irrelevance of the size of the firm. This theory states that if division of labor develops within the firm, the average size of the firm and productivity go up side by side. If division of labor develops between firms, the average size of firms decreases as productivity goes up. Inframarginal analysis of the trade off between positive network effects of division of labor on aggregate productivity and transaction costs can predict recently popular business practices of down sizing, oursourcing, contracting out, focusing on core competence, and disintegration. We present evidence for a negative correlation between average employment of labor by firms and productivity.

Keywords: Size of the firm; Division of labor; Theory of the firm

JEL Classification: D23; L11; L22; L23