A Theory of Firm Scope

44 Pages Posted: 18 Dec 2002  

Oliver Hart

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Bengt R. Holmström

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 2 versions of this paper

Date Written: November 4, 2002

Abstract

The existing literature on firms, based on incomplete contracts and property rights, emphasizes that the ownership of assets - and thereby firm boundaries - is determined in such a way as to encourage relationship-specific investments by the appropriate parties. It is generally accepted that this approach applies to owner-managed firms better than large companies. In this paper we attempt to broaden the scope of the property rights approach by developing a simpler model with three key ingredients: (a) decisions are non-contractible, but transferable through ownership, (b) managers (and possibly workers) enjoy private benefits that are non-transferable, and (c) owners can divert a firm's profit. With these assumptions, firm boundaries matter. Nonintegrated firms fail to account for the external effects that their decisions have on other firms. An integrated firm can internalize such externalities, but it does not put enough weight on the private benefits of managers and workers. We explore this trade-off first in a basic model that focuses on the difficulties companies face in cooperating through the market if benefits are unevenly distributed; therefore they may sometimes end up merging. We then extend the analysis to study industrial structure in a model with intermediate production. This analysis sheds light on industry consolidation in times of excess capacity.

Suggested Citation

Hart , Oliver and Holmström, Bengt R., A Theory of Firm Scope (November 4, 2002). MIT Department of Economics Working Paper No. 02-42. Available at SSRN: https://ssrn.com/abstract=355860 or http://dx.doi.org/10.2139/ssrn.355860

Oliver D. Hart

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-496-3461 (Phone)
617-495-7730 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Bengt R. Holmström (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

50 Memorial Drive
Bldg. E52-271d
Cambridge, MA 02142
United States
617-253-0506 (Phone)
617-253-1330 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Paper statistics

Downloads
1,837
Rank
5,833
Abstract Views
7,407