Envy, Comparison Costs, and the Economic Theory of the Firm

45 Pages Posted: 1 May 2006

See all articles by Jackson A. Nickerson

Jackson A. Nickerson

Washington University in St. Louis - John M. Olin Business School

Todd Zenger

University of Utah

Date Written: March 20, 2006

Abstract

An economic theory of the firm must explain both when firms supplant markets and when markets supplant firms. While theories of when markets fail are well developed, the extant literature provides a less than adequate explanation of why and when hierarchies fail. In this paper, we seek to develop a more complete theory of the firm by theorizing about organizational failure. Assuming that market failures provide an impetus to move activities inside the boundaries of the firm, we develop a theory that provides an explanation for both "managerial" diseconomies of scale and scope - an argument that is independent from traditional measurement, rent seeking, and competency arguments. In our theory, hierarchies fail as they expand in scale because social comparison costs imposed on firms escalate and hinder the capacity of managers to optimally structure incentives and production. Further, hierarchy fails as a firm expands in scope for the simple reason that while the need for differentially structured compensation is rising, the costs of differentially structuring compensation within firm are also rising. Thus, we argue that the high cost of organization and limits to its size and scope derive from social comparison costs triggered by envy.

Keywords: theory of the firm, envy, social comparison, compensation, vertical integration

JEL Classification: D23, L22, L23, M52, J41

Suggested Citation

Nickerson, Jackson A. and Zenger, Todd R., Envy, Comparison Costs, and the Economic Theory of the Firm (March 20, 2006). Available at SSRN: https://ssrn.com/abstract=898873 or http://dx.doi.org/10.2139/ssrn.898873

Jackson A. Nickerson

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6366 (Phone)
314-935-6359 (Fax)

Todd R. Zenger (Contact Author)

University of Utah ( email )

David Eccles School of Business
1655 East Campus Center Drive
Salt Lake City, UT 84112
United States
801 585-3981 (Phone)
801 581-7939 (Fax)

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