Knowledge Inputs, Legal Institutions and Firm Structure: Towards a Knowledge Based Theory of the Firm

Abstract

Corporate scholars rely on traditional theories of the firm to analyze corporate organization and corporate contracting. However, traditional theories of the firm, as the authors argue, are incomplete in that they neglect the role that knowledge plays in shaping the internal structure of a firm. The article proceeds to address this gap by focusing on knowledge resources as a key influence on internal corporate governance structures. First the authors introduce a new typology that explains firm internal governance structure based on the types of knowledge used in the production process. Then they analyze the interaction of law and knowledge management. They go on to show how certain legal mechanisms, such as patents, trade secrets, and private contracting (e.g. covenants not to compete) emerged as tools for binding knowledge to the firm. They propose a principle of efficient knowledge allocation, positing that organizational structures must maximize the use of knowledge resources against the background of specific hazards that affect transactions involving knowledge inputs. Applying these theoretical constructs, the authors show how the management of knowledge resources required in mass production, high tech and law firms differentially affect the decisional hierarchies of these types of firms and also their compensation and ownership structure in certain instances. More specifically, the authors argue (1) that a shift in knowledge requirements drove the changes in the organizational structure of mass production firms from the C-form to the M-form, affecting decision-making powers; (2) that the adoption of stock option plans in high-tech firms controls knowledge hazards (stock options prevent leakage by retaining individual knowledge and discouraging hoarding of knowledge); (3) that profit splitting and the partners-associate hierarchy in law firms reflects the need to maximize the use of knowledge resources and that changing knowledge requirements are affecting law firm organization; and finally, (4) that certain business transactions like mergers, joint ventures and licensing contracts are shaped by knowledge inputs. The authors conclude that knowledge considerations provide policy makers with a positive explanation for firm structure and a normative perspective counseling greater attention to the effects of regulation on knowledge allocation within firms.

Keywords: knowledge, corporate organization, theory of the firm, internal corporate governance

JEL Classification: K22, K29