An Economist's Perspective on the Theory of the Firm
An outsider to the field of economics would probably take it for granted that economists have a highly developed theory of the firm. After all firms are the engines of growth of modern capitalistic economies, and so economists must surely have fairly sophisticated views of how they behave. In fact, little could be further from the truth. Most formal models of the firm are extremely rudimentary, capable only of portraying hypothetical firms that bear little relation to the complex organizations we see in the world. Furthermore, theories that attempt to incorporate real world features of corporations, partnerships and the like often lack precision and rigour, and have therefore failed, by and large, to be accepted by the theoretical mainstream.
This article attempts to give lawyers a sense of how economists think about firms. It does not pretend to offer a systematic survey of the area; rather, it highlights several ideas of particular importance, and then explores an alternative theoretical perspective from which to view the firm. 1 Part 1 introduces various established economic theories of the firm. Part 2 turns to a newer theory of the firm, based not upon human capital structures, but rather upon property rights. Part 3 synthesizes this property rights-based theory of the firm with more established theories.
Helpful comments from Jeffrey Gordon, Bengt Holmstrom and Jean Tirole are gratefully acknowledged. This article is based in part on the author's Fisher-Schultze lecture delivered to the Econometric Society in Bologna, Italy in August 1988. Some of the work was done while the author was visiting the Harvard Business School as a Marvin Bower Fellow. He would like to thank that institution for its hospitality and financial support. The author would also like to acknowledge financial assistance from the Guggenheim and Olin Foundations, the Center for Energy and Policy Research at MIT and the National Science Foundation.