Why do firms exist? The question sounds perverse until one notices that a market is supposed to be an efficient allocator, and that inside a firm the market is switched off. Nobody bids for the next task; an instruction is issued and obeyed. A famous answer holds that firms exist because using the price mechanism is costly — searching, negotiating and enforcing all consume resources — and that an organisation is worth having up to the point where the cost of one more instruction equals the cost of one more contract. The account has held up well, and its central insight, that authority is a substitute for pricing rather than an alternative to efficiency, remains among the most useful in the discipline. Its predictions, however, have not aged as gracefully. If firms exist to economise on transaction costs, then technologies that reduce those costs should shrink firms. Contracting, search and monitoring have all become radically cheaper over four decades. The largest firms in history have appeared during the same period, and several of them operate in exactly the sectors where the reduction has been greatest. The usual rescue is to observe that cheaper contracting also enables larger firms to coordinate internally, so the effect is ambiguous. This is true and it is nearly vacuous, since a theory that predicts contraction or expansion depending on which cost falls faster predicts very little. A more promising line abandons the assumption that the firm’s boundary is drawn where the cost curves cross, and asks what the boundary is protecting. On this view a firm is not principally an instrument for avoiding negotiation. It is a device for holding assets whose value would be destroyed by the disclosure that a market transaction requires. Some assets are like this. A reputation cannot be sold without ceasing to be the thing that was sold. Accumulated know-how, once specified in sufficient detail to be contracted for, has been given away in the specifying. Where such assets dominate, no reduction in transaction costs will induce a firm to place them on the market, because the obstacle was never the cost of transacting; it was that the transaction destroys the asset. This explains why the sectors most transformed by cheap contracting have produced not the dissolution of firms into networks of contractors but a small number of very large firms surrounded by many small contractors, which is a different arrangement altogether. The revision has an implication that the original framework obscures. If boundaries exist to protect assets that cannot survive disclosure, then the extent of a firm reflects what it must keep secret, and growth becomes a strategy for enclosing information rather than for economising on negotiation. Policy fashioned on the older assumption, which treats scale as evidence of efficiency achieved, will systematically misread scale that is evidence of enclosure accomplished. The two look identical on a balance sheet, which is presumably part of the attraction.
|
Know Your MBA Exams |
|
