Working Paper: CEPR ID: DP9019
Authors: Wouter Dessein
Abstract: The seminal work by Grossman and Hart (1986) made the study of firm boundaries susceptible to formal economic analysis, and illuminated an important role for markets in providing incentives. In this essay, I discuss some new directions that the literature has taken since. As a central challenge, I identify the need to provide a formal theory of the firm in which managerial direction and bureaucratic decision-making play a key role. Merging a number of existing incomplete contracting models, I propose two approacheswith very different contracting assumptions. As in transaction cost economics, a central element in those theories is the presence of a central office who directs and coordinates the actions of subordinates. More novel, I highlight the superior ability of non-integrated firms to adapt to a changing environment.
Keywords: adaptation; coordination; firm boundaries; incomplete contracts; managerial direction
JEL Codes: D23; D83; L23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Managerial direction (M54) | Coordination outcomes (E61) |
| Integration of firms (L22) | Coordination outcomes (E61) |
| Integration of firms (L22) | Managerial effectiveness (M54) |
| Nonintegration of firms (L22) | Adaptability to changing environments (O30) |
| Decentralized decision-making (D70) | Adaptability to changing environments (O30) |
| Centralized ownership (L22) | Alignment of objectives (L21) |
| Better contractibility (D86) | Preference toward integration (F15) |
| Better contractibility (D86) | Preference toward nonintegration (F55) |
| Integration favored when coordination is paramount (F02) | Managerial direction effectiveness (M54) |
| Nonintegration preferred when motivation is critical (D80) | Managerial direction effectiveness (M54) |