Working Paper: NBER ID: w18495
Authors: Thomas F. Hellmann; Veikko Thiele
Abstract: We develop a new theory of the firm where asset owners sometimes want to change partners ex-post. The model identifies a fundamental trade-off between (i) a "displacement externality" under non-integration, where a partner leaves a relationship even though the benefit is worth less than the loss to the displaced partner, and (ii), a "retention externality" under integration, where a partner inefficiently retains the other. Renegotiation cannot eliminate these inefficiencies when agents are wealth constrained. When there is more asset specificity, displacement externalities matter more and retention externality less, so that integration becomes more attractive. Our model also predicts that integration always provides stronger incentives for specific investments, and that wealthy owners actually want to commit to ex-post wealth constraints. Our analysis differs from the received theories of the firm because of our emphasis on dynamic partner changes.
Keywords: firm theory; partner displacement; asset ownership; externalities
JEL Codes: D23; D82; D86; L22; M20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| joint asset ownership (G32) | prevent inefficient partner displacements (J63) |
| joint asset ownership (G32) | stronger incentives for specific investments (G31) |
| displacement externality (D62) | partner who has an outside option may leave (J63) |
| joint asset ownership (G32) | raises the costs of leaving a relationship (J12) |
| joint asset ownership (G32) | retention externalities (D62) |
| retention externalities (D62) | create inefficiencies in the partnership (L14) |
| wealth constraints (D10) | limit the ability of partners to compensate each other effectively during renegotiation (L14) |