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The Nature of the Firm: Origins, Evolution, and Development.

This volume collects various papers presented at a 1987 Yale University conference celebrating the fiftieth anniversary of Ronald Coase's article "The Nature of the Firm" (Economica, 1937). The volume is particularly timely given Coase's receipt of the 1991 Nobel Prize for economics. Apart from an introduction by Oliver Williamson and a reprinting of Coase's article, versions of each chapter have already appeared in a special issue of the Journal of Law, Economics, and Organization (Spring 1988). Even so, the book is well worth owning, since it gives a comprehensive survey of where the economics of organization has been and where it might be going.

The volume divides into two principal sections. After the introduction and Coase's 1937 article, chapters 3-5 reproduce a series of lectures given by Coase himself. In the remainder of the book, eight prominent economists extend Coase's insights in various ways. Since space is limited, I summarize each chapter briefly and then identify some unresolved issues.

In his first lecture, Coase describes the intellectual path leading to his central formulation: firms exist because it is costly to use markets, and firms expand until further expansion is more costly than market exchange. The second lecture corrects some misconceptions about the meaning of the 1937 article. In his third lecture, Coase reflects on his work. The main defects of the article, as Coase now sees it, are an overemphasis on the employment relationship at the expense of property rights and too much stress on purely contractual issues to the neglect of the managerial processes involved in running a business.

The second part of the book reveals the diverse directions in which economists have taken Coase's ideas. Sidney Winter remarks that if economists were asked about the role of business firms in a market economy, they would respond with "an excited babble of significantly conflicting answers--an interesting babble, but a babble nonetheless" (p. 179). Winter's remark deserves attention not just because it is an unusual confession for the editor of a conference volume to make about his material, but also because it is true. The remaining contributions in the book bear this out.

Sherwin Rosen's chapter on internal labor markets deals with the incentive problems generated by team production methods. He points out that, empirically, most firm-specific human capital takes the form of "good matches" between workers and firms. He also observes that simple incentive systems (piece rates, sharing schemes) may be motivated by their robustness against variations in individual preferences.

In the next chapter, Williamson reviews the modern ideas of transaction cost economics, as formulated in his many influential books and articles. There are two new topics here: a discussion of debt and equity as alternative governance structures and an interesting comparison between Williamson's "process" view of the transaction costs associated with market exchange, as against the "incentive" approach taken by Sanford Grossman and Oliver Hart (Journal of Political Economy, 1986). This chapter is followed by Paul Joskow's valuable survey of recent empirical evidence concerning vertical integration. Joskow argues that the recent theoretical emphasis on asset specificity is justified by available evidence on the subject.

Oliver Hart points out that conventional views of vertical integration require two different theories: one to explain its costs and another to explain its benefits. By emphasizing the role of non-contractible ownership rights over physical assets, Hart constructs a unified theory where either independent or integrated ownership can be efficient under some conditions.

Harold Demsetz focuses on the specialization of knowledge as a determinant of the boundaries of the firm. He argues that title to a product will be transferred to downstream users at a point where further integration would require the mastery of many different forms of technical and organizational expertise. This theme is taken up by Winter, who embraces the view that "business firms are organizations that know how to do things" (p. 189). Both authors recognize that firms operating in the same product market may have quite different capabilities. Winter closes by comparing transaction cost economics with the evolutionary perspective he has developed in collaboration with Richard Nelson (An Evolutionary Theory of Economic Change, 1982).

Scott Masten asks whether there are sanctions available in the employment contract stronger than those available to commercial contractors. If so, differences in legal treatment could help to explain why firms sometimes prefer to transact with employees rather than with independent suppliers. Masten shows that the answer is in the affirmative. The legal obligations of an employee are greater than those of an independent contractor with regard both to obedience and to information supply. These duties are likewise backed up by greater sanctions (employees can more easily be sued for damages and are more readily dismissed).

The book ends with Benjamin Klein's chapter on vertical integration and asset specificity. Klein argues that the hold-up problems resulting from asset specificity motivate integration, and he illustrates his point with the acquisition of Fisher Body by General Motors in 1926. This argument is of particular interest in view of Coase's rejection of the asset specificity hypothesis in chapter 5 and of Demsetz's endorsement of Coase's position. Klein goes on to say that the specific human capital embodied in production teams can be "owned" by a firm in the sense that the employment contracts holding the team together can be transferred from one firm to another. The threat that the team itself will hold up the firm is minimized by the high cost of collusion among the members of large coalitions. This point fits nicely with the emphasis on knowledge and production capabilities in the chapters by Demsetz and Winter.

In closing, I raise an unresolved issue concerning "The Nature of the Firm": namely, what is the nature of the firm? Two divergent (if not incompatible) visions run through the book. In one view (shared by Rosen, Williamson, Masten, and the young Coase), firms possess distinct powers of fiat that are not easily replicated through market contracting. Thus, in his 1937 article Coase sees the firm as a realm of command or authority, whereas markets allocate resources through decentralized price signals. In the alternative view, the firm's boundaries are defined by the set of assets placed under common ownership. This view is shared to varying degrees by Hart, Demsetz, Klein, and perhaps the older Coase (insofar as he regrets his earlier emphasis on the employment relationship). Indeed, Klein extends this notion to include idiosyncratic human capital, not just physical assets. The firm thus becomes a complex collection of contracts, lacking qualitative powers beyond those available under market exchange.

Some hints of a possible reconciliation between these views are scattered throughout the book (especially in the chapters by Williamson, Hart, and Masten). In this respect, as in others, the book reflects the ferment now under way within the economics of organization. But this is a virtue rather than a defect. For students and noneconomists, the volume provides an accessible route into the now enormous literature on economic organization (particularly since the mathematical burden is unusually light). Specialists, on the other hand, will find ample grist for their analytical mills. As Winter says, it is an interesting babble.

Gregory K. Dow is professor of economics at the University of Alberta. He has written a number of articles on the economics of organization, with emphasis on bargaining models and the theory of the labor-managed firm. He is currently preparing a critique of transaction cost economics, to be published in Transaction Costs, Markets, and Hierarchies: Critical Assessment, ed. Christos Pitelis.
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Author:Dow, Gregory K.
Publication:Business History Review
Article Type:Book Review
Date:Dec 22, 1991
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