Blackwell Reference Online

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When economists speak of a theory of the firm, they mean something very specific. They use the term either to denote a theory that addresses the issue of the existence and boundaries of the multi-person firm, or to explain its internal structure and organization. Examples of the former type may rightly be called why theories of the firm, as they seek to explain why firms exist in the face of institutional alternatives like markets and hybrids. Representatives of the latter type are best addressed as how theories of the firm, as they set out to provide accounts of how complex organizations succeed in combining the heterogeneous inputs of differentially motivated individuals into meaningful collective outcomes ( Heugens 2005 ). The distinguishing characteristic of all why theories of the firm is that they treat the formal organization as an aberration, which requires explanation because alternative institutions for organizing economic activities exist. In the words of Ronald Coase (1937) , theoreticians should “attempt to discover why a firm emerges at all in a specialized exchange economy.” Coase's fundamental observation in this respect was that markets are not and can never be without friction, and that there is therefore always a cost attached to using the central coordination system of the market (i.e., the price system). These so-called transaction costs primarily consist ... log in or subscribe to read full text