In 1937, Ronald Coase, who would win a Nobel Prize in 1991, wrote a seminal paper titled “The Nature of the Firm.” This paper is now traditionally considered to be the origin of the development of an economic theory of the firm. Coase argued that the firm was more than the purely technical vision of incorporating inputs and generating outputs, that it had a concrete existence in the business world, and that its internal modes of organization (especially the coordination of individuals by hierarchies) were different from simple market transactions (which are coordinated by prices). He encouraged economists to elaborate realistic hypotheses on what a firm is and what a firm does.
Today, the research agenda opened up by Coase (1937) is far from complete. More recent works on the economics of the firm show how difficult it is to fully grasp and qualify this subject. Thus, the economics of the firm is a combination of different subjects, and no single model or theory captures all elements of the puzzle.
The focus of economists on large managerial firms reflects the impact that this type of firm played in the early stages of the capitalist economist system (1900–1970s), when large, vertically integrated corporations were the dominant form of organization. Joseph Schumpeter (1942) qualified them as the major engines of production, while Alfred Chandler (1977) described the emergence of a “visible hand” era driven by these firms. These organizations represent an important field of investigation because they have significant power in the market, they are able to affect the social and economic environment, and they can elaborate complex strategies based on an appropriate organizational structure. Further, these firmshave two distinctive features: (1) There is a separation between ownership and control, so the professional manager is able to define the objectives of the firm, and (2) There is a united, rather than a multidivisional, form of internal organization. These characteristics became one of the privileged fields of exploration of agency theory and the transaction costs approach, which were interpreted in terms of private information and opportunism. In the first case, the manager benefits from private information that the investor cannot access, leaving room for opportunistic behaviors. In the second case, the united organization of the firm favors the development of suboptimal levels of effort that only become observable when competition is introduced among the different divisions of the firm.
There is surprisingly little agreement on what the objectives of the firm are. William Baumol (1959), for example, supports the maximization of sales or the growth rate of sales as the main objective. Oliver Williamson (1964), however, advocates the maximization of the managers’ discretionary power through opportunistic behaviors. Herbert Simon (1947) has criticized both alternatives, arguing that firms that have only a “limited rationality” due to the uncertainty of the environment will only pursue limited objectives, a process he calls “satisficing.” In this perspective, the search for profit will not be made on the basis of achieving maximum profit. In fact, it is impossible to estimate maximum profit because knowledge is not perfect. The objective can only be to maintain a satisfying profit level in order to keep the firm afloat in an uncertain world.
The discovery that the capitalist system underwent a second period of transition during the latter half of the twentieth century, especially from the late 1970s (a period Richard Langlois  labeled the “vanishing hand” era), marks the beginning of a specific focus by economists on a novel sort of firm. Small, vertically disintegrated firms have generally performed as well as large firms. This view is supported by the remarkable persistence of the skewed size distribution of firms in industrial dynamics (i.e., a large number of small firms and a small number of large firms), and by the extremely important contribution of small firms to global economic development (Geroski 1995; Audretsch 1995). In the late 1990s, the critical resource theory was developed by Rajuram Rajan and Luigi Zingales (1998) to explain the performance of knowledge-intensive companies in which an entrepreneur plays a central role in knowledge creation. The point of departure of the analysis is that the nature of the firm has effectively been changing. In the modern firm, the entrepreneur has a critical resource due to specific skills, talents, and ideas, which are the most important source of potential value creation for the firm. The effective value created by the firm is ultimately dependent on how the entrepreneur develops complementarities between his or her own specific resource and the resources of collaborators.
One of the important issues in the economics of the firm is related to who has the power to make decisions. The concept of ownership has traditionally been perceived of as the ownership of physical assets and power and authority have traditionally been based on this vision of ownership. Today, however, firms are also composed of a range of other resources, such as creative knowledge, ideas, and unique skills; professional control; and corporate reputation, which sometimes generate a higher value than physical assets.
Within small firms the founder/entrepreneur generally has the decision-making power, while in large firms the CEO and the board of directors make the major decisions. In small firms, however, the founder, who often has a technical skill, is often replaced, or at least assisted, by a professional manager or a venture capitalist, whose task is to transform this technical knowledge into a commercial opportunity. In large firms, the board of directors can be composed of shareholders, who may significantly influence the decision-making process.
These observations have stimulated a large number of analytical and empirical investigations. First, the respective tasks and scopes of experience of the entrepreneur, the manager, and the venture capitalist within small firms engendered a specific field of research. Different arrangements among the entrepreneur, the manager, and the venture capitalist can be envisaged, including a sharing of power where each contributes in a complementary manner to the development of the company, or exclusive power held by the fund provider in less risky businesses, where the entrepreneur or manager may have less incentive in terms of investment and effort (Blair 1995; Becht et al. 2005).
Second, the question of how large corporations should be owned and managed has been a recurrent theme. The emergence of the shareholder-value ideology has meant that corporate governance is often oriented toward the interests of investors. Uniformity in modes of governance, however, is now widely debated. The predominant thesis that there should be a unique and universal set of managerial rules neglects the diversity of national experiences and the heterogeneity of firms. Moreover, evidence and analytical results show that such a unique model tends to generate major failures and turbulences. Thus, different types of rules have been proposed to govern firms that differ in size, type, industry of origins, and stages of development (Krafft and Ravix 2005; Lazonick and O’Sullivan 2002).
SEE ALSO Business ; Consumer ; Cooperatives ; Economics ; Venture Capital
Audretsch, David. 1995. Innovation, Growth and Survival. International Journal of Industrial Organization 13 (4): 441–457.
Baumol, William. 1959. Business Behavior, Value, and Growth. New York: Macmillan.
Becht, Marco, Tim Jenkinson, and Colin Mayer. 2005. Corporate Governance: An Assessment. Oxford Review of Economic Policy 21 (2): 155–163.
Blair, Margaret. 1995. Ownership and Control: Rethinking Corporate Governance for the Twenty-First Century. Washington, DC: Brookings Institution Press.
Chandler, Alfred. 1977. The Visible Hand: The Managerial Revolution in the American Business. Cambridge, MA: Belknap Press.
Coase, Ronald. 1937. The Nature of the Firm. Economica 4 (16): 386–405.
Geroski, Paul. 1995. What Do We Know about Entry? International Journal of Industrial Organization 13 (4): 421–440.
Krafft, Jackie, and Jacques-Laurent Ravix. 2005. The Governance of Innovative Firms: An Evolutionary Perspective. Economics of Innovation and New Technology 14 (3): 125–147.
Langlois, Richard. 2003. The Vanishing Hand: The Changing Dynamics of Industrial Capitalism. Industrial and Corporate Change 12 (2): 351–385.
Lazonick, William, and Mary O’Sullivan. 2002. Corporate Governance and Sustainable Prosperity. New York: Palgrave.
Rajan, Rajuram, and Luigi Zingales. 1998. Power in a Theory of the Firm. Quarterly Journal of Economics 113 (2): 387–432.
Schumpeter, Joseph. 1942. Capitalism, Socialism, and Democracy. New York: Harper.
Simon, Herbert. 1947. Administrative Behavior. New York: Macmillan.
Williamson, Oliver. 1964. The Economics of Discretionary Behavior, Managerial Objectives in a Theory of the Firm. Englewood Cliffs, NJ: Prentice-Hall.
firm1 / fərm/ • adj. 1. having a solid, almost unyielding surface or structure: the bed should be reasonably firm, but not too hard. ∎ solidly in place and stable: no building can stand without firm foundations fig. he was unable to establish the store on a firm financial footing. ∎ having steady but not excessive power or strength: you need a firm grip on the steering. ∎ (of a person, action, or attitude) showing resolute determination and strength of character: he didn't like being firm with Larry, but he had to.2. strongly felt and unlikely to change: he retains a firm belief in the efficacy of prayer. ∎ (of a person) steadfast and constant: we became firm friends. ∎ decided upon and fixed or definite: she had no firm plans for the next day. ∎ (of a currency, a commodity, or shares) having a steady value or price that is more likely to rise than fall: the dollar was firm against the yen.• v. [tr.] make (something) physically solid or resilient: an exercise program designed to firm up muscle tone. ∎ fix (a plant) securely in the soil. ∎ [intr.] (of a price) rise slightly to reach a level considered secure: he believed house prices would firm by the end of the year. ∎ make (an agreement or plan) explicit and definite: archaeologists have now firmed up this new view.• adv. in a resolute and determined manner: she will stand firm against the government's proposal.PHRASES: be on firm ground be sure of one's facts or secure in one's position, esp. in a discussion.a firm hand strict discipline or control.DERIVATIVES: firm·ly adv.firm·ness n.firm2 • n. a business concern, esp. one involving a partnership of two or more people: a law firm.