A Theory of Firm Scope

By Oliver Hart, Bengt R. Holmstrom. 2010

406 citations recorded by the source corpus.

The existing literature on firms, based on incomplete contracts and property rights, emphasizes that the ownership of assets - and thereby firm boundaries - is determined in such a way as to encourage relationship-specific investments by the appropriate parties. It is generally accepted that this approach applies to owner-managed firms better than to large companies. In this paper, we attempt to broaden the scope of the property rights approach by developing a simple model with three key ingredients: (a) decision rights can be transferred ex ante through ownership, (b) managers (and possibly workers) enjoy private benefits that are non-transferable, and (c) owners can divert a firm's profit. In our basic model decisions are ex post non-contractible; in an extension we use the idea that contracts are reference points to relax this assumption. We show that firm boundaries matter. Nonintegrated firms fail to account for the external effects that their decisions have on other firms. An integrated firm can internalize such externalities, but it does not put enough weight on the private benefits of managers and workers. We explore this tradeoff in a model that focuses on the difficulties companies face in cooperating through the market if the benefits from cooperation are unevenly divided; therefore, they may sometimes end up merging. We show that the assumption that contracts are reference points introduces a friction that permits an analysis of delegation.

Subfields: Accounting, Economics and Econometrics

View Paper: https://www.semanticscholar.org/paper/9796ce5f5d4244a4151761ce61d0813976d82db0

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Citations in the corpus

Building State Capability: Evidence, Analysis, Action (2017, background): “• In contrast, the Burkina case shows slower, less expansive, and more muddled scaling—through what Uvin and Miller (1996) calls “expansion” (where one builds on pilots) or “association” (where one builds on and through relationships).”
Do Prices Determine Vertical Integration (2016, neutral): “Organization economists have emphasized other benefits, and often associated costs: reductions in the costs of transactions, adaptation, or opportunism (Williamson, 1971, 1975; Klein, Crawford, and Alchian, 1978); better multitasking incentives (Holmström and Milgrom, 1991); alignment of control and”
Capital Allocation and Delegation of Decision-Making Authority within Firms (2014, neutral): “6 In Hart and Holmström (2010), the boss delegates formal authority over decision rights to managers and has incentive not to renege (which would aggrieve the employees and lead them to exert less effort).”
Leadership, Coordination, and Corporate Culture (2013, background): “Future research could build on our model by considering what leader traits might be useful for overcoming other management obstacles, such as resistance to change (see e.g. Hart and Holmstrom (2010); Hart and Moore (2005); or Dow and Perotti (2010)).”
Resistance to Change (2016, background): “Hart and Holmstrom (2010) show how such “shading”undermines cooperation within integrated firms.”
Interpersonal Authority in a Theory of the Firm (This paper is currently being revised) (2007, background): “…contributions in which interpersonal authority plays no role, such as Alchian and Demsetz (1972), the Grossman-Hart-Moore property rights theory, Raghuram G. Rajan and Luigi Zingales (1998), Hart and Holmström (2002), Hart and Moore (2008), and Jonathan Levin and Steve Tadelis (forthcoming).”
Incomplete Contracts and the Internal Organization of Firms (2013, positive): “Third, as stressed by Hart and Holmstrom (2010), taking control back from an agent causes the agent to become aggrieved which in turn may induce the agent to "shade", i.e. to take unobservable actions which are damaging to the firm.”
Earnings Management within Multinational Corporations (2018, background): “The industrial organization literature studies the optimal allocation of decision rights within the firm (e.g., Grossman and Hart, 1986; Aghion and Tirole, 1997; Hart and Holmstrom, 2010).”
Organizing for Synergies (2010, neutral): “For example, even though GE centralizes sourcing globally, the GE CEO does not make the individual sourcing decisions; these are delegated to a functional manager.”