Thom Lambert at Truth on the Market has an excellent summary of the economics of the firm. Here is a very brief excerpt:
The ……

Again, I’m not disagreeing with you that Williamson (and for that matter Klein, Crawford & Alchian) makes the immensely important contribution of giving more meaning to “transactions costs” here by adding asset specificity to the analysis. And the the empirical literature on the relationship between asset specificity and vertical integration IS very consistent — and perhaps strong enough to conclude that asset specificity considerations should be our primary focus in TCE. That Williamson made a very important contribution to further Coase’s analysis, I think, goes without saying. I’m just making the claim here that Coase does more than say “there exist firms … discuss.”

My recollection is that Williamson tries to specify what these costs are, based on various economic characteristics of transactions, e.g. asset specific investments. When I hear references to transaction cost economics I assume people are talking about Williamson’s theories rather than Coase’s more open-ended statement. But aren’t there many plausible explanations as to why “there is a cost of using the price mechanism”? Is there any evidence as to the magnitude of the various economic factors that a Williamsonian transaction cost analysis would suggest, which I assume is what Thom and Vic would have us teach, as compared with a variety of other hypotheses about what the costs of the price mechanism might be?

Finally, one can make an argument that a third basic principle which belongs in the first day of lecture is Capital Structure (M&M; Jensen and Meckling). Of course, this principle overlaps a bit with Agency Cost Theory.

“The main reason why it is profitable to establish a firm would seem to be that there is a cost
of using the price mechanism.”

Second, you make a connection between Coase’s article on the firm and transaction costs that has always troubled me. My recollection of the Coase essay is that he presents the question as to why these “islands of conscious power” form as, if I may use the term, a mystery. It is Williamson who claims that the answer is transactions costs, and I, for one, am much more comfortable with Coase’s question than Williamson’s answer. There are a lot of interesting alternative theories as to why types of business organizations form and survive that are not included in the traditional transaction costs stories.

So, to answer Vic’s question, I find the emphasis on transaction costs suggested by Thom’s post as presenting too limited a picture of the kinds of issues a Business Organizations class should address.

The paper of Coase misses this historical perspective, which is extremely important in understanding the nature of the company and why it lacks transactions. Nowhere in his paper is the word “family” mentioned.

I’m thankful that Thom brought up this topic, because I believe it’s time to revise many of our fundamental assumptions and theories about our society and our economy. For example, the ubiquitous family model of the company is causing huge frustrations among employees and managers alike, not to mention the losses to our economy.

Central planning (the family model) is not more efficient than transactions and will be gradually replaced by the latter. Why?

– we simply cannot have fair pay with central planning; this leads to huge frustrations in the workplace – people changing jobs, the more capable and individualistic prefer to become self-employed; this distortion has also led to the emergence of unions and other such artificial rifts between “top management” and “employees”

– inefficient allocation of resources, slow feedback systems within the company – all this leads to instabilities within businesses, which then propagate to the rest of the economy and render it more volatile

– transactions within the company are cheaper than those on the open-market; within the company we have a more protective and bounded environment, a place where people know each other a lot better and can establish trusted relations with less effort; we cannot simply assume that internal and external transactions have the same cost, and then use this is an argument for central planning

The family model of the company is going to fall, for exactly the same reason why the Soviet Block collapsed: central planning doesn’t work well economically.

I know that teaching can be difficult a job, especially in situations when you have a fuzzy and controversial topic such as organisations, which you long to present as coherently as possible to students. Good luck, and don’t be afraid to show to the young generation that we, the grownups, still haven’t got the answers to all questions

I’m curious if folks think that anything Thom says in his intro is seriously contestable. I don’t, really. Perhaps a bit at the end, when he firmly embraces a contractarian view of the corporation. When I introduce that concept in Deals I tell the students that some smart folks out there take a different view of the corporation, e.g. as a concession of the state, as a moral entity, as a vehicle for achieving other social goals, or as a vehicle for redistributing wealth. But I then ask them to set aside those views for the purposes of the Deals class.