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Coase (1937) revisited: Endogenous fiat in firms and markets

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Abstract

Coase (Economica 4:386–405, 1937) observed that, within firms, employees are directed by fiat. Ever since it has been argued that hierarchical control and fiat are institutional attributes of firms. In contrast with this view, there is evidence that the organizational structure of many interfirm relations, from supply networks to franchising, is also hierarchical. To reconcile Coase’s insight with the evidence, I develop a model where the obligations of both a firm’s contractors and its employees cannot be enforced by courts, so they must be self-enforcing. I show that fiat, in the form of relational contracts where the agent obeys the principal in equilibrium, occurs both when the agent is an employee—so the principal owns all the assets—and when she is a contractor—so the agent owns some assets. However, the principal can give more orders to an employee (contractor) when decisions sufficiently above (close to) those that maximize the value of the contractor’s assets are optimal—for instance, because there are strong positive externalities between the assets. The model has several implications for the theory of the firm, the distinction between markets, hybrids and hierarchies, and the choice between in-house provision and outsourcing of public services.

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Notes

  1. See Lafontaine and Slade (1997, 2007) for detailed reviews of the empirical literature on vertical integration.

  2. This implies that, in these environments, one cannot assume, as in Hart and Holmstrom (2010) and in Baker et al. (2008), that integration concentrates full control over decisions within one party, eliminating the distinction between a principal who orders and an agent who implements.

  3. Klein and Murphy (1997) also point out that employees lose more than contractors in case of termination.

  4. This is not always the case, as the law may award different rights to franchisees and employees. For instance, Brickley et al. (1991) find that franchisors tend to own more outlets in American states where the law protects franchisees from termination.

  5. Consistent with the assumption that asset ownership conveys the right to appropriate payoffs, there is empirical evidence in franchising that firms tend to appropriate most of the profits generated by the assets they own (Krueger 1991; Maness 1996).

  6. See Bull (1987), MacLeod and Malcomson (1989) and Baker et al. (2002, 2011) for related models of relational contracts.

  7. This interpretation of the equilibrium level of d as a measure of the amount of fiat exerted by P may be clearer if one assumes that, instead of implementing one decision, A must implement a continuum of decisions indexed by d. Hence, a relational equilibrium where d is large implies that P orders more decisions to A.

  8. See Lafontaine and Slade (1997, 2007) for detailed reviews of the empirical literature on vertical integration.

  9. Consistent with that, most empirical studies of relational contracts rely on measures of past interactions as proxies for r (Corts and Singh 2004; Kalnins and Mayer 2004). An exception is Gil and Marion (2012), where highway construction schedules issued by the Californian public administration are used as exogenous proxies for the prospect of future interactions between contractors and subcontractors.

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Acknowledgments

Earlier versions of this article circulated under the titles “Fiat without Authority under Vertical Integration” and “Fiat without Authority in Firms and Markets”. I am grateful to Benito Arruñada and Robert Gibbons for continuous advice and encouragement, and to Gani Aldashev, Nicholas Argyres, Marc Bellemare, Antonio Cabrales, Pablo Casas-Arce, Marco Celentani, Silke Forbes-Januszewski, Luis Garicano, Ricard Gil, Anna Grandori, Stephen Hansen, Eduardo Melero, Jean-Philippe Platteau, Emmanuel Raynaud and Dean Williamson for their comments and suggestions. This study received financial support from the Spanish Ministry of Science and Education, through grant ECO2011-29445.

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    Giorgio Zanarone

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Zanarone, G. Coase (1937) revisited: Endogenous fiat in firms and markets. Int Rev Econ 59, 201–221 (2012). https://doi.org/10.1007/s12232-012-0155-z

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