Advanced Search
MyIDEAS: Login to save this paper or follow this series

The Boundary of the Firm in a Model of Trade Within a Hierarchy

Contents:

Author Info

  • Nadav Levy

Abstract

In this paper I present a theory of the boundary of the firm that accounts for some important characteristics of real-world multidivisional firms: Operative decisions are in the hands of middle managers who are rewarded with incentive contracts based on the performance of their units; Managers' decisions are subject to approval and intervention by the top management of the firm; and managers are better informed regarding the affairs of their divisions than their superiors in the firm's hierarchy. In this setup, the integration of a producer of an intermediate input and its buyer as separate divisions within a single firm is unambiguously desirable, as long as the choice of trading partners can be credibly delegated to the divisions' managers. I show that this is satisfied not only under the assumption of full commitment by the general office of the firm, but also interestingly, if it has no commitment power at all. At the time of trade, the uninformed general office prefers to delegate the choice of trading partners to the divisions whose decision is ex-post optimal. An explanation of the boundaries of the firm emerges only if we assume that the general office retains some limited commitment power. The general office may then mandate internal trade in order to encourage the divisions to specialize towards one another before the trade. In the context examined, I show that the general office faces a 'time-consistency' problem. It tends to mandate internal trades in more instances than would have been optimal with full commitment, adversely affecting the levels of investment taken by the divisions' managers. Whenever such inconsistency arises, it may be optimal to have the trade conducted between independent, non-integrated parties.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.albany.edu/economics/research/workingp/2003/theoryofthefirm.pdf
Download Restriction: no

Bibliographic Info

Paper provided by University at Albany, SUNY, Department of Economics in its series Discussion Papers with number 03-13.

as in new window
Length:
Date of creation: 2003
Date of revision:
Handle: RePEc:nya:albaec:03-13

Contact details of provider:
Postal: Department of Economics, BA 110 University at Albany State University of New York Albany, NY 12222 U.S.A.
Phone: (518) 442-4735
Fax: (518) 442-4736

Order Information:
Postal: Department of Economics, BA 110 University at Albany State University of New York Albany, NY 12222 U.S.A.
Email:
Web: http://www.albany.edu/economics/research/workingp/index.shtml

Related research

Keywords:

This paper has been announced in the following NEP Reports:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Aghion, Philippe & Tirole, Jean, 1997. "Formal and Real Authority in Organizations," Journal of Political Economy, University of Chicago Press, vol. 105(1), pages 1-29, February.
  2. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
  3. Martin J. Osborne & Ariel Rubinstein, 2005. "Bargaining and Markets," Levine's Bibliography 666156000000000515, UCLA Department of Economics.
  4. Hart, Oliver & Moore, John, 1990. "Property Rights and the Nature of the Firm," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1119-58, December.
  5. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," Journal of Law, Economics and Organization, Oxford University Press, vol. 7(0), pages 24-52, Special I.
  6. Baker, George P, 1992. "Incentive Contracts and Performance Measurement," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 598-614, June.
  7. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March.
  8. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
  9. Holmstrom, Bengt & Tirole, Jean, 1991. "Transfer Pricing and Organizational Form," Journal of Law, Economics and Organization, Oxford University Press, vol. 7(2), pages 201-28, Fall.
  10. Moore, John & Repullo, Rafael, 1988. "Subgame Perfect Implementation," Econometrica, Econometric Society, vol. 56(5), pages 1191-1220, September.
  11. Patrick Bolton & David S. Scharfstein, 1998. "Corporate Finance, the Theory of the Firm, and Organizations," Journal of Economic Perspectives, American Economic Association, vol. 12(4), pages 95-114, Fall.
  12. repec:att:wimass:9714 is not listed on IDEAS
  13. Donald B. Hausch & Yeon-Koo Che, 1999. "Cooperative Investments and the Value of Contracting," American Economic Review, American Economic Association, vol. 89(1), pages 125-147, March.
Full references (including those not matched with items on IDEAS)

Citations

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:nya:albaec:03-13. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (John Bailey Jones).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.