Uncertainty and the nature of the firm: From Frank Knight and Ronald Coase to an evolutionary approach

In his article ‘The Nature of the Firm’ Coase Economica 4:386-405, (1937), Ronald Coase enquired why organisations such as firms exist in a specialised exchange economy. He concluded that the main reason to establish and grow a firm is to avoid some of the transaction costs of using the price mechanism. Earlier, a similar issue was considered, albeit not so explicitly, by Frank Knight in his book, ‘Risk, Uncertainty, and Profit’ Knight, (1921). According to Knight, the emergence and growth of a modern enterprise is associated with ‘the fact of uncertainty’. In this paper, we address the seminal Coasian question regarding the firm and compare his and Knight’s views on the nature of the firm in its relation to uncertainty. We argue in favour of conceiving of the firm as an institution of a dynamic economy and explain the relationship between the firm and the market in terms of their complementarity, coevolution, increasing complexity and order. We also examine the notion of transaction costs and outline the concept of Coasian uncertainty. Toward the end, we demonstrate the advantages of the firm from the perspective of its complexity, evolutionary adaptability and its viability in the face of uncertainty. We suggest that both Knight and Coase came close to perceiving the nature of the firm in terms of complex systems, but from fundamentally different angles. Thus, we formulate the criteria to determine the boundaries of the firm with regard to the problem of complexity and the system's viability, considering both Knight’s and Coase’s uncertainties.