Four Formal(izable) Theories of the Firm?

In this essay, I define and compare elemental versions of four theories of the firm. These elemental theories are distilled from important contributions by Hart, Holmstrom, Klein, Williamson, and others. Although these contributions have been widely cited and much discussed, I have found it difficult to understand the commonalities, distinctions, and potential combinations of these seemingly familiar contributions. In this essay, therefore, I attempt to clarify these issues, in three steps: I begin with informal summaries of the theories, then turn to simple but formal statements of each elemental theory, and finally nest the four elemental theories in an integrative framework. * I thank Matthew Bidwell and Marek Pycia for exemplary research assistance, George Baker, Oliver Hart, Paul Joskow, Kevin J. Murphy, and Michael Whinston for helpful comments, Pierre Azoulay, Jacques Crémer, Luis Garicano, Bengt Holmstrom, Ben Klein, Claude Menard, John Roberts, Eric Van den Steen, Michael Waldman, and Oliver Williamson for detailed suggestions, and Jonathan Levin, Scott Masten, Stéphane Saussier, and Steven Tadelis for sustained dialogues on the frailties of this essay. I also thank seminar audiences at ATOM (Paris I), Berkeley, Chicago, Harvard-MIT, ISNIE, Stanford, and USC for helpful comments and MIT’s Program on Innovation in Markets and Organizations, Harvard Business School, and the NSF (SBR-9809107) for financial support. This essay will evolve into two chapters in my forthcoming book, Organizational Economics (Princeton University Press, 2006), so comments are still very welcome. Four Formal(izable) Theories of the Firm?