Saturday, 18 April 2015

Chicago's best ideas: "contract law, transaction costs, and the boundary of the firm"

If you have an hour free this weekend one way to spend it would be to watch this video by Anup Malani, professor at the University of Chicago Law School, talking about "Contract Law, Transaction Costs, and the Boundary of the Firm".

[...] describes a number of surprising contract provisions that can be used to tackle the holdup problem, where a buyer and seller agree on a price for a future date, but the seller later demands a higher price. He also discusses how contract law can affect the scope and ownership of firms.

In 1937, Ronald Coase asked: if markets are so efficient at allocating resources, why are so many resources allocated within firms? His answer was that market allocation entailed transactions costs and, when these were very high, transactions will take place within firms.

Oliver Hart, with Sanford Grossman and John Moore, suggested the holdup problem could be overcome if the buyer owns a key asset of the seller or the seller's whole firm, which can prevent the seller from holding up the buyer. Hart, Grossman, and Moore transformed Coase's theory of how large firms were into a theory of who owns firms. Since then, there have been numerous efforts to demonstrate that asset ownership or integration is not necessary to overcome the holdup problem.

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