Wednesday, 25 March 2009

The glue of firms

This morning the HoD sent me a link to an interesting new paper to do with the theory of the firm. I have started reading it this afternoon and there is one point about which I'm not sure I agree with the author. The paper is "From fictions and aggregates to real entities in the theory of the firm" by David Gindis, Journal of Institutional Economics, 5(1) 2009: 25–46.

On page 30 Gindis writes
What, then, is the link between the owner (e.g., employer) and the other agents necessary for production (e.g., employees)? The existence of such a link is important for a theory of the firm, and Hart (1995: 57) rightly stresses that ‘without something to hold the firm together, the firm is just a phantom’. Hart(1995: 57–59) says:
A firm’s nonhuman assets . . . simply represent the glue that keeps the firm together . . . If such assets do not exist, then it is not clear what keeps the firm together . . . One would expect firms without at least some significant nonhuman assets to be flimsy and unstable entities, constantly subject to the possibility of break-up or dissolution.
Clearly, Hart provides a wrong answer to a good question. Hart makes a logical mistake by stating that a collection holds itself together. Far from being the sort of thing that could bind anything together, a collection is itself in need of being bound together if it is to form a whole. Without some sort of ‘glue’, a collection is no different from a heap of sand easily blown away on a windy day. Arguably, Hart also makes a theoretical mistake by excluding human assets or people from his definition of the firm. Given that property rights hold nonhuman assets together, the glue question makes sense only if it is about what holds human beings together.
To me Gindis misses the point Hart is trying to make here. My take on what Hart is saying is that while property rights hold the nonhuman assets in place, it is the nonhuman assets that keep the human assets in place. That is, the employees stay at the firm because the firm has control-property rights-over the nonhuman assets. These nonhuman assets make the employees more productive and thus the workers wish to remain with the firm to remain productive.

I shall have to ponder longer.


Matt Nolan said...

I agree with you that the non-human assets are one of the reason that value is created through the trade between the capital owner and the worker. As a result, looking at them is not irrelevant.

However, when we are discussing the "glue", I'm not really sure that the existence of non-human assets itself is the issue. Isn't it more an issue of contracts. I mean, even if the capital owner has no non-human capital (and the production function only had one factor - labour) - but the owner has contracts with other workers, then their could still be value for an additional worker to join the firm rather than work alone.

And even in the case where non-human capital exists - it is contracts that ensure the production process involving labour and capital occurs in the first place. As a result, I'd put down contracts as glue for a firm.

Paul Walker said...

If there is only human capital involved in the firm then I'm not sure what a firm is. As Hart (1995: 56-7) explains, at least some, nonhuman assets are essential to a theory of the firm. To see why this may be so consider a situation where `firm' 1 acquires `firm' 2, which consists entirely of human-capital. The question Hart raises is, What is to stop firm 2's workers from quitting? Without any physical assets-e.g. buildings-firms 2's workers would not even have to relocate themselves physically. If these workers were linked by telephones or computers, which they themselves own, they could simply announce one day that they had decided to become a new firm. For the acquisition of firm 2 by firm 1 to make economic sense there has to be a source of value in firm 2 over and above the human-capital of the workers. It makes little sense to buy a `firm' if that `firm' can just get up and walk away. Hart argues there must be some `glue' holding firm 2's workers in place.

The value which acts as this glue may consist of as little as a place to meet; the firm's name, reputation, or distribution network; the firm's files, containing important information about its operations or its customers; or even a contract that prohibits firm 2's workers from working for competitors or from taking existing clients with them should they quit. The source of value may even just represent the difficulty firm 2's workers face in coordinating a move to another firm. But without something binding the firm together, the firm becomes a phantom, and as such we should expect that such firms would be flimsy and unstable entities, constantly subject to the possibility of break-up or dissolution.

It not clear to me if there is only human capital involved why they would even need a contract. For example I write papers with co-authors without a contract-and my co-author brings the human capital! Even if they did have a contract why would this make them a firm or rather than it just being a market transaction?

Sean said...

This smacks me of the problems one can get into when the role of the entrepreneur is ignored. Instead of contract, relationships, negotiation, vision and leadership we get "human assets", a concept so vague as to be meaningless (unless advocating slavery). It also highlights some of the conceptual/empistomological short-comings of our discipline.

Matt Nolan said...

Hi Paul,

Because a (complete) contract can ensure that agents act in each others interest in all states of the world. As a result, even if the production function was only in labour there could still be a role for contracts to bind the firm together.

Furthermore, without contracts non-human capital still might not be enough to "glue the firm together". As we could have a case where an employee used the capital and gains the output - and then they are unwilling to give the capital owner any of the proceeds. We need contracts to ensure that this sort of thing can't happen.

Paul Walker said...

But the whole framework being used here is an incomplete contracts framework so the type of contract you want to write is impossible. Given that, all we have left to keep the firm together is the relationship between the human and non-human assets.