Introduction

In Chapter 5 we study how the ownership structure of the firm affects economic outcomes. Continuing the discussion begun in Chapter 2, we see the firm as a nexus of contracts involving in various ways the owners of inputs and the buyers of commodities. An examination of the economic logic of these contractual arrangements and their relation to the costs of transacting is reserved for Chapter 6.

We begin this chapter with a digression on property rights and production functions and go on to look at some major types of firms that are found in modern market economies. These include not only privately owned firms, which often are subject to various forms of government regulations and restrictions on the right to contract, but also “political firms,” that is, firms owned by the state.

Rights, incentives, and production functions

Why do we expect that the economic outcomes of productive activities organized within firms depend on the internal rules of the firms and, more generally, on the external structure of property rights? In answer to this question, Jensen and Meckling (1979) have argued that production functions depend on the structure of property rights just as they depend on the state of technology. They define the firm as a network of contracts specifying the rewards and costs that arise out of the cooperation of individuals in production.