ABSTRACT
The theory of the firm is a central element in modern economics and the firm is one of the central economic institutions of capitalism. There is considerable controversy regarding the relative importance of the techno-functional and institutional foundations of the theory of the firm. An economic explanation of why firms exist – first suggested by Coase (1937) – is because they are efficient. The costs of organizing a transaction within the firm must be less than the costs of using the market for firms to exist. The modern theory of the firm explains the boundaries of the firm based on three major costs of organizing firms: communication and coordination costs (Coase, 1937; Williamson, 1975; Radner, 1992), agency costs (Alchian and Demsetz, 1972) and the hold-up problem (Klein et al., 1978; Williamson, 1985). These costs can be lumped together and viewed as different kinds of transaction costs. However, there is still room for controversy, as Dietrich (2006) suggests: the firm can be conceived primarily as a legal unit, a governance structure or a strategic entity, which has different theoretical implications. However, common to this literature on the theory of the firm is the view that the size of the firm is largely independent of technological considerations which dominate the literature on plant size. The neglect of technology in this literature has been noted by a number of commentators (e.g. Antonelli, 1999; Lindbeck and Snower, 2003). However, most modern developments falling within the rubric of the economic theory of the firm have looked at the firm as a bundle of bilateral contracts. This implies a major neglect of the technological and organizational aspects of production. This view is epitomized by Alchian and Demsetz (1972), who do not see any relevant difference between the relation which occurs between employer and employee and the one between a grocer and his customers.
