Authority in a Theory of the Firm

Abstract

We study a simple model of the firm comprised of a production unit, a sales unit, and an owner with interests in both units. The owner has the right to adapt the production quantity to changes in demand and costs. Whether the owner effectively assumes this right or delegates decision-making depends on the relative uncertainty about demand and costs, on the division of surplus in the firm, and on the riskiness of the environment the firm faces. We characterize conditions that make acquiring ownership rights feasible and effcient. The same conditions determine the boundaries of the firm in our model.

Keywords: authority, common and private values, delegation, Noisy information, organizations, ownership, Strategic communication

JEL Classification: D82, D83