"The Nature of the Firm" (1937) is an article by Ronald Coase published in the economics journal Economica. It offered an economic explanation of why individuals choose to form partnerships, companies, and other business entities rather than trading bilaterally through contracts on a market. The author was awarded the Nobel Memorial Prize in Economic Sciences in 1991 in part due to this paper. Despite the honor, the paper was written when Coase was an undergraduate and he described it later in life as "little more than an undergraduate essay."
The article argues that firms emerge because they are better equipped to deal with the transaction costs inherent in production and exchange than individuals are. Economists such as Oliver Williamson, Douglass North, Oliver Hart, Bengt Holmström, Armen Alchian and Harold Demsetz expanded on Coase's work on firms, transaction costs and contracts.
Summary
Given that production could be carried on without any organization, Coase asks, 'Why and under what conditions should we expect firms to emerge?' Since modern firms can only emerge when an entrepreneur of some sort begins to hire people, Coase's analysis proceeds by considering the conditions under which it makes sense for an entrepreneur to seek hired help instead of contracting out for some particular task.
The traditional economic theory of the time suggested that, because the market is "efficient" (that is, those who are best at providing each good or service most cheaply are already doing so), it should always be cheaper to contract out than to hire.
The paper has had an outsized impact on the field of microeconomics, particularly in essentially inventing the body of research that deals with the theory of the firm. According to Google Scholar, the paper has been cited more than 59,000 times as of September 2024.
This article was famously referred by Yochai Benkler in his article "Coase's Penguin, or, Linux and The Nature of the Firm", where he links Coase's essay to the emergence of commons-based peer production communities using the Internet. In particular, Benkler considers the commons-based peer production a third alternative coordination mechanism for economic transactions besides the dichotomy composed of markets and hierarchies. In the article's title, ‘penguin’ refers to the logo of the Linux operating system, invoking the challenge it poses to Coase's work by working through different mechanisms than those present in markets and firms. Resolving this challenge, according to Benkler, lies in substituting the role of transaction costs in Coase's work with the concept of information opportunity costs when explaining the emergence of commons-based peer production.
The World Bank's 2019 World Development Report on The Changing Nature of Work suggests that firms and production processes become less vertically integrated as technology makes it cheaper to resort to the open market to complete portions of the production process.
See also
- Economic analysis of law
- "The Problem of Social Cost"
- Theory of the firm