留學生經濟學碩士dissertationProduction, Information Costs, and Economic Organization
Armen A. Alchian; Harold Demsetz
The American Economic Review, Vol. 62, No. 5. (Dec., 1972), pp. 777-795.
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Thu Nov 15 10:46:02 2007
Production, Information Costs, and
Economic Organization
The mark of a capitalistic society is that
resources are owned and allocated by such
nongovernmental organizations as firms,
households, and markets. Resource owners
increase productivity through cooperative
specialization and this leads to the demand
for economic organizations which facilitate
cooperation. \$'hen a lumber mill
employs a cabinetmaker, cooperation between
specialists is achieved within a firm,
and when a cabinetmaker purchases wood
from a lumberman, the cooperation takes
place across markets (or between firms).
Two important problems face a theory of
economic organization-to explain the
conditions that determine whether the
gains from spkcialization and cooperative
production can better be obtained within
an organization like the firm, or across
markets, and to explain the structure of
the organization.
I t is common to see the firm characterized
by the power to settle issues by
fiat, by authority, or by disciplinary action
superior to that available in the conventional
market. This is delusion. The firm
does not own all its inputs. I t has no
power of fiat, no authority, no disciplinary
action any different in the slightest degree
from ordinary market contracting between#p#分頁標題#e#
any two people. I can "punish" you
only by withholding future business or by
seeking redress in the courts for any failure
to honor our exchange agreement. That is
exactly all that any employer can do. He
* Professors of economics at the Fniversit~ of California,
1.0s Xngeles .\ckno~\ledgment is made for financia1
aid from the F. I,ill> Endowment, Inc, grant to
cCL.4 for research in the behavioral effects of property
rights
can fire or sue, just as I can fire my grocer
by stopping purchases from him or sue
him for delivering faulty products. What
then is the content of the presumed power
to manage and assign workers to various
tasks? Exactly the same as one little consumer's
power to manage and assign his
grocer to various tasks. The single consumer
can assign his grocer to the task of
obtaining whatever the customer can induce
the grocer to provide at a price acceptable
to both parties. That is precisely
all that an employer can do to an employee.
To speak of managing, directing,
or assigning workers to various tasks is a
deceptive way of noting that the employer
continually is involved in renegotiation of
contracts on terms that must be acceptable
to both parties. Telling an employee to
type this letter rather than to file that
document is like my telling a grocer to
sell me this brand of tuna rather than that
brand of bread. I have no contract to continue
to purchase from the grocer and
neither the employer nor the employee is
bound by any contractual obligations to
continue their relationship. Long-term
contracts between employer and employee
are not the essence of the organization
we call a firm. My grocer can count
on my returning day after day and purchasing
his services and goods even with
the prices not always marked on the goods
-because I know what they are-and he
adapts his activity to conform to my
directions to him as to what I want each
day . . . he is not my employee.
iyherein then is the relationship between
a grocer and his different
from that between a grocer and his cus-
777
778 THE AMERICAX ECONOMIC REL'IE\IT
tomers? It is in a team use of inputs and a
centralized position of some party in the
contractual arrangements of all other inputs.
It is the centralized contractz~al agent
in a team ProductiCLle process-not some
superior authoritarian directive or disciplinary
power. Exactly what is a team
process and why does it induce the contractual
form, called the firm? These problems
motivate the inquiry of this paper.
I. The Metering Problem
'The economic organization through
which input owners cooperate will make
better use of their comparative advantages#p#分頁標題#e#
to the extent that it facilitates the payment
of rewards in accord with productivity.
If rewards were random, and without
regard to productive effort, no incentive
to productive effort would be provided
by the organization; and if rewards
were negatively correlated with productivity
the organization would be subject
to sabotage. Two key demands are placed
on an economic organization-metering
input productivity and metering rewards.'
Metering problems sometimes can be
resolved well through the exchange of
products across competitive markets, because
in many situations markets yield a
high correlation between rewards and
productivity. If a farmer increases his output
of wheat by 10 percent at the prevailing
market price, his receipts also increase
by 10 percent. This method of organizing
economic activity meters the
output directly, reveals the marginal product
and apportions the rewards to resource
owners in accord with that direct
measurement of their outputs. The success
of this decentralized, market exchange in
promoting productive specialization requires
that changes in market rewards fall
Meter means to measure and also to apportion. One
can meter (measure) output and one can also meter
(control) the output. LVe use the word to denote both;
the context should indicate which.
on those responsible for changes in oz~tpz~t.~
'I'he classic relationship in economics
that runs from marginal productivity to
the distribution of income implicitly assumes
the existence of an organization, be
it the market or the firm, that allocates
rewards to resources in accord with their
productivity. The problem of economic
organization, the economical means of
metering productivity and rewards, is not
confronted directly in the classical analysis
of production and distribution. Instead,
that analysis tends to assume sufficiently
economic-or zero cost-means,
as if productivity automatically created
its reward. 'IVe conjecture the direction of
causation is the reverse-the specific sys-
A producer's wealth would be reduced by the present
capitalized value of the future income lost by loss of
reputation. Reputation, i.e., credibility, is an asset,
which is another way of saying that reliable information
about expected performance is both a costly and a
valuable good. For acts of Cod that interfere with contract
performance, both parties have incentives to
reach a settlement akin to that which would have been
reached if such events had been covered by specific contingency
clauses. The reason, again, is that a reputation
for "honest" dealings-i.e., for actions similar to those
that would probably have been reached had the contract#p#分頁標題#e#
provided this contingency-is wealth.
Almost every contract is open-ended in that many
contingencies are uncovered. For example, if a fire
delays production of a promised product by A to B,
and if B contends that A has not fulfilled the contract,
how is the dispute settled and what recompense, if any,
does A grant to B? A person uninitiated in such questions
may be surprised by the extent to which contracts
permit either party to escape performance or to nullify
the contract. In fact, it is hard to imagine any contract,
which, when taken solely in terms of its stipulations,
could not be evaded by one of the parties. Yet that is
the ruling, viable type of contract. LL:hy? Undoubtedly
the best discussion that we have seen on this question is
by Stewart Macaulay.
There are means not only of detecting or preventing
cheating, but also for deciding how to allocate the losses
or gains of unpredictable events or quality of items
exchanged. Sales contracts contain warranties, guarantees,
collateral, return privileges and penalty clauses for
specific nonperformance. These are means of assignment
of risks of losses of cheating. A lower price without warranty-
an "as is" purchase-places more of the risk on
the buyer while the seller buys insurance against losses
of his "cheating." On the other hand, a warranty or
return privilege or service contract places more risk on
the seller with insurance being bought by the buyer.
.ALCHT-AX AND DEMSETZ: ECONOMIC ORGANIZ.4TION 779
tem of rewarding which is relied upon
stimulates a particular productivity response.
If the economic organization
meters poorly, with rewards and productivity
only loosely correlated, then productivity
will be smaller; but if the economic
organization meters well productivity
will be greater. What makes metering
difficult and hence induces means of
economizing on metering costs?
11. Team Production
Two men jointly lift heavy cargo into
trucks. Solely by observing the total
weight loaded per day, it is impossible to
determine each person's marginal productivity.
\I'ith team production it is
difficult, solely by observing total output,
to either define or determine each individual's
contribution to this output of the
cooperating inputs. The output is yielded
by a team, by definition, and it is not a
sum of separable outputs of each of its
members. Team production of Z involves
at least two inputs, X, and XI, with
d2Z1dX,dX,#0.3 The production function
is not separable into two functions
each involving only inputs X, or only inputs
XI. consequently there is no sum
of Z of two separable functions to treat
as the Z of the team production function.
(:In example of a separable case is Z= aX: +b,Y; which is separable into Z,= aX; and#p#分頁標題#e#
Zj= blY,L, and Z= Z,+Z,. 'This is not team
production.) 'There exist production techniques
in which the Z obtained is greater
than if X, and XI had produced separable
Z. 'l'eam production will be used if it
yields an output enough larger than the
sum of separable production of Z to cover
the costs of organizing and disciplining
team members-the topics of this paper.4
The function is separable into additive functions if
the cross partial derivative is zero, i.e., if a2Z/aAY,a?i,=0.
' LVith suficient generality of notation and conception
this team production function could be formulated
as a case of the generalized production function interpretation
given by our colleague, E. A. Thompson.
Usual explanations of the gains from
cooperative behavior rely on exchange
and production in accord with the comparative
advantage specialization principle
with separable additive production.
However, as suggested above there is a
source of gain from cooperative activity
involving working as a team, wherein individual
cooperating inputs do not yield
identifiable, separate products which can
be sz~mmed to measure the total output.
For this cooperative productive activity,
here called "team" production, measuring
margiltal productivity and making payments
in accord therewith is more expensive
by an order of magnitude than for
separable production functions.
Team production, to repeat, is production
in which 1) several types of resources
are used and 2) the product is not a sum
of separable outputs of each cooperating
resource. .An additional factor creates a
team organization problem-3) not all resources
used in team production belong to
one person.
JI'e do not inquire into why all the
jointly used resources are not owned by
one person, but instead into the types of
organization, contracts, and informational
and payment procedures used among
owners of teamed inputs. With respect to
the one-owner case, perhaps it is sufficient
merely to note that (a) slavery is prohibited,
(b) one might assume risk aversion
as a reason for one person's not borrowing
enough to purchase all the assets
or sources of services rather than renting
them, and (c) the purchase-resale spread
may be so large that costs of short-term
ownership exceed rental costs. Our problem
is viewed basically as one of organization
among different people, not of the
physical goods or services, however much
there must be selection and choice of combination
of the latter.
How can the members of a team be rewarded
and induced to work efficiently?
780 THE *IMERICAN ECONOMIC REVIE%'
In team production, marginal products of
cooperative team members are not so#p#分頁標題#e#
directly and separably (i.e., cheaply) observable.
IThat a team offers to the
market can be taken as the marginal
product of the team but not of the team
members. The costs of metering or ascertaining
the marginal products of the team's
members is what calls forth new organizations
and procedures. Clues to each input's
productivity can be secured by observing
behatliar of individual inputs. 'ClThen lifting
cargo into the truck, how rapidly does a
man move to the nest piece to be ldaded,
how many cigarette breaks does he
take, does the item being lifted tilt downward
toward his side?
If detecting such behavior were costless,
neither party would have an incentive
to shirk, because neither could impose
the cost of his shirking on the other (if
their cooperation was agreed to voluntarily).
Hut since costs must be incurred
to monitor each other, each input owner
will have more incentive to shirk when he
works as part of a team, than if his performance
could be monitored easily or if
he did not work as a team. If there is a
net increase in productivity available by
team production, net of the metering cost
associated with disciplining the team, then
team production will be relied upon rather
than a multitude of bilateral exchange of
separable individual outputs.
Both leisure and higher income enter a
person's utility functi0n.j Hence, each
person should adjust his work and realized
reward so as to equate the marginal rate of
substitution between leisure and production
of real output to his marginal rate of
substitution in consumption. That is, he
would adjust his rate of work to bring his
demand prices of leisure and output to
equality with their true costs. However,
llore precisely: "if anything other than pecuniary
income enters his utility function." Leisure stands for all
nonpecuniary income for simplicity of e~position.
with detection, policing, monitoring, measuring
or metering costs, each person will
be induced to take more leisure, because
the effect of relaxing on his realized (reward)
rate of substitution between output
and leisure will be less than the effect on
the trzbe rate of substitutioil. His realized
cost of leisure will fall more than the true
cost of leisure, so he "buys" more leisure
(i.e., more nonpecuniary reward).
If his relaxation cannot be detected perfectly
at zero cost, part of its effects will
be borne by others in the team, thus making
his realized cost of relaxation less than
the true total cost to the team. The difficulty
of detecting such actions permits
the private costs of his actions to be less
than their full costs. Since each person
responds to his private realizable rate of#p#分頁標題#e#
substitution (in production) rather than
the true total (i.e., social) rate, and so
long as there are costs for other people to
detect his shift toward relaxation, it will
not pay (them) to force him to readjust
completely by making him realize the
true cost. Only enough efforts will be
made to equate the marginal gains of detection
activity with the marginal costs of
detection; and that implies a lower rate of
productive effort and more shirking than
in a costless monitoring, or measuring,
world.
In a university, the faculty use office
telephones, paper, and mail for personal
uses beyond strict university productivity.
The university administrators could stop
such practices by identifying the responsible
person in each case, but they can do so
only at higher costs than administrators
are willing to incur. The extra costs of
identifying each party (rather than merely
identifying the presence of such activity)
wouid exceed the savings from din~inished
faculty "turpitudinal peccadilloes." So
the faculty is allowed some degree of
"privileges, perquisites, or fringe benefits."
,2nd the total of the pecuniary wages paid
ALCHIAN ,AND DEMSETZ: ECONOMIC ORGANIZATION 781
is lower because of this irreducible (at
acceptable costs) degree of amenity-seizing
activity. Pay is lower in pecuniary
terms and higher in leisure, conveniences,
and ease of work. But still every person
would prefer to see detection made more
effective (if it were somehow possible to
monitor costlessly) so that he, as part of
the now more effectively producing team,
could thereby realize a higher pecuniary
pay and less leisure. If everyone could, at
zero cost, have his reward-realized rate
brought to the true production possibility
real rate, all could achieve a more preferred
position. But detection of the responsible
parties is costly; that cost acts
like a tax on work rewards6 Viable shirking
is the result.
It'hat forms of organizing team production
will lower the cost of detecting "performance"
(i.e., marginal productivity)
and bring personally realized rates of
substitution closer to true rates of substitution?
Market competition, in principle,
could monitor some team production.
(It already organizes teams.) Input
owners who are not team members can
offer, in return for a smaller share of the
team's rewards, to replace excessively (i.e.,
overpaid) shirking members. Rlarket competition
among potential team members
would determine team membership and
individual rewards. There would be no
team leader, manager, organizer, owner,
or employer. For such decentralized organizational
control to work, outsiders,#p#分頁標題#e#
possibly after observing each team's total
Do not assume that the sole result of the cost of
detecting shirking is one form of payment (more leisure
and less take home money). \Vith several members of
the team, each has an incentive to cheat against each
other by engaging in more than the average amount of
such leisure if the employer can not tell at zero cost
which employee is taking more than average. As a
result the total ~roductivitv of the team is lowered.
Shirking detection costs thus change the form of payment
and also result in lower total rewards. Because the
cross I,artial derivatives are ,,os,tive, shirking reduces
other people's marginal products.
output, can speculate about their capabilities
as team members and, by a market
competitive process, revised teams with
greater productive ability will be formed
and sustained. Incumbent members will be
constrained by threats of replacement by
outsiders offering services for lower reward
shares or offering greater rewards to the
other members of the team. Any team
member who shirked in the expectation
that the reduced output effect would not
be attributed to him will be displaced if
his activity is detected. Teams of productive
inputs, like business units, would
evolve in apparent spontaneity in the
market-without any central organizing
agent, team manager, or boss.
But completely effective control cannot
be expected from individualized market
competition for two reasons. First, for
this competition to be completely effective,
new challengers for team membership
must know where, and to what extent,
shirking is a serious problem, i.e., know
they can increase net output as compared
with the inputs they replace. To the extent
that this is true it is probably possible for
existing fellow team members to reccgnize
the shirking. But, by definition, the detection
of shirking by observing team output
is costly for team production. Secondly, assume
the presence of detection costs, and
assume that in order to secure a place on
the team a new input owner must accept
a smaller share of rewards (or a promise to
produce more). Then his incentive to shirk
would still be at least as great as the incentives
of the inputs replaced, because he
still bears less than the entire reduction in
team output for which he is responsible.
111. The Classical Firm
One method of reducing shirking is for
someone to specialize as a monitor to check
the input performance of team members.'
' \Vhat is meant by performance? Input energy, initiative,
work attitude, ~ e r s ~ i r a t i orna,t e of euhaustion?
(Contrnut i i )
THE ,AMERICAN ECONOMIC REVIEW
But who will monitor the monitor? One#p#分頁標題#e#
constraint on the monitor is the aforesaid
market competition offered by other
monitors, but for reasons already given,
that is not perfectly effective. Another
constraint can be imposed on the monitor:
give him title to the net earnings of the
team, net of payments to other inputs.
If owners of cooperating inputs agree with
the monitor that he is to receive any
residual product above prescribed amounts
(hopefully, the marginal value products of
the other inputs), the monitor will have
an added incentive not to shirk as a
monitor. Specialization in monitoring plus
reliance on a residual claimant status will
reduce shirking; but additional links are
needed to forge the firm of classical economic
theory. How will the residual
claimant monitor the other inputs?
iVe use the term monitor to connote
several activities in addition to its disciplinary
connotation. It connotes measuring
output performance, apportioning
rewards, observing the input behavior of
inputs as means of detecting or estimating
their marginal productivity and giving assignments
or instructions in what to do
and how to do it. (It also includes, as we
shall show later, authority to terminate
or revise contracts.) Perhaps the contrast
between a football coach and team captain
is helpful. The coach selects strategies
and tactics and sends in instructions
about what plays to utilize. The captain
is essentially an observer and reporter of
Or output? It is the latter that is sought--the eject or
output. But performance is nicely ambiguous because it
suggests both input and output. I t is nicely ambiguous
because as we shall see, sometimes by inspecting a team
member's input activity we can better judge his output
effect, perhaps not with complete accuracy hut better
than by watching the output of the team. I t is not always
the case that watching input activity is the only or best
means of detecting, measuring or monitoring output
effects of each team member, but in some cases it is a
useful way. For the moment the word performance
glosses over these aspects and facilitates concentration
on other issues.
the performance at close hand of the members.
The latter is an inspector-steward
and the former a supervisor manager.
For the present all these activities are included
in the rubric "monitoring." All
these tasks are, in principle, negotiable
across markets, but we are presuming that
such market measurement of marginal
productivities and job reassignments are
not so cheaply performed for team production.
And in particular our analysis
suggests that it is not so much the costs
of spontaneously negotiating contracts in
the markets among groups for team production#p#分頁標題#e#
as it is the detection of the performance
of individual members of the
team that calls for the organization noted
here.
The specialist who receines the residual
rewards will be the monitor of the members
of the team (i.e., will manage the use
of cooperative inputs). The monitor earns
his residual through the reduction in
shirking that he brings about, not only by
the prices that he agrees to pay the owners
of the inputs, but also by observing and
directing the actions or uses of these inputs.
Managing or examining the ways to
which inputs are used in team production
is a method of metering the marginal productivity
of individual inputs to the team's
output.
To discipline team members and reduce
shirking, the residual claimant must have
power to revise the contract terms and incentives
of indioidual members without
having to terminate or alter every other
input's contract. Hence, team members
who seek to increase their productivity
will assign to the monitor not only the
residual claimant right but also the right
to alter individual membership and performance
on the team. Each team member,
of course, can terminate his own
membership (i.e., quit the team), but
only the monitor may unilaterally terminate
the membership of any of the
ALCHIAS ASD DEMSETZ: ECOSOMIC ORGANTZ=\TTOS
other members without necessarily terminating
the team itself or his association
with the team; and he alone can expand or
reduce membership, alter the mix of
membership, or sell the right to be the
residual claimant-monitor of the team. It
is this entire bundle of rights: 1) to be a
residual claimant; 2) to observe input
behavior; 3) to be the central party common
to all contracts with inputs; 4) to
alter the membership of the team; and
5) to sell these rights, that defines the
oelnership (or the employer) of the classical
(capitalist, free-enterprise) firm. The
coalescing of these rights has arisen, our
analysis asserts, because it resolves the
shirking-information problem of team
production better than does the noncentralized
contractual arrangement.
The relationship of each team member
to the owner of the firm (i.e., the party
common to all input contracts and the
residual claimant) is simply a ('quid pro
quo" contract. Each makes a purchase
and sale. The employee ('orders" the owner
of the team to pay him money in the same
sense that the employer directs the team
member to perform certain acts. The
employee can terminate the contract as
readily as can the employer, and longterm
contracts, therefore, are not an essential
attribute of the firm. Nor are
((authoritarian," "dictational," or ('fiat"#p#分頁標題#e#
attributes relevant to the conception of the
firm or its efficiency.
In summary, two necessary conditions
exist for the emergence of the firm on the
prior assumption that more than pecuniary
wealth enter utility functions: 1) It is
possible to increase productivity through
team-oriented production, a production
technique for which it is costly to directly
measure the marginal outputs of the cooperating
inputs. This makes it more
difficult to restrict shirking through simple
market exchange between cooperating inputs.
2) It is economical to estimate marginal
productivity by observing or specifying
input behavior. The simultaneous occurrence
of both these preconditions leads
to the contractual organization of inputs,
known as the classical capitalist firms with
(a) joint input production, (b) several input
owners, (c) one party who is common
to all the contracts of the joint inputs, (d)
who has rights to renegotiate any input's
contract independently of contracts with
other input owners, (e) who holds the
residual claim, and (f) who has the right
to sell his central contractual residual
s t a t u ~ . ~
Other Theories of the Firm
At this juncture, as an aside, we briefly
place this theory of the firm in the contexts
of those offered by Ronald Coase and
Frank KnighLg Our view of the firm is not
necessarily inconsistent with Coase's; we
attempt to go further and identify refutable
implications. Coase's penetrating insight
is to make more of the fact that
markets do not operate costlessly, and he
relies on the cost of using markets to form
contracts as his basic explanation for the
existence of firms. IVe do not disagree with
the proposition that, ceteris paribus, the
higher is the cost of transacting across
markets the greater will be the comparative
advantage of organizing resources
within the firm; it is a difficult proposition
to disagree with or to refute. LYe could
with equal ease subscribe to a theory of
the firm based on the cost of managing,
for surely it is true that, ceteris paribus,
the lower is the cost of managing the
greater will be the comparative advantage
of organizing resources within the firm. TO
move the theory forward, it is necessary
to know what is meant by a firm and to
Removal of (b) converts a capitalist proprietary firm
to a socialist firm.
9 Recognition must also be made to the seminal inquiries
by Morris Silver and Richard Auster, and by
H. R. Malmgren.
784 THE AMERIC.43 ECOKOMIC REVIEW
explain the circumstances under which
the cost of "managing" resources is low
relative to the cost of allocating resources
through market transaction. The conception#p#分頁標題#e#
of and rationale for the classical firm
that we propose takes a step down the
path pointed out by Coase toward that
goal. Consideration of team production,
team organization, difficulty in metering
outputs, and the problem of shirking are
important to our explanation but, so far
as we can ascertain, not in Coase's. Coase's
analysis insofar as it had heretofore been
developed would suggest open-ended contracts
but does not appear to imply anything
more-neither the residual claimant
status nor the distinction between employee
and subcontractor status (nor any
of the implications indicated below). And
it is not true that employees are generally
employed on the basis of long-term contractual
arrangements any more than on a
series of short-term or indefinite length
contracts.
The importance of our proposed additional
elements is revealed, for example,
by the explanation of why the person to
whom the control monitor is responsible
receives the residual, and also by our
later discussion of the implications about
the corporation, partnerships, and profit
sharing. These alternative forms for organization
of the firm are difficult to resolve
on the basis of market transaction
costs only. Our exposition also suggests a
definition of the classical firm-something
crucial that was heretofore absent.
In addition, sometimes a technological
development will lower the cost of market
transactions while, at the same time, it
expands the role of the firm. When the
"putting out" system was used for weaving,
inputs were organized largely through
market negotiations. LTith the development
of efficient central sources of power,
it became economical to perform weaving
in proximity to the power source and to
engage in team production. The bringing
in of weavers surely must have resulted in
a reduction in the cost of negotiating
(forming) contracts. Yet, what we observe
is the beginning of the factory system
in which inputs are organized within
a firm. \Thy? The weavers did not simply
move to a common source of power that
they could tap like an electric line, purchasing
power while they used their own
equipment. Now team production in the
joint use of equipment became more important.
l'he measurement of marginal
productivity, which now involved interactions
between workers, especially through
their joint use of machines, became more
difficult though contract negotiating cost
was reduced, while managing the behavior
of inputs became easier because of the increased
centralization of activity. The
firm as an organization expanded even
though the cost of transactions was reduced
by the advent of centralized power.#p#分頁標題#e#
l'he same could be said for modern assembly
lines. Hence the emergence of
central power sources expanded the scope
of productive activity in which the firm
enjoyed a comparative advantage as an
organizational form.
Some economists, following Knight,
have identified the bearing of risks of
wealth changes with the director or central
employer without explaining why that is
a viable arrangement. Presumably, the
more risk-averse inputs become employees
rather than owners of the classical firm.
Risk averseness and uncertainty ~ l i t hregard
to the jirm's fortulzes have little, if
anything, to do with our explanation although
it helps to explain why all resources
in a team are not owned by one
person. That is, the role of risk taken in
the sense of absorbing the windfalls that
buffet the firm because of unforeseen competition,
technological change, or fluctuations
in demand are not central to our
theory, although it is true that imperfect
knowledge and, therefore, risk, in this
sense of risk, underlie the problem of
ALCHIAS -4NT) DEJ ISETZ: ECOSOMIC ORGANIZ-4TIOS 785
monitoring team behavior. We deduce the
system of paying the manager with a
residual claim (the equity) from the desire
to have efficient means to reduce shirking
so as to make team production economical
and not from the smaller aversion to the
risks of enterprise in a dynamic economy.
We conjecture that "distribution-of-risk"
is not a valid rationale for the existence
and organization of the classical firm.
Although we have emphasized team
production as creating a costly metering
task and have treated team production as
an essential (necessary?) condition for the
firm, would not other obstacles to cheap
metering also call forth the same kind of
contractual arrangement here denoted as
a firm? For example, suppose a farmer
produces wheat in an easily ascertained
quantity but with subtle and difficult to
detect quality variations determined by
how the farmer grew the wheat. -4 vertical
integration could allow a purchaser to
control the farmer's behavior in order to
more economically estimate productivity.
But this is not a case of joint or team
production, unless "information" can be
considered part of the product. (While a
good case could be made for that broader
conception of production, we shall ignore
it here.) Instead of forming a firm, a buyer
can contract to have his inspector on the
site of production, just as home builders
contract with architects to supervise building
contracts; that arrangement is not a
firm. Still, a firm might be organized in
the production of many products wherein
no team production or jointness of use of#p#分頁標題#e#
separately owned resources is involved.
This possibility rather clearly indicates
a broader, or complementary, approach
to that which we have chosen. 1) As we do
in this paper, it can be argued that the
firm is the particular policing device
utilized when joint team production is
present. If other sources of high policing
costs arise, as in the wheat case just indicated,
some other form of contractual arrangement
\+rill be used. Thus to each
source of informational cost there may be
a different type of policing and contractual
arrangement. 2) On the other hand, one
can say that where policing is difficult
across markets, various forms of contractual
arrangements are devised, but there is
no reason for that known as the firm to be
uniquely related or even highly correlated
with team production, as defined here. I t
might be used equally probably and viably
for other sources of high policing cost. We
have not intensively analyzed other
sources, and we can only note that our
current and readily revisable conjecture
is that 1) is valid, and has motivated us in
our current endeavor. In any event, the
test of the theory advanced here is to see
whether the conditions we have identified
are necessary for firms to have long-run
viability rather than merely births with
high infant mortality. Conglomerate firms
or collections of separate production agencies
into one owning organization can be interpreted
as an investment trust or investment
diversification device-probably
along the lines that motivated
Knight's interpretation. A holding company
can be called a firm, because of the
common association of the word firm with
any ownership unit that owns income
sources. The term firm as commonly used
is so turgid of meaning that we can not
hope to explain every entity to which the
name is attached in common or even technical
literature. Instead, we seek to identify
and explain a particular contractual
arrangement induced by the cost of information
factors analyzed in this paper.
IV. Types of Firms
A. Projit-Sharing Firms
Explicit in our explanation of the
capitalist firm is the assumption that the
cost of managing the team's inputs by a
central monitor, who disciplines himself
because he is a residual claimant, is low
786 THE AMEKICXK ECONOhf IC REYIEK
relative to the cost of metering the marginal
outputs of team members.
If we look within a firm to see who
monitors- -hires, fires, changes, promotes,
and renegotiates-we should find him being
a residual claimant or, at least, one
whose pay or reward is more than any
others correlated with fluctuations in the
residual value of the firm. They more#p#分頁標題#e#
likely will have options or rights or bonuses
than will inputs with other tasks.
An implicit "auxiliary" assumption of
our explanation of the firm is that the
cost of team production is increased if the
residual claim is not held entirely by the
central monitor. That is, we assume that
if profit sharing had to be relied upon for
all team members, losses from the resulting
increase in central monitor shirking
woulti exceeti the output gains from the
increased incentives of other team members
not to shirk. If the optimal team size
is only two owners of inputs, then an
equal division of profits and losses between
them will leave each with stronger
incentives to reduce shirking than if the
optimal team size is large, for in the latter
case only a smaller percentage of the losses
occasioned by the shirker will be borne by
him. Incentives to shirk are positively related
to the optimal size of the team under
an equal profit-sharing scheme. lo
The preceding does not imply that profit
sharing is never viable. Profit sharing to
encourage self-policing is more appropriate
for small teams. And, intieeti, where input
owners are free to make whatever contractual
arrangements suit them, as generally
is true in capitalist economies, profit
sharing seems largely limited to partner-
IVhile the degree to which residual clainis are centralized
will afiect the size of the team, this will be only
one of many factors that determine team size, so as an
approximation, we can treat team size as exogenously
determined. Cnder certain assumptions about the
shape of the "typical" utility function, the incentive to
avoid shirking with unequal profit-sharing can 1)e measured
hy the Herfindahl index.
'0
ships with a relatively small number of
uctioe" partners. Another advantage of
such arrangements for smaller teams is
that it permits more effective reciprocal
monitoring among inputs. Rlonitoring
need not be entirely specialized.
Profit sharing is more viable if small
team size is associated with situations
where the cost of specialized management
of inputs is large relative to the increased
productivity potential in team effort. IVe
conjecture that the cost of managing team
inputs increases if the productivity of a
team member is difficult to correlate with
his behavior. In "artistic" or "professional"
work, watching a man's activities
is not a good clue to what he is actually
thinking or doing with his mind. 1I:hile it
is relatively easy to manage or direct the
loading of trucks by a team of dock
workers where input activity is so highly
related in an obvious way to output, it is#p#分頁標題#e#
more difficult to manage and direct a
lawyer in the preparation anti presentation
of a case. Dock workers can be directed
in detail without the monitor himself
loading the truck, and assembly line
workers can be monitoreti by varying the
speed of the assembly line, but detailed
direction in the preparation of a law case
woulti require in much greater tiegree that
the monitor prepare the case himself. As
a result, artistic or professional inputs,
such as lawyers, advertising specialists,
and doctors, will be given relatively freer
reign with regarti to intiividual behavior.
If the management of inputs is relatively
costly, or ineffective, as it would seem to
be in these cases, but, nonetheless if team
effort is more productive than separable
production with exchange across markets,
then there will develop a tendency to use
profit-sharing schemes to provide incentives
to avoid shirking.'"
l1 The use of the word active will he clarified in our
discussion of the corporation, which follows below,
l2 Some sharing contracts, like crop sharing, or rental
AILCHIAX AXD I3EAISETZ: ECONOAIIC ORGASIZATION
B. Socialist Firms
\Ye have analyzed the classical proprietorship
and the profit-sharing firms in the
context of free association and choice of
economic organization. Such organizations
need not be the most viable when political
constraints limit the forms of organization
that can be chosen. I t is one thing to have
profit sharing when professional or artistic
talents are used by small teams. But if
political or tax or subsidy considerations
induce profit-sharing techniques when
these are not otherwise economically
justified, then additional management
techniques will be developed to help reduce
the degree of shirking.
For example, most, if not all, firms in
Jugoslavia are owned by the employees in
the restricted sense that all share in the
residual. This is true for large firms and
for firms which employ nonartistic, or
nonprofessional, workers as well. \Yith a
decay of political constraints, most of
these firms could be expected to rely on
paid wages rather than shares in the residual.
This rests on our auxiliary assumption
that general sharing in the resiclual
results in losses from enhanced shirking
by the monitor that exceed the gains from
reduced shirking by residual-sharing employees.
If this were not so, profit sharing
with employees should have occurred more
frequently in IYestern societies where such
organizations are neither banned nor
preferred politically. \There residual sharing
by employees is politically imposed,
as in Jugoslavia, we are led to expect that
some management technique will arise to#p#分頁標題#e#
reduce the shirking by the central monitor,
a technique that will not be found frequently
in \Yestern societies since the
monitor retains all (or much) of the rep-
--- --- -
paJments based on gross sales In retail stores, come
close to profit sharing Honeber, it is gross output 5har
ing rather than proht shar~ng If e are unal~le to sl)ecif\
the impl~c a t~oonf s t he d~fference\ I e refer the reader to
S iT Cheung
sidual in the \Test and profit sharing is
largely confined to small, professionalartistic
team production situations. IYe do
find in the larger scale residual-sharing
firms in Jugoslavia that there are employee
committees that can recommend
(to the state) the termination of a manager's
contract (veto his continuance)
with the enterprise. IYe conjecture that
the workers' committee is given the right
to recommend the termination of the
manager's contract precisely because the
general sharing of the residual increases
iiexcessively" the manager's incentive to
shirk.13
C. The Corporation
All firms must initially acquire command
over some resources. The corporation
does so primarily by selling promises
of future returns to those who (as creditors
or owners) provide financial capital. In
some situations resources can be acquired
in advance from consumers by promises
of future delivery (for example, advance
sale of a proposed book). Or where the
firm is a few artistic or professional persons,
each can "chip in" with time and
talent until the sale of services brings in
revenues. For the most part, capital can
be acquired more cheaply if many (riskaverse)
investors contribute small portions
to a large investment. The economies
of raising large sums of equity capital in
this way suggest that modifications in the
relationship among corporate inputs are
required to cope with the shirking problem
l3 Incidentally, investment activity will be changed.
The inal~ility to capitalize the investment value as
"take-home" proviate property ~c*enlt/orf the members of
the firm means that the benefits of the investment must
he taken as annual income 11y those who are employed
at the time of the income. Investment will he confined
more to those with shorter life and with higher rates or
pay-offs if the alternative of investing is paying out the
firm's income to its employees to take home and use as
private propert). 1,'or a development of this proposition,
see the pal)ers hy Eirik 1:urohotn and Svetozar
Pejovich, and t ~ yPe jovich.
788 THE AMERICAN ECOKOMIC REVIEW
that arises with profit sharing among large
numbers of corporate stockholders. One
modification is limited liability, especially#p#分頁標題#e#
for firms that are large relative to a stockholder's
wealth. I t serves to protect stockholders
from large losses no matter how
they are caused.
If every stock owner participated in
each decision in a corporation, not only
would large bureaucratic costs be incurred,
but many would shirk the task of
becoming well informed on the issue to be
decided, since the losses associated with
unexpectedly bad decisions will be borne
in large part by the many other corporate
shareholders. More effective control of
corporate activity is achieved for most
purposes by transferring decision authority
to a smaller group, whose main function
is tonegotiatewith and manage(renegotiate
with) the other inputs of the team. The
corporate stockholders retain the authority
to revise the membership of the management
group and over major decisions that
affect the structure of the corporation or
its dissolution.
As a result a new modification of partnerships
is induced-the right to sale of
corporate shares without approval of any
other stockholders. ,Any shareholder can
remove his wealth from control by those
with whom he has differences of opinion.
Rather than try to control the decisions
of the management, which is harder to do
with many stockholders than with only a
few, unrestricted salability provides a
more acceptable escape to each stockholder
from continued policies with which
he disagrees.
Indeed, the policing of managerial
shirking relies on across-market competition
from new groups of would-be managers
as well as competition from members
within the firm who seek to displace existing
management. In addition to competition
from outside and inside managers,
control is facilitated by the temporary
congealing of share votes into voting blocs
owned by one or a few contenders. Proxy
battles or stock-purchases concentrate the
votes required to displace the existing
management or modify managerial policies.
But it is more than a change in policy that
is sought by the newly formed financial
interests, whether of new stockholders or
not. I t is the capitalization of expected
future benefits into stock prices that concentrates
on the innovators the wealth
gains of their actions if they own large
numbers of shares. IYithout capitalization
of future benefits, there would be less incentive
to incur the costs required to exert
informed decisive influence on the corporation's
policies and managing personnel.
Temporarily, the structure of ownership is
reformed, moving away from diffused
ownership into decisive power blocs, and
this is a transient resurgence of the classical
firm with power again concentrated#p#分頁標題#e#
in those who have title to the residual.
In assessing the significance of stockholders'
power it is not the usual diffusion
of voting power that is significant but instead
the frequency with which voting
congeals into decisive changes. Even a
one-man owned company may have a
long term with just one manager-continuously
being approved by the owner.
Similarly a dispersed voting power corporation
may be also characterized by a
long-lived management. The question is
the probability of replacement of the
management if it behaves in ways not acceptable
to a majority of the stockholders.
The unrestricted salability of stock and
the transfer of proxies enhances the probability
of decisive action in the event current
stockholders or any outsider believes
that management is not doing a good job
with the corporation. We are not comparing
the corporate responsiveness to that
of a single proprietorship; instead, we are
indicating features of the corporate structure
that are induced by the problem of
.\LCHIAK ASP) DEMSETZ: ECOSO?tlIC ORGASIZA4TIOK
delegated authority to manager-monitors.'"
D. Mutual and Nonprofit Firms
The benefits obtained by the new management
are greater if the stock can be
purchased and sold, because this enables
of anticipated future im-
'"nstead of thinking of shareholders as joint oztners,
we can think of them as investors, like bondholders,
e\-cept that the stockholders are more optimistic than
bondholders about the enterprise prospects. Instead of
buying bonds in the corporation, thus enjoying smaller
risks, shareholders prefer to invest funds with a greater
realizable return if the firm prospers as expected, but
with smaller (possibly negative) returns if the firm performs
in a manner closer to that expected by the more
pessimistic investors. The pessimistic investors, in
turn, regard only the t~ondsa s likely to pay off.
If the entrepreneur-organizer is to raise capital on the
best terms to him, it is to his advantage, as well as that
of ~ ~ r o s ~ ~ e cintvievseto rs, to recognize these differences in
espectations. The residual claim on earnings enjoyed by
shareholders does not serve the function of enhancing
their efficiency as monitors in the general situation. The
stockholders are "merely" the less risk-averse or the
more optimistic member of the group that finances the
firm. Being more optimistic than the average and seeinq
a higher mean value future return, they are willing to
pay more for a certificate that allows them to realize
gain on their expectations. One method of doing so is to
buy claims to the distribution of returns that "they see"
while bondholders, who are more pessimistic, purchase a#p#分頁標題#e#
claim to the distritjution that they see as more likely to
emerge. Stockholders are then con1parat)le to warrant
holders. They care not about the voting rights (usually
not attached to warrants) ; they are in the same position
in so far as voting rights are concerned as are hondholders.
The only difference is in the proba1)ility distribution
of rewards and the terms on which they can
place their bets.
If we treat t~ondholders, preferred and convertible
preferred stockholders, and common stockholders and
warrant holders as simply different classes of investorsdiffering
not only in their risk averseness hut in their
beliefs about the pro1)ability distritjution of the firm's
future earnings, why should stockholders he regarded as
"owners" in any sense distinct from the other financial
investors? The entrepreneur-organizer, who let us
assume is the chief operating officer and sole repository
of control of the corporation, does not find his authority
residing in common stockholders (except in the case of a
take over). Does this type of control make any difference
in the way the firm is conducted? Li'ould it make
any difference in the kinds of behavior that ~ r o ~ i lbde
tolerated 1)y competing managers and investors (and we
here deliberately refrain from thinking of them as
owner-stockholders in the traditional sense)?
provements into present .c:lealth of new
managers who bought stock and created
a larger capital by their management
changes. But in nonprofit corporations,
colleges, churches, cou1ltry clubs, mutual
savings banks, mutual insurance companies,
and "coops," the future c o n s -
quences of improved management are not
Investment old timers recall a significant incidence of
nonvoting common stock, now prohibited in corporations
whose stock is traded on listed exchanges. (Li'hy
prohibited?) The entrepreneur in those days could hold
voting shares while investors held nonvoting shares,
which in every other respect were identical. Nonvoting
share holders were simply investors devoid of ownership
connotations. The control and behavior of inside owners
in such corporations has never, so far as we have ascertained,
been carefully studied. I'or esample, at the
simplest level of interest, does the evidence indicate that
nonvoting shareholders fared any worse because of not
having voting rights? Did owners permit the nonvoting
holders the normal return availaljle to voting shareholders?
Though evidence is prohibitively espensive to
obtain, it is remarkable that voting and nonvoting
shares sold for essentially identical prices, even during
some prosy battles. I lo~rever ,o ur casual evidence deserves
no more than interest-initiating weight.
One more point. The facade is deceptive. Instead of#p#分頁標題#e#
nonvoting shares, today we have warrants, convertible
preferred stocks all of which are solely or partly "equity"
claims xirithout voting rights, though they could he converted
into voting shares.
In sum, is it the case that the stockholder-investor
relationship is one emanating from the divisioiz of
owrzerslrip among several people, or is it that the collection
of investment funds from people of varying anticipations
is the underlying factor? If the latter, why
should any of them he thought of as the owners in
\vhom voting rights, whatever they may signify or however
exercisable, should reside in order to enhance efficiency?
IVhy voting rights in any of the outside, participating
investors?
Our initial perception of this possibly significant difference
in interpretation was precipitated by Henry
XIanne. -1reading of his paper makes it clear that it is
hard to understand why an investor who wishes to back
and "share" in the consequences of some new l~usiness
should necessarily have to acquire voting power (i.e.,
power to change the manager-operator) in order to
invest in the venture. In fact, we invest in some ventures
in the hope t h a t no other stockholders ~i-ilbl e so
"foolish" as to try to toss out the incumbent management.
\Ye want him to have the power to stay in office,
and for the prospect of sharing in his fortunes we buy
nonvoting common stock. Our willingness to invest is
enhanced 11). the knowledge that we can act leqally via
fraud, emt,ez~lement and other laws to help assure that
we outside investors will not be "milked" beyond our
initial discounted anticipations.
790 THE AMERICAN ECONOMIC REVIEIT
capitalized into present wealth of stockholders.
(As if to make more difficult that
competition by new would-be monitors,
mutiple shares of ownership in those enterprises
cannot be bought by one person.)
One should, therefore, find greater shirking
in nonprofit, mutually owned enterprises.
(This suggests that nonprofit enterprises
are especially appropriate in
realms of endeavor where more shirking is
desired and where redirected uses of the
enterprise in response to market-revealed
values is less desired.)
Team production in artistic or professional
intellectual skills will more likely
be by partnerships than other types of
team production. This amounts to marketorganized
team activity and to a nonemployer
status. Self-monitoring partnerships,
therefore, will be used rather than
employer-employee contracts, and these
organizations will he small to prevent an
excessive dilution of efforts through shirking.
Also, partnerships are more likely to
occur among relatives or long-standing#p#分頁標題#e#
ac~~uaintances,not necessarily because
they share a common utility function, but
also because each knows better the other's
work characteristics and tendencies to
shirk.
F. Employee Unions
Employee unions, whatever else they
do, perform as monitors for employees.
Employers monitor employees and similarly
employees monitor an employer's performance.
Are correct wages paid on time
and in good currency? Usually, this is
extremely easy to check. Hut some forms
of employer performance are less easy to
meter and are more subject to employer
shirking. Fringe benefits often are in nonpecuniary,
contingent form; medical. hospital,
and accident insurance, and retirement
pensions are contingent payments
or performances partly in kind by employers
to employees. Each employee
cannot judge the character of such payments
as easily as money wages. Insurance
is a contingent payment-what the
employee will get upon the contingent
event may come as a disappointment. If
he could easily determine what other
employees had gotten upon such contingent
events he could judge more accurately
the performance by the employer.
He could "trust" the employer not to
shirk in such fringe contingent payments,
but he would prefer an effective and economic
monitor of those payments. We see
a specialist monitor- t h e union employees'
agent-hired by them and monitoring
those aspects of employer payment most
difficult for the employees to monitor. Employees
should be willing to employ a
specialist monitor to administer such
hard-to-detect employer performance,
even though their monitor has incentives
to use pension and retirement funds not
entirely for the benefit of employees.
V. Team Spirit and Loyalty
Every team member would prefer a
team in which no one, not even himself,
shirked. Then the true marginal costs and
values could be equated to achieve more
preferred positions. If one could enhance
a common interest in nonshirking in the
guise of a team loyalty or team spirit, the
team would be more efficient. In those
sports where team activity is most clearly
exemplified, the sense of loyalty and team
spirit is most strongly urged. Obviously
the team is better, with team spirit and
loyalty, because of the reduced shirking---
not because of some other feature inherent
in loyalty or spirit as such.15
Is Sports Leag~ies: Professional sports contests among
teams is typically conducted hy a league of teams iVe
assume that sports consumers are interested not only in
absolute sporting skill but also in skills relative to other
teams. Being slightly better than o[y)osing teams enables
one to claim a major portion of the receipts; the#p#分頁標題#e#
- -
AIXHIAK AKI I I IEMSETZ: ECONOMIC ORGAKIZATIOK 791
Corporations and business firms try to
instill a spirit of loyalty. This should not ~ ~
be viewed simply as a device to increase
profits by ocer-working or misleading the
employees, nor as an adolescent urge for
belonging. I t promotes a closer approsimation
to the employees' potentially available
true rates of substitution between
production and leisure and enables each
team member to achieve a more preferred
inferior team does not release resources and reduce costs,
since they were expected in the play of contest. Hence,
absolute skill is developed beyond the equality of marginal
investment in sporting skill with its true social
marginal value product. I t follows there will he a tendency
to overinvest in training athletes and developing
teams. ''Reverse shirking" arises, as budding players
are induced to overpractice hyperactively relative to the
social marginal value of their enhanced skills. To prevent
overinvestment, the teams seek an agreement with
each other to restrict practice, size of teams, and even
pay of the team members (which reduces incentives of
young people to overinvest in developing skills). Ideally,
if all the contestant teams were owned by one owner,
overinvestment in sports would be avoided, much as
ownership of common fisheries or underground oil or
water reserve would prevent overinvestment. This
hyperactivity (to suggest the opposite of shirking) is
controlled by the league of teams, wherein the league
adopts a common set of constraints on each team's behavior.
In effect, the teams are no longer really owned
by the team owners but are supervised by them, much
as the franchisers of some product. They are not fullfledged
owners of their business, including the brand
name, and can not "do what they wish" as franchises.
Comparable to the franchiser, is the league commissioner
or conference president, who seeks to restrain
hyperactivity, as individual team supervisors compete
with each other and cause esternal diseconomies. Such
restraints are usually regarded as anticompetitive, antisocial,
collusive-cartel devices to restrain free open competition,
and reduce players' salaries. However, the
interpretation presented here is premised on an attempt
to avoid hyperinvestment in team sports production.
Of course, the team operators have an incentive, once
the league is formed and restraints are placed on hyperinvestment
activity, to go further and obtain the private
benefits of monopoly restriction. To what estent overinvestment
is replaced by monopoly restriction is not
yet determinable; nor have we seen an empirical test of
these two competing, but mutually consistent interpretations.#p#分頁標題#e#
(This interpretation of league-sports activity
was proposed by Earl Thompson and formulated by
Michael Canes.) Again, athletic teams clearly exemplify
the specialization of monitoring with captains and
coaches; a captain detects shirkers while the coach trains
and selects strategies and tactics. Both functions may
be centralized in one person.
situation. The difficulty, of course, is to
create economically that team spirit and
loyalty. I t can be preached with an aura
of moral code of conduct-a morality with
literally the same basis as the ten commandments-
to restrict our conduct toward
what we would choose if we bore our
full costs.
VI. Kinds of Inputs Owned
by the Firm
To this point the discussion has examined
why firms, as we have defined
them, exist? That is, why is there an
owner-employer who is the common
party to contracts with other owners of
inputs in team activity? The answer to
that cluestion should also indicate the kind
of the jointly used resources likely to be
owned by the central-owner-monitor and
the kind likely to be hired from people
who are not team-owners. Can we identify
characteristics or features of various inputs
that lead to their being hired or to
their being owned by the firm?
How can residual-claimant, centralemployer-
owner demonstrate ability to
pay the other hired inputs the promised
amount in the event of a loss? He can pay
in advance or he can commit wealth sufficient
to cover negative residuals. The
latter will take the form of machines, land,
buildings, or raw materials committed to
the firm. Commitments of labor-wealth
(i.e., human wealth) given the property
rights in people, is less feasible. These considerations
suggest that ,residual claimants-
o\n7ners of the firm-will be investors
of resalable capital equipment in the
firm. The goods or inputs more likely to
be invested, than rented, by the owners
of the enterprise, will have higher resale
values relative to the initial cost and will
have longer expected use in a firm relative
to the economic life of the good.
But beyond these factors are those developed
above to explain the existence of
THE AMERICAAN ECOKOMIC REVIEIT
the institution known as the firm-the
costs of detecting output performance.
\Then a durable resource is used it will
have a marginal product and a depreciation.
Its use requires payment to cover at
least use-induced depreciation; unless that
user cost is specifically detectable, payment
for it will be demanded in accord
with expected depreciation. *And we can
ascertain circumstances for each. indestructible
hammer with a readily detectable
marginal product has zero user#p#分頁標題#e#
cost. But suppose the hammer were destructible
and that careless (which is
easier than careful) use is more abusive
and causes greater depreciation of the
hammer. Suppose in addition the abuse
is easier to detect by observing the way it
is used than by observing only the hammer
after its use, or by measuring the
output scored from a hammer by a
laborer. If the hammer were rented and
used in the absence of the o\n7ner, the depreciation
would be greater than if the use
were observed by the o\n7ner and the user
charged in accord with the imposed depreciation.
(Careless use is more likely
than careful use-if one does not pay for
the greater depreciation.) An absentee
owner would therefore ask for a higher
rental price because of the higher expected
user cost than if the item were used by the
o\n7ner. The expectation is higher because
of the greater difficulty of observing
specific user cost, by inspection of the
hammer after use. Renting is therefore in
this case more costly than o\n7ner use. This
is the valid content of the misleading expressions
about ownership being more
economical than renting-ignoring all
other factors that may work in the opposite
direction, like tax provision, shortterm
occupancy and capital risk avoidance.
Better examples are tools of the trade.
iyatch repairers, engineers, and carpenters
tend to on7n their own tools especially if
they are portable. Trucks are more likely
to be employee owned rather than other
equally expensive team inputs because it
is relatively cheap for the driver to police
the care taken in using a truck. Policing
the use of trucks by a nondriver owner is
more likely to occur for trucks that are
not specialized to one driver, like public
transit busses.
The factor with which we are concerned
here is one related to the costs of monitoring
not only the gross product performance
of an input but also the abuse or depreciation
inflicted on the input in the course of
its use. If depreciation or user cost is more
cheaply detected when the owner can see
its use than by only seeing the input before
and after, there is a force toward
owner use rather than renting. Resources
whose user cost is harder to detect when
used by someone else, tend on this count
to be owner-used. AAbsentee ownership, in
the lay language, will be less likely. Assume
momentarily that labor service cannot
be performed in the absence of its
owner. The labor owner can more cheaply
monitor any abuse of himself than if somehow
labor-services could be provided without
the labor owner observing its mode of
use or knowing what was happening. Also
his incentive to abuse himself is increased#p#分頁標題#e#
if he does not own himself.16
'6 Professional athletes in baseball, football, and basketball,
where athletes having 5old their source of
service to the team owners upon entering into sports
activity, are owned by team owners. Here the team
owners must monitor the athletes' physical condition
and behavior to protect the team owners' wealth. The
athlete has less (not, no) incentive to protect or enhance
his athletic prowess since capital value changes have less
impact on his own wealth and more on the team owners.
Thus, some athletes sign up for big initial bonuses
(representing present capital value of future services).
Future salaries are lower by the annuity value of the
prepaid "bonus" and hence the athlete hasless to lose by
subsequent abuse of his athletic prowess. Any decline in
his subsequent service value would in part be borne by
the team owner who owns the players' future service.
This does not say these losses of future salaries have no
effect on preservation of athletic talent (we are not making
a "sunk cost" error). Instead, we assert that the
AALCHIXN AAND DEMSETZ: ECONOMIC ORGAANIZAATION 793
The similarity between the preceding
analysis and the question of absentee
landlordism and of sharecropping arrangements
is no accident. The same factors
which explain the contractual arrangements
known as a firm help to explain
the incidence of tenancy, labor hiring or
sharecropping."
VII. Firms as a Specialized Market
Institution for Collecting, Collating,
and Selling Input Information
The firm serves as a highly specialized
surrogate market. Any person contemplating
a joint-input activity must search
and detect the qualities of available joint
inputs. He could contact an employment
agency, but that agency in a small to\n7n
would have little advantage over a large
firm with many inputs. The employer, by
virtue of monitoring many inputs, acquires
special superior information about
their productive talents. This aids his
directive (i.e., market hiring) efficiency. He
"sells" his information to employee-inputs
as he aids them in ascertaining good input
combinations for team activity. Those
who work as employees or who rent services
to him are using him to discern superior
combinations of inputs. Not only
preservation is reduced, not eliminated, because the
amount of loss of wealth suffered is smaller. The athlete
will spend less to maintain or enhance his prowess
thereafter. The effect of this revised incentive system is
evidenced in comparisons of the kinds of attention and
care imposed on the athletes at the "eupense of the
team owner" in the case where atheletes' future servies
are owned by the team owner with that where future#p#分頁標題#e#
labor service values are owned by the athlete himself.
LVhy athletes' future athletic services are owned by the
team owners rather than being hired is a question we
should be able to answer. One presumption is cartelization
and monopsony gains to team olvners. Another is
exactly the theory being expounded in this paper-costs
of monitoring production of athletes; we know not on
which to rely.
l7 The analysis used by Cheung in explaining the
prevalence of sharecropping and land tenancy arrangements
is built squarely on the same factors-the costs
of detecting output performance of jointly used inputs
in team production and the costs of detecting user costs
imposed on the various inputs if owner used or if rented.
does the director-employer "decide" what
each input will produce, he also estimates
which heterogeneous inputs will work together
jointly more efficiently, and he
does this in the contest of a privately
owned market for forming teams. The department
store is a firm and is a superior
private market. People who shop and
work in one town can as well shop and
work in a privately owned firm.
This marketing function is obscured in
the theoretical literature by the assumption
of homogeneous factors. Or it is
tacitly left for individuals to do themselves
via personal market search, much as if a
person had to search without benefit of
specialist retailers. Whether or not the
firm arose because of this efficient information
service, it gives the directoremployer
more knowledge about the
productive talents of the team's inputs,
and a basis for superior decisions about
efficient or profitable combinations of
those heterogeneous resources.
In other words, opportunities for profitable
team production by inputs already
within the firm may be ascertained more
economically and accurately than for resources
outside the firm. Superior combinations
of inputs can be more economically
identified and formed from resources
already used in the organization than by
obtaining new resources (and knowledge
of them) from the outside. Promotion and
revision of employee assignments (contracts)
will be preferred by a firm to the
hiring of new inputs. To the extent that
this occurs there is reason to expect the
firm to be able to operate as a conglomerate
rather than persist in producing
a single product. Efficient production
with heterogeneous resources is a result
not of having better resources but in knowing
more accurately the relative productive
performances of those resources. Poorer
resources can be paid less in accord with
their inferiority; greater accuracy of
THE AMERICAAN ECONOMIC REIrIEIV
knowledge of the potential and actual productive#p#分頁標題#e#
actions of inputs rather than having
high productivity resources makes a
firm (or an assignment of inputs) profitable.
18
VIII. Summary
IVhile ordinary contracts facilitate efficient
specialization according to comparative
advantage, a special class of contracts
among a group of joint inputs to a
team production process is commonly
used for team production. Instead of
multilateral contracts among all the joint
inputs' owners, a central common party
to a set of bilateral contracts facilitates
efficient organization of the joint inguts in
team production. The terms of the contracts
form the basis of the entity called
the firm-especially appropriate for organizing
team production processes.
Team productive activity is that in
which a union, or joint use, of inputs yields
a larger output than the sum of the products
of the separately used inputs. This
la .lccording to our interpretation, the firm is a
specialized surrogate for a market for team use of inputs;
it provides superior (i.e., cheaper) collection and collation
of kno\vledge at)out heterogeneous resources. The
greater the set of inputs ahout which knowledge of performance
is being collated within a firm the greater are
the present costs of the collation activity. Then, the
larger the firm (market) the greater the attenuation of
monitor control. To counter this force, the firm will 11e
divisionalized in \yay that economize on those costs --
just as will the market be sl~ecial i~eSdo. far as ive can
ascertain, other theories of the reasons for firms have no
such implications.
In Japan, employees t)y custom ~vork nearly their
entire lives with one firm. and the firm aqrees to that
expectation. Firms will tent1 to be large and coriglomerate
to enable a ljroader scope of input revision. Each
firm is, in effect, a small economy engaging in "intranational
and international" trade. ;\nalogously, . h e r -
icans expect to sljenrl their whole lives in the United
States. and the bigger the country, in terms of variety
of resources. the easier it is to adjust to changing tastes
and circumstances. Japan, with its lifetime employees,
should he characterized more by large, conglomerate
firms. Presum;~hly, at some size of the firm. specialized
knowletlge about inputs becomes as expensive to transmit
across divisions of the firms as it does acrozs markets
to other firms.
team production requires-like all other
production processes-an assessment of
marginal productivities if efficient production
is to be achieved. Nonseparability
of the products of several differently
owned joint inputs raises the cost of assessing
the marginal productivities of
those resources or services of each input#p#分頁標題#e#
owner. Monitoring or metering the productivities
to match marginal productivities
to costs of inputs and thereby to
reduce shirking can be achieved more
economically (than by across market bilateral
negotiations among inputs) in a
firm.
The essence of the classical firm is
identified here as a contractual structure
with : 1) joint input production; 2) several
input owners; 3) one party who is common
to all the contracts of the joint inputs;
1)who has rights to renegotiate any
input's contract independently of contracts
with other input owners; 5) who
holds the residual claim; and 6) who has
the right to sell his central contractual
residual status. The central agent is called
the firm's owner and the employer. S o
authoritarian control is involved; the arrangement
is simply a contractual structure
subject to continuous renegotiation
with the central agent. ?'he contractual
structure arises as a means of enhancing
efficient organization of team production.
In particular, the ability to detect shirking
among owners of jointly used inputs in
team production is enhanced (detection
costs are reduced) by this arrangement and
the discipline (by revision of contracts) of
input owners is made more economic.
Testable implications are suggested by
the analysis of different types of organizations--
nonprofit, proprietary for profit,
unions, cooperatives, partnerships, and by
the kinds of inputs that tend to be owned
by the firm in contrast to those employed
by the firm.
IVe conclude with n highly conjectural
ALCHrAN AND DEMSETZ: ECONOMIC ORGAANIZXTION 795
but possibly significant interpretation. As
a consequence of the flow of information
to the central party (employer), the firm
takes on the characteristic of an efficient
market in that information about the productive
characteristics of a large set of
specific inputs is now more cheaply available.
Better recombinations or new uses of
resources can be more efficiently ascertained
than by the conventional search
through the general market. In this sense
inputs compete with each other within and
via a firm rather than solely across markets
as conventionally conceived. Emphasis on
interfirm competition obscures intrafirm
competition among inputs. Conceiving
competition as the revelation and exclzange
of knowledge or information about qualities,
potential uses of different inputs in
different potential applications indicates
that the firm is a device for enchancing
competition among sets of input resources
as well as a device for more efiiciently rewarding
the inputs. In contrast to markets
and cities which can be viewed as publicly
or nonowned market places, the firm can#p#分頁標題#e#
be considered a privately owned market;
if so, we could consider the firm and the
ordinary market as competing types of
markets, competition between private
proprietary markets and public or communal
markets. Could it be that the
market suffers from the defects of communal
property rights in organizing and
influencing uses of valuable resources?
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You have printed the following article:
Production, Information Costs, and Economic Organization
Armen A. Alchian; Harold Demsetz
The American Economic Review, Vol. 62, No. 5. (Dec., 1972), pp. 777-795.
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References
The Nature of the Firm
R. H. Coase
留學生經濟學碩士dissertationEconomica, New Series, Vol. 4, No. 16. (Nov., 1937), pp. 386-405.
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