An outsider to the field of economics would probably take it for granted that economists have a highly developed theory of the firm. After all, firms are the engines of growth of modern capitalistic economies, and so economists must surely have fairly sophisticated views of how they behave. In fact, little could be further from the truth. Most formal models of the firm are extremely rudimentary, capable only of portraying hypothetical firms that bear little relation to the complex organizations we see in the world. Furthermore, theories that attempt to incorporate real-world features of corporations, partnerships, and the like often lack precision and rigor and have therefore failed, by and large, to be accepted by the theoretical mainstream.

This article attempts to give lawyers a sense of how economists think about firms. It does not pretend to offer a systematic survey of the area; rather, it highlights several ideas of particular importance, and then explores an alternative theoretical perspective from which to view the firm. Part I introduces various established economic theories of the firm. Part II turns to a newer theory of the firm, based not upon human capital structures, but rather upon property rights. Part III synthesizes this property rights-based theory of the firm with more established theories.

Established theories

Transaction cost economics

While the neoclassical paradigm, modified by principal–agent theory, progressed along the above lines, a very different approach to the theory of the firm developed under the heading of transaction cost economics.