The Austrian theory of the firm: Retrospect and prospect

Using as a focusing device the famous arguments of Coase (Economica 4(16), 386–405 1937) and Hayek (The American Economic Review 35(4): 519–530 1945), I sketch in bold strokes what an Austrian theory of the firm would look like. Such a theory would pay serious attention to issues of knowledge, uncertainty, change, and complementarity. I describe a literature in which much of this theory has already been constructed; make connections to closely related literatures in economics and management; and suggest directions for future development.     

The Austrian theory of the cooperative firm

This paper draws on Wicksell's Value, Capital and Rent. The (comparative-statics) response of the cooperative to a change in its parameters (capital stock, rate of interest paid on capital stock, and production function) is examined. Severe employment problems may be expected if, in a cooperative setting, the rate of interest is, by macroeconomic management, kept at a relatively low level. Technological progress also may lead to a contraction in employment and even, under some circumstances, cause a decline in output per man. The cooperative is throughout contrasted with its capitalist counterpart.     

Dr. Anderson and the Austrians: Price formation as a cumulative process

The formation of money prices is a pervasive feature of market economies. The theoretical explanation of money prices requires economists to recognize that prices are the result of a cumulative process in which past prices and practices create present prices, which are the basis of the plans and actions that will create future prices and practices. Lavoie’s interpretive economics embraces the historical element in economic theory and furnishes an approach congenial to studying the market as a cumulative process.     

Regret theory and the banking firm: The optimal bank interest margin

This paper examines the optimal bank interest margin, i.e., the spread between the loan rate and the deposit rate of a bank, when the bank is not only risk-averse but also regret-averse. Regret-averse preferences are characterized by a utility function that includes disutility from having chosen ex-post suboptimal alternatives. We show that the presence of regret aversion raises or lowers the optimal bank interest margin than the one chosen by the purely risk-averse bank, depending on whether the probability of default is below or above a threshold value, respectively. Regret aversion as such makes the bank less prudent and more prone to risk-taking when the probability of default is high, thereby adversely affecting the stability of the banking system.     

Regret theory and the competitive firm: A comment

In a recent paper, Wong [Wong, K. P. (2014), Regret theory and the competitive firm. Economic Modelling, 36, 172–175.] develops a model to examine the production behavior of a regret averse competitive firm. Wong discusses the sufficient condition to ensure the conventional result that the optimal output level under uncertainty is less than that under certainty hold. Our contributions in this note are two-fold. Firstly, we point out that Wong's condition in terms of the first order derivatives of the utility function and the regret function is actually not sufficient. Secondly and more importantly, we show that a sufficient condition should be in terms of the relatively increase rate of the first order derivatives of the two functions. That's, it's the ratio of the risk aversion and regret aversion degree that matters. Our proposed condition requests that the firm should be not too regret averse.     

Regret theory and the competitive firm

This paper examines the production decision of the competitive firm under uncertainty when the firm is not only risk averse but also regret averse. Regret-averse preferences are characterized by a modified utility function that includes disutility from having chosen ex-post suboptimal alternatives. The extent of regret depends on the difference between the actual profit and the maximum profit attained by making the optimal production decision had the firm observed the true realization of the random output price. If the firm is not too regret averse, we show that the conventional result that the optimal output level under uncertainty is less than that under certainty holds. Using a simple binary model wherein the random output price can take on either a low value or a high value with positive probability, we show the possibility that the firm may optimally produce more, not less, under uncertainty than under certainty, particularly when the firm is sufficiently regret averse and the low output price is very likely to prevail.     

The legacy of Max Weber and the early Austrians

The Review of Austrian Economics - This paper explores Max Weber’s intellectual relationship to the first generations of the Austrian School. Challenging his portrayal as a one-sided...     

The regulated firm and the DCF model: Some lessons from financial theory

This paper explores lessons from established financial theory for allowed rate of return calculations within the constant-growth dividend (DCF) framework. Analysts using this model have been wedded to the conventional cost-of-equity formula. We set forth equivalent alternatives which make the analysts' task easier, more precise, and more confident. What is even more important, we derive a set of consistency conditions that must be observed for the appropriate use of the model. We also use a basic capital-market principle to determine an alternative, flotation-cost adjusted, rate of return, an expression which provides useful insights for regulatory participants.     

A bargaining theory of the firm

Suppose that a firm has several owners and that the future is uncertain in the sense that one out of many different states of nature will realize tomorrow. An owner’s time preference and risk attitude will determine the importance he places on payoffs in the different states. It is a well-known problem in the literature that under incomplete asset markets, a conflict about the firm’s objective function tends to arise among its owners. In this paper, we take a new approach to this problem, which is based on non-cooperative bargaining. The owners of the firm play a bargaining game in order to choose the firm’s production plan and a scheme of transfers which are payable before the uncertainty about the future state of nature is resolved. We analyze the resulting firm decision in the limit of subgame-perfect equilibria in stationary strategies. Given the distribution of bargaining power, we obtain a unique prediction for a production plan and a transfer scheme. When markets are complete, the production plan chosen corresponds to the profit-maximizing production plan as in the Arrow–Debreu model. Contrary to that model, owners typically do use transfers to redistribute profits. When markets are incomplete, the production plan chosen is almost always different from the one in a transfer-free Drèze (pseudo-)equilibrium and again owners use transfers to redistribute profits. Nevertheless, our results do support the Drèze criterion as the appropriate objective function of the firm.     

Information,Knowledge and Agency: The Information Theoretic Approach and the Austrians

Both the Information Theoretic Economics and Austrian Economics investigate the impact on market activity of problems of information and knowledge. The conceptions of information and knowledge they employ, however, as well as their respective views on and treatment of economic agency, are quite different. The purpose of this paper is to examine these differences, not primarily from an abstract philosophical point of view, but by looking at substantive examples of the economics offered by the two approaches. An attempt is made to explain the Austrian preference for non-formalist approaches to economic analysis.     

On the opportunism-independent theory of the firm

Previous developments in the opportunism-independent theoryof the firm are either restricted to special cases or are derivedfrom the capabilities or resource-based perspective. However,a more general opportunism-independent approach can be developed,based on the work of Demsetz and Coase, which is neverthelesscontractual in nature. This depends on ‘direction’,that is, deriving economic value by permitting one set of actorsto direct the activities of another, and of non-human factorsof production. Direction helps to explain not only firm boundariesand organisation, but also the existence of firms, without appealingto opportunism or moral hazard. The paper also considers theextent to which it is meaningful to speak of ‘contractual’theories in the absence of opportunism, and whether this analysiscan be extended beyond the employment contract to encompassownership of assets by the firm.     

Consistent firm choice and the theory of supply

Summary. This paper analyzes the problem of deriving predictions, regarding supply behavior of a competitive firm, from prior consistency postulates about input-output choices made by such a firm. It extends the literature by introducing a consistency postulate for firm choice, which is weaker than profit-maximization. This consistency postulate is nevertheless both necessary and sufficient for supply responses predicted by the standard theory of firm choice based on the postulate of profit-maximization. Furthermore, our rationality postulate, in conjunction with another condition, is shown to be equivalent to firm choice behavior that can be rationalized in terms of profit maximization.Received: 11 April 2003, Revised: 26 April 2004, JEL Classification Numbers: D21.Indraneel Dasgupta: I thank Bhaskar Dutta and two anonymous referees for helpful comments on earlier versions.     

The firm as a subeconomy

This article explores the economic role of the firm in a marketeconomy. The analysis begins with a discussion and critiqueof the property rights approach to the theory of the firm asexposited in the recent work by Hart and Moore ('Property Rightsand the Nature of the Firm'). It is argued that the Hart-Mooremodel, taken literally, can only explain why individuals ownassets, but not why firms own assets. In particular, the logicof the model suggests that each asset should be free standingin order to provide maximal flexibility for the design of individualincentives. These implications run counter to fact. One of thekey features of the modern firm is that it owns essentiallyall the productive assets that it employs. Employees rarelyown any assets; they only contribute human capital. Why is theownership of assets clustered in firms? This article outlinesan answer based on the notion that control over physical assetsgives control over contracting rights to those assets. Metaphorically,the firm is viewed as a miniature economy, an 'island' economy,in which asset ownership conveys the CEO the power to definethe 'rules of the game', that is, the ability to restructurethe incentives of those that accept to do business on (or with)the island. The desire to regulate trade in this fashion stemsfrom contractual externalities characteristic of imperfect informationenvironments. The inability to regulate all trade through asingle firm stems from the value of exit rights as an incentiveinstrument and a tool to discipline the abuse of power.