Abstract:
· Theorizing about how businesses operate can be divided into two periods: the foundational theory of the neoclassical school and its opponents in the early20th century, followed by attempts at synthesis and a revival of theorizing after the 1970s.
· It is paradoxical that before the revival, theory did not always succeed in clearly defining the boundaries of the company and its objectives, despite its major role in capitalism.
Similarly, theory has long sought to determine whether the object of study should be the company or the entrepreneur. Ultimately, a plethora of theories now make it possible to analyze the company as a whole, with highly fluid structures.
In response to these theoretical shortcomings, a more modern theory has developed over the past 50 years, which has helped to overcome some of the difficulties posed by the company. This led to the emergence of fields such as firm theory, organization theory, and corporate finance.
In recent years, there have been numerous publications on firm theory. Olivier Williamson’s 2009 Nobel Prize in Economics for his analysis of the boundaries of the firm in terms of governance is a testament to this. Epistemological, theoretical, and practical thinking about the firm thus appears to be central, but it took almost a hundred years of analysis to get there. Before the 1960s and 1970s, the firm was relegated to second place in the economic analysis of economic policy institutions. Indeed, even though » the enterprise is the capitalist microcosm, the cardinal institution of capitalism » (Le Capitalisme, 1992) according to François Perroux[1], until modern financial theory emerged, it was an institution that had not been fully analyzed in economic thought. The lack of historical study of the company creates a paradox that is necessarily surprising, given that it is the central institution of industrial and financial capitalism, both yesterday and today.
Theorizing the nature of the company and its internal and external activities therefore seems essential to understanding an actor at the heart of economic life, especially in a context of heightened globalization. However, defining the boundaries of the company and its objectives, and determining whether it is an object or an instrument of study, is not so clear. It is commonly accepted that the company refers to an institutional entity whose activity is pecuniary through commercial production. It is therefore an organization in dynamic interaction with its environment, as a center of decision-making.
The end of the Glorious Thirty marked the beginning of a different economic mindset in global society, with other priorities. This was accompanied by the development of new theories, including for the firm. Here, we propose to provide an overview highlighting the importance of theoretical developments in the early20th century, which are often little known or misunderstood but essential to the constitution of the company as an economic entity at the heart of economic policy. We then provide a brief overview of theoretical developments concerning the company post-1970 and their implications for the vision of the company. This article is somewhat theoretical, but it lays the groundwork for the modern analysis of the enterprise.
I. The firm in economic theory up to the 1970s
a. The firm as seen by the neoclassical school
According to neoclassical theory, the function of a business is a simple objective: to maximize profit in a competitive environment, led by an individual entrepreneur. Microeconomics builds its analysis on this basic premise and simplistic assumptions (rationality, no technical progress, etc.). However, reality is not limited to this, but the theory did not go much further until heterodox economists opposed the neoclassical view at the beginning ofthe 20th century. Thus, research on the different modes of operation of the firm appeared in American literature at the end of the19th century. Previously, the classical economists had only an external view of the firm as an actor with relatively little power and whose only function of interest was its productive function[2].
In reality, this was more a theory of the market than a theory of the firm. The role of the entrepreneur appeared with Jean-Baptiste Say (1814, 1819), but the only terms used were » point firm » and » automatic firm. » The concern for realism led to a reformulation of the various hypotheses previously used (the end of perfect information, pure and perfect competition (PPC), the single objective of maximization, etc.). However, this orthodoxy had to wait until the writings of Ronald Coase in the late 1930s, with his work on the nature of the firm (which provides an alternative to the market for coordination and demonstrates real power of authority and hierarchy), to bring to light an analysis in terms of decision-making, creation, and innovation concerning the company. Based on the questioning of the assumptions of neoclassical analysis, the company appears as something other than a simple individual agent with no concern for internal logic. This is why the firm has long remained a « black box » as an unexploited theme, amalgamating company and entrepreneur. This is all the more so since American lawyers consider that no one really owns the company. However, as we know, major American industrialists punctuate economic history (Rockefeller, Carnegie, Vanderbilt, etc.) and are the central nexus of the liberal economy that developed at the turn of the century, rapidly transforming market production structures. We will return later to the significance of Coase’s writings, which only really came to the fore in the early 1960s.
b. The 1930s: the managerial revolution
From the 1930s onwards, the changes in market structures and the concentration movements at the turn of the century were so significant that a new, heterodox literature emerged. Among them, Berle and Means published a book in 1932 entitled The Modern Corporation and Private Property and changed the way stakeholders viewed companies. In reality, the analytical approach to business at the turn of the century was based on actual observations of how companies operated. This was referred to as the managerial revolution, giving rise to the famous managerial theory. Large joint-stock companies developed, involving the dispersion and fragmentation of ownership among many small shareholders and the separation of management and ownership functions. This was the first modern approach to the firm outside of standard theory, and it would have a very significant influence.
The main idea of separation of powers meant that decision-making was no longer in the hands of shareholders but of a new ruling class: « managers. » New concepts of corporate governance emerged and have been making a strong comeback since the late 1980s. Berle and Means presented the first theory of the corporation that examined the behavior of divergent interest groups within the corporation (shareholders, managers, credit institutions, workers). The question was raised as to who controls the firm and who provides an institutional framework for the corporation, since its environment has a strong impact on its structure (financial markets, type of market, type of companies, etc.). There is therefore a conflict between managers and owners of the company. The former have a practical objective of growing the company and achieving returns that reflect a certain industrial prestige, while the latter are simply shareholders with financial interests. The 1940s also saw the emergence of Burnham’s (1940) directorial approach, which, also drawing on the work of Berle and Means, gave rise to the behavioral approach during the theoretical synthesis efforts of the 1970s.
In the same vein, Schumpeter, in his 1942 work, acknowledged the disappearance of the concept of the innovative and committed entrepreneur—as reflected in industry—that he had described in his previous works. Scitovsky (1943) was the first to base profit maximization on a particular psychology on the part of the entrepreneur. There was a whole school of thought in the 1940s that sought to integrate the entrepreneur, notably in the context of the creation of the Research Center in Entrepreneurial History by AH Cole in 1948. However, these years of reflection and work made it possible to broaden the definitions of business and entrepreneur.
II. Modern schools of thought focus on theorizing the entity of the firm and renewing it
It took 40 years for the first synthesis of how businesses actually function to appear, following the revolutions in financing methods in the 1960s, which also gave rise to new analytical tools. Businesses therefore remained a marginal subject of study until the 1960s. Heterodox theories had not really been applied until then, so they did not lead to a real paradigm. But with this ideological shift, a plethora of new, more general theories emerged, competing with the standard theory.
This was a veritable scientific revolution in business analysis. Goods were no longer central to business activity; instead, contracts became the means of coordinating the functioning of commercial exchange between markets and businesses. Work was now seen as a subject of study in its own right within the business: it was a contract between employer and employee (Favereau 1996). The focus then shifted to the organizational side of the theory, with an interest in contractual rules and « internal markets. » This triggered a reflection on the competencies of the firm, even though organizational theory had already been focusing on this since the beginning of the20th century[3].
Broadly speaking, there are three opposing and complementary schools of thought:
a. The new orthodox school
Firstly, there is the theory of property rights, which emerged in the 1960s with Alchian and Demsetz (1972). They notably revisited the idea of Coase’s theorem[4], which had been neglected at the beginning of the century, focusing on the company as the most efficient form of organization in terms of technical constraints, labor, and various costs. It allows for effective specialization and incentives. This raises the question of authority within the firm, based on the issue of ownership and the need to establish a market for these rights. In addition, Alfred Chandler‘s historical analysis aligns with Coase’s vision of a firm as an institution, a complex organization that administratively and hierarchically coordinates all the relationships in which it is involved. For him, the firm appears to be the institutional solution to specific problems. It has learned in practice (since themid-19th century ) to coordinate multiple flows and has had to invent specific management methods. However, economic history shows us (with the work of Patrick Verley, among others) that firms have always attempted to influence market laws and build networks with aims that are not always in line with collective well-being and the proper functioning of structures and the market.
Then we have agency theory, which complements the previous theory. It is inspired by Berle and Means’ representation of the firm, but also by Arrow, Akerlof (1970) and his » market for lemons « [6] with the issues of information asymmetries that are dear to him, giving rise to the new orthodoxy according to Coriat[7] and Weinstein[8] (1995). It was not until the work of Jensen and Meckling (1976) that the agency relationship between the principal and the agent in the execution of a task was defined, with delegation as the central argument. This led to an awareness of the problems associated with these contracts and their costs. Theories such as implicit contracts, efficiency wages, and the insider-outsider model began to emerge. All the shortcomings of the standard neoclassical model were then highlighted. This theory refers to the divergent behaviors of two groups of agents within the company, due to information asymmetries. The principal and the agent have different contracts, information, and interests. However, this can incur costs for the organization, which must strive to limit these differences between the principal and the agents. The efficiency of joint-stock companies is therefore based on the primacy of the shareholder in managing the company. However, the position of these new models remains very liberal, in contrast to Coase. Indeed, they see the company as a place without authority relationships, with free contracts and no opposition to the market, because the firm is an internal, private market. The employment contract is then considered to be a simple commercial contract without any specific characteristics. Similarly, the behaviorist approach was developed by Cyert and March in 1963, in which the company is seen as a place of learning, a complex body, a hub of cooperation but also of conflict with divergent interests. The classic homo economicus reappears in both of the theoretical approaches just described.
b. The heterodox side of the new theory of the firm
On the other hand, the latest tradition concerns transaction cost economics or new institutional economics with Olivier Williamson (1960). Coase is revisited here, as the importance and need for resources prior to exchange is emphasized. This gives rise to the managerial school, already theorized by Burnham in the 1940s. The firm is then merely a mode of coordination to enable costs and the environment to be supported. This tradition gives rise to hypotheses about the behavior of agents in complex environments, incomplete contracts, and therefore possible opportunistic behavior. It is then that the organization makes it possible to combat these asymmetries that give rise to costs, particularly when investments create dependencies between individuals. The coordination of the company is therefore preferred to that of the market; this is internalization. The firm is a system of skills (collective capacity). This is in line with new heterodox evolutionary theories. In any case, firms are consistently superior to any other organization in terms of the accumulation of skills and knowledge. To quote an economist we have not cited here, a firm is a technostructure, central to and energizing the economy (Galbraith[10], 1967).
These three contrasting contractual approaches are the dominant view today and ultimately reflect the pioneering work of Coase. Each of them highlights the need for institutional frameworks and a shift in the thinking about the « firm » as an object, even if no theory has yet combined the two. It is clear that it is complicated to pursue research in this direction. The theorization of the firm remains a « black box » due to the diversity of forms of rationality, coordination, properties, structures, etc. As the field of study is vast, complex, and evolving, new theories raise certain questions about the « black box, » but the company remains separate in economic analysis and retains its status as a « gray box. » The synthesis efforts of the 1970s preserve the conflicts in the definition of the firm. These concepts are very diverse and, in an era of globalization and the preeminence of firms and the market, this seems inevitable and problematic, even though the history of economic thought is full of writings focusing on the specificities of the firm and all the great economists have taken an interest in it (Walras, Marx, Schumpeter, etc.).However, at the heart of industrial economics, market theories, and financial theories, branches of economics specific to the firm have developed: organizational theory, firm theory, corporate financial theory, etc., but this work is ultimately recent. The black box was opened in the 1970s, making it possible to bring theory and reality closer together in terms of how companies operate. Today, we understand that multidisciplinarity is central and that it must be used to understand the company as a network, a node of contracts, and no longer just a complex set of techniques and modes of organization. The reconstruction of the firm may seem utopian, but in the context of financial globalization, it remains a strategic issue for the direction of the economy.
Conclusion
As we can see, with the economic measures proposed by Emmanuel Macron, the company is at the heart of everything, of the entire economic and social life of contemporary society. We highlight that the industrial economy has become an important branch of economic analysis. The company is not an ordinary agent, it is not a household, and it requires specifications and special attention in economic theory and modeling.
As economist Bernard Guerrien points out, » By equating the firm with an individual, we obviously empty it of all substance. This is why some say that the firm in microeconomics is a ‘black box’. » As a result, the object of study known as the « firm » underwent significant changes during the20th century. The question of its identity and lack of unity remains unresolved (particularly today in a context of flexibilization, subcontracting, franchising, etc.). Concerns about the vision of business structure, methods of incentive and control, and the gap between theory and empirical evidence are a recurring theme. We are moving from the firm-point to a more detailed analysis of inputs, their allocation, outputs, and market management. However, the problem remains that there is no consensus definition of the company, the governance model, and what is expected of it.
Bibliography:
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[1] François Perroux was a20th-century professor and economist who was highly critical of neoclassical thinking and who theorized, defined, and popularized such important concepts as growth, development, solidarity, and public action in the context of « unbridled capitalism. » He was particularly interested in industrialization, the upheavals linked to companies in power relations, and the different phases of transition in growth.
[2] The theory of the production process is limited to the mechanisms of resource allocation and price determination.
[3] Taylor, Fayol, Weber, March, Simon, Nelson, and Winter, among others.
[4] Coase’s theorem comes from the 1960 article « The Problem of Social Cost. » It refers to the state’s failures in managing market failures. Property rights are central, as are transaction costs for the optimal allocation of resources in the economy. To manage externalities, the state must intervene to correct them using the tax tool.
[5]He also draws on Douglas North’s 1961 theory on the revolutions in transportation and communication technologies to support his arguments concerning the innovative nature of firms in their modes of organization, coordination, and control.
[6] To explain the trend toward concentration of supply and its impact on the quality of goods, Akerlof offers this small example from the used car market to prove that, overall, there is a decline in the quality of goods as the market shrinks. Since buyers look at overall market statistics, sellers have an incentive to sell poor-quality goods, as the benefits of good quality are ultimately shared among all sellers.
[7] An economist with a contrarian view, he offers a new perspective on industrial and business economics. He has also worked on the return of the commons and international economics.
[8] A professor at Paris 13 University, his areas of research include the economics of innovation, the economics of firms and organizations (forms, inter-firm relations, and historical transformations of large companies), the social construction of markets, and the economic analysis of property.
[9] The theory of incomplete contracts emerged from transaction costs. It is not always possible to foresee future outcomes. Contracts are therefore renegotiated when an unforeseen event occurs. However, unlike transaction cost theory, which postulates that in an indeterminate case the authority has decision-making power, implicit contract theory is about asserting property rights.
[10] The New Industrial State is a seminal work, one of the few to really raise the questions that enable us to understand the « black box » that is the company.
