Ownership and its components

The production of goods and services commonly requires a large variety of inputs, including financial resources, risk-bearing services, and decision making. Decision making is a necessary input because production takes place in real time, and relevant events, such as mechanical failures, technical innovations, or changes in market conditions, cannot be foreseen when agreements to undertake production are initiated. Financial inputs are required because it is usually worthwhile to employ techniques entailing a lag between the investment of resources and the completion of saleable products. Risk bearing is required when the realizable value of the products cannot be known with certainty at the time that costly effort, materials, and services of capital goods are used up.

In most business firms, decision-making rights are held by persons who are also financial risk bearers and suppliers of funds. The holders of these rights are known as the owners of the firm. Ownership refers to a bundle of rights that an economic agent is entitled to exercise over an asset. Its main components are the right of utilization, the right to the products of the asset, and the right to alienate or dispose of the asset and of these rights of utilization and return (Montias, 1976, p. 116; Ryan, 1987, p. 1029). The firm as an ownable asset is an entity that acts as a legal agent in the marketplace, entering into contractual agreements with other agents in order to produce and sell goods and services.

With the exception of this Preface and the Introduction, the present volume consists of selections from material previously published in books or professional journals. With each piece is included a source note that gives the full bibliographic reference of the original work and acknowledges those who granted permission to use the material. In the case of articles, the degree of completeness versus abridgement is indicated by the phrases “reprinted from,” “reprinted with minor abridgements,” “reprinted with abridgements,” and “excerpted from,” in increasing order of abridgement. Book excerpts are understood to constitute only small selections from the originals. The chapter or section from which each portion is taken has been indicated in section headings within such selections. Ellipses within both book and journal selections are used to indicate omitted portions. However, where footnotes have been deleted, no notation has been made, and the remaining notes have been renumbered consecutively.

Minor alterations in style have been made for purposes of consistency. The references have been gathered into a single listing at the end of the book, and bibliographic particulars have been added, when necessary and feasible, to make the references as complete as possible and to have them accord with the standard format of major professional journals. Reference data, except for citations of authors' names and the dates of publication, have been moved to this list from the text and notes.

Two decades ago, noticing the increasing attention being given to questions of economic organization and the nature of firms, we compiled the initial version of this Reader. At that time, we noted the growing frequency of references to writings such as Ronald Coase's 1937 classic as well as work published in the 1970s by Armen Alchian and Harold Demsetz, Michael Jensen and William Meckling, and Oliver Williamson. The years that followed have seen those and related works serve as the core of a literature that has deepened in institutional detail, branched out into empirical studies, and inspired progress in formal analysis. Coase's pioneering role was recognized with the awarding of a Nobel Memorial Prize in Economic Science in 1991. Williamson's ideas, which build on those of Coase and incorporate a number of new elements, have occupied a prominent place in the study of organizations by economists and students of related disciplines. What can be called the “new institutional economics” has had increasing influence, as shown by its treatment in a growing formal analytical literature by such writers as Oliver Hart, Bengt Holmstrom, and Paul Milgrom, a marked departure from a time when the “mathematical-formalist” and nonmathematical literatures included few citations by the one of the other. With unfolding research still suggesting that our original selection of “classic writings” indeed brought together core sources, with interest in the materials remaining strong, and with the fruits of more recent research providing the basis for further steps forward, we are pleased to offer our second revision of The Economic Nature of the Firm: A Reader.

Humans are social animals. Being animals we are biological organisms imbued with the drive to maintain ourselves by consuming food and sheltering ourselves from the elements. Being social, we are physically, intellectually and emotionally interdependent. We are born helpless and need others' nurturing. We are born at all because our parents are moved by desires for intimate relations. We are cared for because they are endowed with the drive to nurture us and with tendencies to bond to each other to facilitate such nurturance. We learn to think – to converse with ourselves mentally, using words – only by interacting with one another, using languages that are the products of millennia of such interactions. Our senses of self emerge in our early encounters with others, and we construct identities by comparing ourselves with others and apprehending our places in a social order. How odd that we should ever have thought up a social science that gives short shrift to social interactions!

About twelve thousand years ago our ancestors, who had recently begun to fashion more elaborate tools, started to exploit their environments in new ways. The old lifestyles of hunting and gathering gradually gave way to new ones based on agriculture and animal husbandry. As technological progress fed population growth, more differentiated divisions of labour came into being and the intimate band gave way to the more complex village and to still larger societies and polities. Little by little, the self-sufficiency of the band gave way to specialisation and trade.