Incomplete Contracts and Firm Boundaries: New Directions

Political Economy 691–19.) made the study of firm boundaries susceptible to formal economic analysis, and illuminated an important role for markets in pro-viding incentives. In this essay, I discuss some new directions that the literature has taken since. As a central challenge, I identify the need to provide a formal theory of the firm in which managerial direction and bureaucratic decision-making play a key role. Merging a number of existing incomplete con-tracting models, I propose two approaches with very different contracting as-sumptions. As in transaction cost economics, a central element in those theories is the presence of a central office that directs and coordinates the actions of subordinates. More novel, I highlight the superior ability of nonintegrated firms to adapt to a changing environment. JEL: D23, D83, D86, L22, L23. 1