The Boundaries of the Firms as Information Barriers

Most existing theories of the firms define a firm as a collection of physical assets, and hence can not explain the firm from a human-asset perspective, which is of particular importance for understanding human-capital intensive firms. To fill in the gap, this paper proposes an alternative definition -- a firm is a group of people who work in a very close way so that outsiders cannot clearly distinguish one group member from another. By this definition, the boundaries of the firm matter because they can alter investment specificity and hence alleviate or aggravate the hold-up problem. Specifically, when there is substantial investment externalities integration is more efficient, and conversely separation is more efficient when investment externalities are small. This result is obtained under both Nash and alternating-offer bargaining. The effect of `relational contracts' (Baker, Gibbons and Murphy [2002]) is also examined to show that the newly defined organization structures matter even when relational contracts can be signedBoundaries of the firms; Information Barriers