Coase, Knight, and the Nexus-of-Contracts Theory of the Firm: A Reflection on Reification, Reality, and the Corporation as Entrepreneur Surrogate

Working within the nexus-of-contracts model, scholars have struggled to develop a rhetorical paradigm that accurately predicts or describes corporation law. This difficulty flows from twin flaws in the currently dominant model—the equation of the corporation and the firm and the exclusion of the entrepreneur. Coase and his progenitor, Frank Knight, saw the firm as having an “inside” and an “outside” and a distinct central actor—the entrepreneur. Contrary to the allocation of resources by the unconscious processes of the market fundamental to the perfect competition model favored by free-market, nexus-of-contracts theorists, Knight and Coase looked inside the firm and identified the entrepreneur as the central economic actor; it was the entrepreneur who consciously allocated resources within the firm by command. If, following Knight and Coase, we conceive of the corporation as a small inner circle comprised of the relations between officers, directors, and shareholders, and the firm as a larger circle comprised of the relationships between the corporation (acting as entrepreneur–owner) and the employees (and other constituents), then we have the beginning point for a comprehensive theory of the incorporated firm. The rhetorical device that this model suggests is entrepreneur primacy, the claim that corporation law serves to ensure that corporations are operated entrepreneurially. This article develops these points by taking a fresh look at the evolution of the theory of the firm and then detailing how a new account of the incorporated firm is warranted. Part II of this article outlines the research agenda that dominated mainstream economic accounts of the firm prior to Knight and Coase. Part III sketches Knight’s seminal account of the entrepreneur. Part IV describes Coase’s theory of the firm, placing it in the context of Knight’s earlier work and highlighting Coase’s important identification of the law’s place in a real world theory of the firm. Part V explores the implications of Coase’s seminal insights for corporation law scholars working to understand the modern corporation and the theory of the corporation that Coase’s work suggests for that work. Part VI provides concluding thoughts