A Brief Prehistory of the Theory of the Firm

Paul Walker

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781351041362
• Edition: 1
• Topic: Commerce
• Subtopic: Commerce Général

The theory of the firm did not exist, in any serious manner, until around 1970. Only then did the current theory of the firm literature begin to emerge, based largely upon the work of Ronald Coase and to a lesser degree Frank Knight. It was work by Armen Alchian, Robert Crawford, Harold Demsetz, Michael Jensen, Benjamin Klein, William Meckling and Oliver Williamson, among others, that drove the upswing in interest in the firm among mainstream economists.

This accessible book provides a valuable overview of the 'prehistory' of the firm. Spanning an impressive timeline, it delves into Antiquity, the Medieval era, the pre-classical economics period and the 19th and 20th centuries. Next, the book traces the theoretical contributions from pre-classical, classical and neoclassical economics.

It will be illuminating reading for students and researchers of the history of economic thought, industrial organization, microeconomic theory and business history.

1
Background

The ‘firm’¹ is an ancient and important empirical feature of the economic landscape. ‘Firms’, of some description,² have existed around the world for several thousand years.³

If we look, for example, at ancient India we see a sophisticated form of business organisation called the Sreni. The Sreni was a complex organisational entity that shared similarities with companies, guilds and producers cooperatives. According to Khanna (2005) the Sreni was being used as early as 800 BC and was in more or less continuous use from that time until 1000 AD, at which time an Islamic invasion of India started. Khanna (2005) explains that the Sreni were separate legal entities which could hold property separately from their owners, create their own regulations controlling the behaviour of their members, contract, sue and be sued in their own name (Khanna 2005: 8-9). Table 1.1 gives a more detailed summary of characteristics of the Sreni. Notice that the Sreni shares a number of these characteristics with the modern business company. Sreni were utilised in occupations involving workers such as carpenters, ivory workers, bamboo workers, money-lenders, barbers, jewellers and weavers (Khanna 2005: 10).

In other regions of the world firms go back ever further. At the beginning of the second millennium BC firms were involved in the long-distance trade between the city-state of Assur and Anatolia. Documents from around 1850 BC detail profit-oriented trade in commodities such as textiles and metals (Jursa 2014: 27). Assyrian merchants traded expensive woolen textiles, tin and lapis lazuli for silver and gold, which they shipped back to Assur.⁴

The institutions of trading have been well documented.

Most of these traders had become more independent by having become managers of a “joint-stock fund” (called naruqqum, “money bag”), usually set up in Assur. This phenomenon appeared for the first time around 1900 BC and seems to have been an Old Assyrian invention that went beyond individual partnerships and cooperation in a joint caravan. The arrangement, rather similar to that of the early medieval compagnia, meant enlisting a number (usually about a dozen) of investors

Table 1.1 Characteristics of the Sreni

Characteristics	Present in Ancient Indian Sreni?
Separate entity	Yes
Centralized management	Yes
Transferability of interest	Probably Yes
Limited liability	Probably Not
Agent has power to bind entity?	Yes
Management elected?	Yes (though at times appears hereditary)
Can management be removed?	Yes
Duty of loyalty	Probably Yes
Duty of care	Yes
Liability insulation	Yes (though apparently not very detailed)
Screens on shareholder suits and internal cement activity	Yes (though apparently not very detailed)
Internal rules have binding effect	Yes
Some reimbursement for legal defense	Yes
Formation is easy	Yes
Register with state	Yes
State approval needed	Yes
Use of incentive payments	Yes (though apparently not very detailed)
Entry is easy	Some conditions, but no caste bars.
Sharing of assets and liabilities	Terms of agreement and additional rules
Exit is easy	Yes, but with obligations potentially
Board/committee independence	Probably Yes
Other board qualifications	Yes (though apparently not very detailed)
Voting regulation	Yes (though apparently not very detailed)
Open debate in meetings & shareholder resolutions	Yes, with some limits (though apparently not very detailed)
Transparency is valuable and disclosure is encouraged	Probably Yes (though apparently not very detailed)

(Khanna 2005: Table 1, p. 27; table footnotes removed.)

(ummiānum, “financiers”), who supplied capital rated in gold, usually in all ca. 30 kilos, ideally consisting of shares of 1 or 2 kilos of gold each. It was entrusted to a trader (the tractator), usually for ca. ten years, for the generally formulated purpose of “carrying out trade.” The contract contained stipulations on a final settlement of accounts, on paying dividends, on the division of the expected profit, and on fines for premature withdrawal of capital (meant to secure the duration of the business). Investors or shareholders mostly lived in Assur, but successful traders in Anatolia too invested in funds managed by others, perhaps also as a way of sharing commercial risks. In such cases a contract would to be drawn up in Anatolia that obliged the tractator “to book in Assur x gold in his joint-stock fund in the investor’s name.” Among the investors we find members of the tractator’s family, but also business relations and others, probably a kind of “merchant-bankers,” and other rich citizens, who aimed at fairly safe, long-term investments.

(Veenhof 2010: 55)

Silver (1995: 50) notes that

[p]rivate firms (btātu) were prominent in late-third-millennium Akkad (the region south of Baghdad), in the Old Assyrian trade with Cappadocia […] and, somewhat later, at Nippur. In the mid-second millennium the firm of Tehip-tilla played a major role in the real estate transactions and other business activities at Nuzi. A list of about the some time from Alalakh in northwest Syria refers to sixty-four firms participating in leatherworking, jewelry, and carpentry.

If we examine the economy of ancient Greece we find that there were some relatively large firms, but they were few in number (Bresson 2014: 45). Most of the commercial operations that did exist were small and of limited duration. The (in theory) infinitely lived firm did not exist; partners would agree to cooperate for just a single business operation. There may have been many investors or several active partners, but their cooperation lasted for only one voyage or one operation. The development of permanent firms for commerce was unnecessary since low transaction costs meant that market transactions were sufficient for business operations.⁵ Alain Bresson explains,

[a]ccording to Coase’s famous definition, a capitalist firm is first defined as an alternative to coordinating production and distribution through external markets (Coase 1937). But as a matter of paradox and by contrast to the medieval world, resorting to market in antiquity was so easy that it did not seem necessary to build permanent firms proprio sensu. Investors could contract in a series of different business operations, thus both minimizing risks and maximizing their profits by making for themselves the best choices of investment.

(Bresson 2014: 57-8)

With regard to the size of firms in ancient Greece Bresson (2014: 45) writes

large [handicraft] workshops, with possibly a few dozen workers (sometimes up to 120 as in the case of the metic Kephalos in Athens in the fourth century, as mentioned by Lysias 12.19 [Todd 2000]) could indeed exist, but they were rare.

If we turn to the rural economy in ancient Greece we see that when compared to their urban counterparts, farms were longer lived, hieratical organisations, often family owned and operated with a slave workforce (Bresson 2014: 57-9).

The use of private firms for the provision of many economic goods and services during the Roman Republic has been noted by Sobel (1999: 21):

[t]he republican Senate left virtually all economic activities to private individuals and companies, known collectively as the publicani. Tax collection, supplying the army, providing for religious sacrifices and ceremonies, building construction and repair, mining, and so on were all contracted out. There was even a contract for summoning the assembly in session and one for feeding the sacred geese.

Micklethwait and Wooldridge (2003: 4) also note that private ‘companies’ were formed for the purpose of collecting taxes, and other commercial activities:⁶

[t]he societates of Rome, particularly those organized by tax farming publicani, were slightly more ambitious affairs. To begin with, tax collecting was entrusted to individual Roman knights; but as the empire grew, the levies became more than any one noble could guarantee, and by the Second Punic War (218-202 b.c.), they began to form companies − societates − in which each partner had a share. These firms also found a role as the commercial arm of conquest, grinding out shields and swords for the legions. Lower down the social scale, craftsmen and merchants gathered together to form guilds (collegia or corpora) that elected their own managers and were supposed to be licensed.

In some cases these ancient firms grew to be of reasonable size. Silver (1995: 66-7) notes,

[w]e may note here that during the Ur III period a new mill at Girsu required the services of 679 women and 86 men (Maekawa 1980: 98).

and

[a] number of cities possessed large workshops employing hundreds of women in spinning and weaving. For example, a late-third-millennium text from Eshnunna lists 585 female and 105 male employees in a weaving house.

(Silver 1995: 143)

Ancient firms also diversified their activities.

Large commercial houses flourish...

Table of contents

• Cover
• Title
• Copyright
• Contents
• Preface and acknowledgements
• 1 Background
• 2 The division of labour and the firm
• 3 Development of a theory of production or the firm
• 4 Possible reasons for the neglect of the firm
• Index