11 - Norms and the theory of the firm

Summary

Introduction

Most standard models of incentives and/or organizations assume that economic agents are self-interested and must rely on formal contracts enforced by the courts to uphold their relationships. In reality, of course, many economic transactions are sustained by self-enforcing (“implicit”) contracts, or norms of behavior, such as honesty or trust. An interesting question to ask is: does ignoring norms/self-enforcing contracts lead to misleading conclusions? That is, would a theory of incentives or organizations that incorporated norms look very different from the standard theory?

In this chapter, I will consider this question, focusing particularly on some of the attempts economists have made in the last ten years or so to integrate norms into the theory of the firm. I will argue that (a) although norms are undoubtedly very important both inside and between firms, incorporating them into the theory has been very difficult and is likely to continue to be so in the near future; (b) so far norms have not added a great deal to our understanding of such issues as the determinants of firm boundaries (the “make-or-buy” decision) – that is, at this point a norm-free theory of the firm and a norm-rich theory of the firm don't seem to have very different predictions.

Background

To begin with, it is worth mapping out some of the territory. I will follow Richard Posner in defining a norm as “a rule that is neither promulgated by an official source, such as a court or a legislature, nor enforced by the threat of legal sanctions, yet is regularly complied with” (see Posner 1997).