Coase, Theory of the Firm, Tirole chapter 0 Eric Rasmusen, [e-mail]

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Coase, Theory of the Firm, Tirole chapter 0 Eric
Rasmusen, erasmuse_at_Indiana.edu

G604, Tirole-Coasle, size of firms, march 28, 2006

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• Classics Organization     R. H. Coase (1937)
  "The Nature of the Firm," Economica, New Series,
  4, 16 386-405 (November 1937)
•    

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Coase (1937)
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Transaction Costs
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Using Marginalism
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Master and Servant

• The last part of Coase is about authority. The
  principal commands the agent.
• Why is the principal the entrepreneur and not the
  worker? (not in Coase)
• Why does the residual claimant have the
  authority? (not in Coase)

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Tirole

• Top person in theoretical IO, Id say. He writes
  books a lot. Toulouse, MIT.
• p. 20. Why do economies of scale have to be
  exploited within the firm?
• This relates to Coase (1937)

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Why Not One Big Firm?

• Williamsons Puzzle of Selective Intervention
  why not merge two firms and then manage them just
  the same as before? (p. 21)
• One answer we cannot contract to make the CEO
  of each firm a residual claimant.
• Think of Holmstroms Teams model (1982).
• Rasmusen and Zenger, Diseconomies of Scale in
  Employment Contracts,'' Journal of Law, Economics
  and Organization (June 1990), 6(1) 65-92 .

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Bargaining Power (Rasmusen)

• Two possible meanings
• 1. The threat point (Apex gets 2, Brydox gets 8)
  vs. (Apex gets 7, Brydox gets 3)
• 2. The division of surplus (Apex gets 100,
  Brydox gets 0) vs. (Apex gets 20, Brydox gets
  80)

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Bargaining Why the Coase Theorem Breaks Down
(pp. 22-24)

• (2) Nature chooses buyer value v using density
  f(v) on a,b with seller cost c in (a,b). The
  buyer observes this.
• (3) The seller offers price p to the buyer.
• (4) The buyer accepts or rejects.
• This leads to inefficiency-the
  Myerson-Satterthwaite problem.
• Seller proposing an offer at (1) would not help.
• Merging at (1) would help. So we should put buyer
  and seller in the same firm.
• OR give all the bargaining power to the
  informed party, e.g. the contract at time (1)
  gives a lump sum X to the seller and gives the
  buyer the right to buy 0 or 1 unit at price pc
  (an option contract) OR use a fancy mechanism
  (footnote 29)

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Asset Specificity/The Hold-Up Problem (p. 24)

• (1) The buyer value is v3. The seller can invest
  2 to get c0 or not invest, to keep c4.
• (2) The buyer offers price p to the seller. (or,
  use 50-50 split)
• (3) The seller accepts or rejects.
• This leads to investment of 0.
• The buyer proposing an offer at (0) would
  help.
• Merging at (0) would help too. So we should put
  buyer and seller in the same firm.
• OR give all the bargaining power to the
  investing party, i.e. the seller here.

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Asset Specificity/The Hold-Up Problem Example (p.
28)

• Joskow found that when coal quality is diverse,
  not many transportation methods, and few mines,
  then long-term contracts will be used (West US)
• In the opposite case, short-term contracts (spot
  markets) are used (East US)

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Authority (p. 30)

• Authority changes the threat point in bargaining.
  It changes, in a sense, bargaining power.
• Think of the UN Security Council. Suppose Russia
  and France do not care about Rwanda policy, but
  the US does. Is the effect of giving them veto
  power over US policy to change US policy?

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Unconstrained Bargaining (pp. 31-32)

• (0) The buyer and seller have made a basic
  contract.
• (1) The buyer invests Ix2/2 in researching a
  new feature that will cost the seller c to
  produce.
• (2) The buyer value of the new feature is vgtc
  with probability x and 0 otherwise.
• (3) Buyer and seller bargain for a price p for
  the feature. If they disagree, the new feature
  is not added to the product.
• Assume bargaining splits the gains from
  agreement.
• Result Underinvestment

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Seller Has Authority to Make Changes ( p. 32)

• (0) The buyer and seller have made a basic
  contract.
• (1) The buyer invests Ix2/2 in researching a
  new feature that will cost the seller c to
  produce.
• (2)The buyer value of the new feature is vgtc
  with probability x and 0 otherwise.
• (2.5) The seller decides whether to add the new
  feature to the product.
• (3) Buyer and seller bargain for a price p for
  the feature. The feature is added only if the
  seller agrees to add it.
• Assume bargaining splits the gains from
  agreement.
• Result Underinvestment

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Buyer Has Authority to Make Changes ( pp. 32-33)

• (0) The buyer and seller have made a basic
  contract.
• (1) The buyer invests Ix2/2 in researching a
  new feature that will cost the seller c to
  produce.
• (2)The buyer value of the new feature is vgtc
  with probability x and 0 otherwise.
• (2.5) The buyer decides whether to add the new
  feature to the product.
• (3) Buyer and seller bargain over whether the
  new feature is to be added. The decision is
  ultimately up to the buyer.
• Assume bargaining splits the gains from
  agreement.
• Result Overinvestment

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What if the New Feature Might Be Actually a
Negative?

• We can run that model with probability x of value
  vgtc and probability (1-x) of value ylt0 too.
  Then, buyer authority does not result in
  overinvestment, I think--- for reasons elucidated
  in Lyon and Rasmusen, Buyer-Option
  Contracts, Renegotiation, and the Hold-Up
  Problem,' Journal of Law, Economics and
  Organization, 20,1 148-169 (April 2004)

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• A link to the course website
• http//www.rasmusen.org/g604/0.g604.htm