Economic power and corporate contractual arrangements

Since Coase (1991) drew attention to the “black box,” a reference to the firm, there has been rapid development of firm contract theory. In neoclassical economics, the firm is considered a micro-organization of production. Enterprise behavior is geared toward the pursuit of profit maximization, the distribution of production resources inside the firm, and the allocation of the firm’s income among its members can be resolved by the competition in the factor market. In reality, firms face additional challenges. For example, the organizational and capital structure of firms varies according to the industry. Additionally, it is entirely possible that the manager’s behavior is not geared toward the pursuit of profit within a firm. The manager theory argues that for their own interests, managers may be inclined to pursue market share, sales targets, or autonomy. The development of modern enterprise contract theory provides a better explanation for the behavior of internal firm members and the structure of the firm in the following three aspects.

First, we consider the contractual nature of the firm. We explain the nature of the firm from the perspective of the contract and at a level where the firm can be unified with the market. This is different from traditional theory. Traditional theory holds that the market and government are two methods of resource allocation. Both firms and residents are two economic subjects in the resource allocation process, but enterprise contract theory argues that the firm is another conduit for resource allocation in addition to the market and the government; the firm is not only an economic subject in the market but also an organizer of different production resources. The varied organizational structure of firms reveals different allocation efficiency of resources, and transaction cost is an indicator of the efficiency of the two methods of resource allocation, which are bureaucracy and market competition. Second, we consider the enterprise target. The firm is composed of economic subjects pursuing different goals. The behavior of the internal members of the firm have strong externalities on the organizational level of the firm; therefore, the internal property rights arrangements and the income distribution of the firm significantly affect the behavior of firm members and firm performance, which reflect on the different efficiency of corporate governance. Third, we consider property rights transaction and institutional change. The concept of transaction costs and the tradability of property rights provide a platform for institutional research. The firm, as an institutional form, is a result of economic entities pursuing economic efficiency and profit. Therefore, the endogenous theory of institutional change and the evolution of the firm’s organizational form developed.

In this chapter, we develop the enterprise contract theory based on the concept of economic power. We hold that the power structure among economic subjects affects the property rights arrangement, income distribution, and the firm’s efficiency in the contracting process of the firm’s contract. The firm’s performance appears to be determined by different corporate governance structure, but we show in this chapter that it is the distribution of economic power among different economic subjects that plays the decisive role in a firm’s performance. Either the governance structure or the income distribution structure and even the performance of the firm are endogenous variables.

This chapter can be divided into three parts. First, we address the formation and allocation of the corporate right of internal control. Second, we discuss the distribution of the firm’s revenue among its different members, including the nature of corporate governance, residual claim, and firm pricing. Third, we present a model on the power structure and firm performance before concluding the chapter. The content of this chapter is progressive. The distribution of the right of control among different members is the basis of a firm’s organizational structure and serves as a basic indicator to distinguish the different corporate governance structures. In summary, the pursuit of the right of control is the same as the pursuit of profit. Hence, the allocation of a firm’s profit determines the productivity and shirking behavior of the internal members of the firm. On the contrary, the behavior of firm members determines a firm’s performance.

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