Edited by Theodore Eisenberg and Giovanni B. Ramello
Chapter 2: Markets, contracts, and firms: A unified model of organizational choice
A sizeable amount of literature, beginning with Coase (1937), has arisen to examine the boundary between the market and the firm. The key question addressed by this literature is, when is it more efficient to organize a transaction through the market rather than within the confines of a firm? Such an analysis, however, often overlooks the different ways in which a market (arms-length) transaction can be organized. For example, it can be a spot transaction in which the parties meet and negotiate an instantaneous exchange under certainty, or it can be governed by a contractual arrangement that was negotiated in the past before all information pertinent to the transaction was known. The advantage of the contract is that it allows commitments to be made that are enforceable by a third party (the court), thereby avoiding the holdup problem. (This arrangement is therefore sometimes referred to as ‘court ordering’.) The disadvantage is that the terms of the contract must often be negotiated under uncertainty, thus leading to the possibility of costly litigation once the information is revealed.
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