Inside the Coasean Firm: Why Variations in Competence and Taste Matter

Ronald Coase’s signal achievement relates to the role of transactions costs in two contexts: the formation and maintenance of the firm and the systematic analysis of social costs. These transaction-cost explanations, however, do not offer a complete explanation of the variations observed in the internal structures of firms, which are elucidated by noting the irreducible role of variations in individual competence, temperament, and taste in explaining both why firms are formed and how they are structured. Thus, some firms are organized as partnerships and others as straight employment arrangements, with many permutations in between. Sometimes these differences are driven by tax and regulatory considerations that Coase well understood, but these differences remain prominent even in wholly unregulated markets. Understanding the internal construction helps explain the difficulties faced by regulation in areas as diverse as employment discrimination law, capital markets, and tort liability.