Anup Malani, "Contract Law, Transactions Costs and the Boundary of the Firm"

In 1937, Ronald Coase asked a profound question: if markets are so efficient at allocating resources, why are so many resources allocated within firms? Coase’s answer was that market allocation entailed transactions costs and, when these were very high, transactions will take place within firms. Oliver Williamson, a Nobel Prize winner like Coase, elaborated on the sorts of transactions costs that discouraged market transactions. Among these was the holdup problem: buyer agrees to pay a set price for a widget to be supplied by seller at some future date, but when the date arrives the seller demands a higher price. Oliver Hart, with co-authors Sanford Grossman and John Moore, suggested this problem could be overcome if the buyer owns a key asset of the seller or the seller’s whole firm. This can prevent the seller from holding up the buyer. In this manner Hart et al. transformed Coase’s theory of how large firms were into a theory of who owns firms. Since then there have been numerous efforts to demonstrate that asset ownership or integration is not necessary to overcome the holdup problem. In this presentation, Professor Malani will describe a number of surprising contract provisions that can be used to tackle the holdup problem and how contract law can affect the scope and ownership of firms. This talk was recorded on November 9, 2011 as part of the Chicago's Best Ideas lecture series. Anup Malani is Lee and Brena Freeman Professor of Law at the University of Chicago Law School.