Discovering the Role of the Firm: The Separation Criterion and Corporate Law

Abstract

Professor Daniel F. Spulber presents a theory of the firm based on the ability to separate the objectives of the firm from those of its owners. He introduces a separation criterion which defines a firm as a transaction institution such that the consumption objectives of the institution’s owners can be separated from the objectives of the institution itself. The separation criterion provides a bright line distinction between firms and other types of transaction institutions. Firms under this criterion include profit-maximizing sole proprietorships, corporations, and limited-liability partnerships. Institutions that are not classified as firms include contracts, clubs, workers’ cooperatives, buyers’ cooperatives, merchants associations, basic partnerships, government enterprises, and government sponsored enterprises. The separation theory of the firm yields insights into corporate law that extend and complement the standard contractarian approach. The separation theory of the firm places emphasis on shareholder property rights and corporate governance. _____________________________ * Elinor Hobbs Distinguished Professor of International Business, Professor of Management Strategy, Kellogg School of Management, Northwestern University, 606 Jacobs Center, 2001 Sheridan Road, Evanston, IL 60208-2013, e-mail: jems@kellogg.northwestern.edu I am grateful for the support of a grant from the Ewing Marion Kauffmann Foundation for research on entrepreneurship. I thank Michael Baye, Henry Butler, Shane Greenstein, David Haddock, Gillian Hadfield, Peter G. Klein, Jin Li, Henry Manne, Scott Masten, Troy Paredes, Jens Prufer, Steve Ramirez, Larry Ribstein, John Rust, Scott Stern, and Joshua Wright for helpful comments on an earlier draft.