Productivity, Focus and Property Rights

Abstract

We show the scope of the firm is determined by three parameters: the relationships between assets at the margin (whether the assets are complementary or substitutes at the margin), the marginal productivity of the agents with their asset, and the focus effect (when assets are substitutes at the margin, focusing on fewer assets increases the incentives of the agents). In the Property Right Theory of Grossman, Hart and Moore (Grossman and Hart, Journal of Political Economy, 1986, and Hart and Moore, Journal of Political Economy, 1990, hereafter GHM), ownership of an asset provides “residual rights of control.” This can improve the ex-post bargaining power of the owner and, thus, creates ex-ante incentives to invest. Therefore, ownership provides incentives. But, why should asset ownership be so central to the production activity? After all, most productive agents in an economy do not own assets and most asset owners (shareholders) do not produce. In this paper, we view property rights as the privilege to access (or use) an asset and the ability to exclude (veto) others from using it. Ownership of an asset is defined as having both of these benefits. Under GHM, ownership provides control. Integrating Rajan and Zingales’ (RZ) intuition that access provides power (Quarterly Journal of Economics, 1998), we define control over an asset as access, provided that no one else has veto. In this conception (compatible with both GHM’s and RZ’s intuitions), access gives control and veto removes control from the other agents. This allows for a more general view of the idea of control of an asset, thereby expanding the set of available contracts. Applying the framework developed by Hart and Moore (1990), we highlight the specific roles access and veto can take to mitigate inefficiencies in ex-ante investment. Complementarity or substitution between assets at the margin, marginal productivity of the agents with their asset, and the focus effect determine the optimal allocation of access and veto and, hence, the scope of the firm. Thus, we rationalize many observed governance structures. Outside ownership, joint ownership, partnerships, hybrid governance structures can all be optimal. Int Adv Econ Res (2008) 14:352 DOI 10.1007/s11294-008-9159-6