Manual Property Rights, Economics and the Environment: 5 (The Economics of Legal Relationships)

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In modern firms, human capital is more mobile, but specialized human investments have greater value in the existing employment relationship than in alternative uses. In this view, Blair , p. Employees accept their dependent relationship, even if they know that they will also be engaged in real economic inertia that limits their reemployability because they could get a promotion, rent and more power see section 4.

In human capital intensive firms, the opportunity given by property rights is often proposed employee shareholding plan. Participation in management, like in Japanese or German firms see Charny, , seems to be an informal and nonlegal mechanism for creating a collective social identity. There, labor management interacts with corporate governance Damiani, As a consequence, cohesion of the group cannot be analyzed separately from corporate governance.

Therefore, norms, corporate culture, organizational goals and social relationships have to be taken into consideration see Rajan and Wulf, At the same time, the physical assets have become less important to value creation when compared with human assets and intangible assets. The maximization of shareholder value no longer leads to the maximization of the value of the firm in a knowledge-based economy that is not strictly based on market prices.

The main limit of the nexus of contracts model is indeed focused on the distribution of the surplus and is not about the creation of value. Such a perspective necessarily leads one to analyze inalienable assets, such as human and intangible assets, separately from the corporate governance. Yet, a crucial feature of the modern firm is to be linked to a dynamically changing environment that needs to implement organizational structures based on intangible and distinctive assets.

These assets, which are neither physical nor financial, appear to be a source of sustainable advantage in the economic value creation process at both the micro- and macroeconomic levels. For example, Commons , p. Certain types of assets can be the object of property rights, such as with intellectual property rights for patents, trademarks, designs and copyrights.

Intellectual property rights have a market value and are elements of goodwill 6. Other intangible assets, which are embedded either in social and relational capital 7 or in the organizational capital 8 of the firm, cannot be the objects of contracts or traditional property rights enforced by the law Mahoney, Asher and Mahoney, Intangible assets are idiosyncratic to the firm and are difficult to be materialized and measured. Thus, they cannot be clearly enforced by property law.

  1. The law and economics of the modern firm: a new governance structure of power relationships.
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The concept of ownership does not apply to things like loyalty or friendship. That is why some economists prefer using the term of implicit or relational contracts as a means of shaping decisions. In other words, complementarities mean the whole system is worth more than the sum of its parts and members see Baron and Kreps, These complementary effects are based on firm-specific information, knowledge and personal networks. The aim of the management is to protect the integrity and the durability of the whole corporate entity by considering these cognitive and relational elements. Essential legal principles, particularly contract and ownership, can only link shareholders and tangible assets to the firm, whereas complementarities can economically link stakeholders and intangible assets to the firm.

One of the more crucial questions is about the value of intangible capital. Intangible assets are not marketable and seem to be far from the efficient market hypothesis. Furthermore, the development of intangible assets needs important resources that should be provided by shareholders. However, such investments are risky, which is due to their irreversibility. Because of this growing part of intangible assets, links between vertically autonomous firms have been strengthened to both share risks and access to technological and industrial complementarities.

However, these new trends in the industrial world have led firms to inter-firm cooperation. The developments of these inter-firm relationships have taken two distinct directions: Horizontal cooperation takes place between competing firms whereas vertical cooperation takes place between different firms positioned along a single supply chain. In addition, in terms of diversification, large conglomerates dominated the industrial landscape. However, changes in the last decades have led to the break-up of the conglomerate firm and a movement toward vertical disintegration.

This movement is explained by the weakening of the control of the outsiders who own the physical capital. This trend towards vertical disintegration results in a qualitative and quantitative transformation of inter-firm relationships that leads firms to concentrate on their core businesses. This leads to the claim that firms should concentrate on the activities for which they are the best suited for and outsource the activities that are far from their core competencies Bettis, Bradley and Hamel, Thus, the governance of the modern firm should incorporate new institutional agreements such as the development of trust and long term relationships with subcontracting suppliers that secure the component quality, just-in-time management and flexible responses to the changing market conditions.

However, owing to the movement toward vertical disintegration and the development of complex productive systems, definitions of the firm and analyses of its boundaries based exclusively on asset property rights are no longer sufficient. Vertical, inter-firm cooperation processes that have profoundly affected the relationships between legally independent economic entities and the so-called network-firms are the best evidence of this tendency. Firms are vertically integrated without recourse to equity ownership. This complex economic organization is based on some form of control that exists independently of the subscription of the employment contracts and from the integration of vertical ownership.

First, the partners of a network-firm are situated either upstream or downstream in the supply chain. Second, the internal architecture of the network-firm is structured in a pyramidal form composed by two, three or more levels that are coordinated by the hub-firm, which implies a significant delegation of responsibility.

Third, most of the exchanged products in the network-firm do not pre-exist the market transaction. Fourth, the network-firm is built on narrow links between different firms that are economically interdependent, owing to the complementarity and the difficult orchestration of their specific resources. Therefore, the inclusion of such relational consideration needs to go hand in hand with a reconsideration of the traditional corporate governance. Precisely, corporate governance should be based on a new model of power relationships that are derived from other sources than asset ownership.

Such a perspective needs to supplement the more orthodox legal and economic theories of the firm. Such changes can be observed through the lens of power relationships. The concept of power is at the heart of the corporate governance issue. In addition, it appears that the modern firm coincides with the vanishing hand of management see Langlois, , which results in the redistribution of the power between the individual entities. The corporate governance of the modern firm should fulfill two requirements: The former refers to the structure of intra-firm power, and the latter refers to the structure of inter-firm power.

Consequently, they cannot appreciate the role of power in the creation and sharing of cooperative rent. In contrast, some economists are opposed to the neo-classical dismissal of power and have shown that power is a socioeconomic fact of the real world. From this perspective, power can be considered as a unit of analysis useful for understanding the capitalist system and the firms that make it functional and durable. To Galbraith , it is inaccurate to isolate the economics from the real world by avoiding any discussion of power and by refusing to consider economics in the context of the political sciences.

In this view, nonorthodox economists analyze power in economics independently of contractual considerations and this viewpoint differs significantly from the orthodox view of market power. Power relationships appear crucial as soon as one considers the production process and its associated industrial relationships.


If contracts were complete, power would not exist. Consequently, power is more a manifestation of inefficiency as opposed to a source of efficiency Williamson, This phenomenon explains the denial of power concept in the economics of the firm. However, power can be resurrected in economics under the condition that theorists reconsider the positive relationship between power and the productive efficiency of the modern firm.

This assertion comes from the fact that power, as a vehicle of collective cohesion, leads to cooperation. Similarly, Bierstedt , p. This is one of the main questions of the theory of the firm. First, the ownership of man by a man is impossible without allowing slavery. One cannot force employees to cooperate. But, the employment contract formally gives an existence to the employer-employee subordination. But, does this mean that power stricto sensu is not present in the employment relationship? The law simply recognizes it. Besides, subordination is a latent decision in the allocation of tasks.

Authority refers to a mutual arrangement that stops when the contract expires Palermo, Power happens when authority vanishes. Power emerges in situations of confrontation that are the result of insubordination in the Foucaldian philosophy see Foucault, In this view, power is, by nature, different from authority, which is the institutionalization of power and a distinct moment in the power process. This authority is necessarily unique, whereas power can be observed in each relational node. Formal authority that results from an employment contract matters in the firm because it is an important source of cooperation that establishes an ontological distinction between the firm and the market devoid of any authority Williamson, However, authority is not exclusive but coexists naturally with different powers in the modern firm.

Thus, it seems interesting to propose a typology, which takes into account the two sources of power that are different from authority. The first, called de jure , comes from the legal system of private property that confers the right to exclude discharge. It is because entity A can deprive entity B of its work, which B has valuable competences such that A has de jure power over B see Grosmann and Hart, Ownership is a formal resource. This argument is close to the Marxian theory. Most of time, only the employer or top managers have this resource and the right of exclusion is delegated by sovereign shareholders.

However, the structural transformations described previously have significantly tempered the impact of this argument. The second, called de facto power, does not strictly result from contractual and legal mechanisms but from an informal device: It is because B is involved in an employment contract and invests in human capital that B has access to the key resources of the collective entity controlled by A, and therefore, B has de facto power over A.

The vehicle of power is the specialization of human capital that is at the heart of resource interdependence. The employees who are specialized get control over a new critical resource: This new critical resource gives them a part of the power. De facto power is in the hands of the employer and his corporate executives as well as in the hands of the employees because each of them participates in the intra-firm knowledge-creating process.

The industrial evolutions mentioned in the previous section have made the de facto power greater. This singular approach to the incomplete contract economic theory has the merit to bring aspects of the organization theory to the theory of the firm see Chassagnon, b. Even though the definitions of power and the firm are not suitable, and their recognition of the legal and social nature of the firm is insufficient, these authors have come in from the cold on the concept of power to place it in a nonneoclassical view of the firm.

This form of power is a direct result of the development of inalienable assets. The starting point is that employees do not have resources other than their specific human capital in capitalist firms, so they must be indispensable, productive and effective in order to obtain part of the power. It is economically more efficient to grant employees access to the critical resources of the collective entity rather than to confer to them property rights on these resources.

Indeed, ownership seems to be less efficient than access because ownership has adverse effects on the incentives to specialize and prevent from exclusion. From this argument, Rajan and Zingales concluded that ownership must be held by a third party. A large part of the shareholders do not directly participate in the production process, and ownership must be given to the shareholders see Zingales, Thus, capitalism is source of power, but the traditional relationship between ownership and power is no longer exclusive. It is not ownership, but the absence of ownership of productive assets that gives employees de facto power by inciting them to specialize and invest in human capital.

Consequently, the more an organization is based on specific human capital, the less power the employer and his executive team have over the employees Zald, — so long as the relational resources are inalienable. This argument weakens the role of the ownership in the definition of the firm. Thus, it is necessary to add that the development of the knowledge-based economy is sustainable only if employees, who have intellectual resources, become identified with the firm and are loyal Alvesson, In such a context, the internal governance of the modern firm is based ex post on the threefold relationship between formal authority of Williamson , de jure power of Grosmann, Hart and Moore and de facto power of Rajan and Zingales , as shown in Figure 1.

Finally, the internal governance of the modern firm is based on widespread forms of power that tend to reduce the role of ownership and outside shareholders in corporate governance, as the development of outsourcing practices and inter-firm networks do as well. The different sources of power in the intra-firm cooperation process. The main consequence of this outsourcing is to make two distinct models of how power relationships exist.

Indeed, the origins of power are different within and between firms. It was shown that intra-firm governance rests on formal and informal mechanisms that are linked with authority and power. However, at the inter-firm level, there are no employment contracts that regulate the subordinate relationship between order taker and order maker. Power no longer coexists with authority.

Even though member firms of the network-organization are not integrated into the same legal structure, the legal contractual autonomy does not imply that the different parties have equal economic power Sacchetti and Sugden, In an employment relationship, the transfer of power is held in its legal definition, whereas in an inter-firm relationship, it is the economic dependence that is at the origin of this power.

Yet, inter-firm network actors are interrelated in the interdependent activities of a single social system, which are identifiable but not recognized by the law labor law, commercial law, or corporate law. Masten identified the aspects that distinguish the firm from the market by comparing employment law and commercial contract law. He sought to establish whether any rights or authority of the employer can be replicated in commercial contracts, that is, between legally autonomous firms. His main conclusion was that the law does not invariably treat commercial transactions and employment relationships.

In other words, a firm cannot legally aspire to a formal authority on the employees of its subcontractors. Therefore, authority, which is a formal vehicle of cooperation within firms, is not present in inter-firm relationships. Similarly, de jure power that results from the ownership of assets is not a characteristic of inter-firm governance. Power does not work in the same way within and between firms. Only de facto power that results from resource dependence is a source of coordination. The main difference lies in the fact that trust, which results from the distribution of power, makes inter-firm networks relational organizations Powell, The coordination of intra-network activities is not strictly contractual but depends on the relational aspects as well.

Relational interdependence promotes incentives for long-term cooperation and palliates the absence of formalized control systems of authority Uzzi, If one of the more important properties of hierarchy is to complete employment contracts by instituting a regulatory authority, one of the more important properties of inter-firm relationships is to complete buy-sell contracts by establishing a relational governance that distributes power.

The integration of the entire inter-firm network is not based on formal contracts or on a specific allocation of property rights but is based on power relationships. The property rights law no longer seems to be suitable for the explanation of the inter-firm diffusion of power. To strengthen this argument, it is interesting to focus on the network-firm that does not involve capital participation.

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The analysis of the relationship of power in the network-firm reveals the absence of any legal basis for professional subordination. There is no authority in the network-firm. There are only contractual obligations, which regulate the enforcement of commercial commitments that come from the subcontracting relationship. Consequently, the network-firm is directly based on power but strictly devoid of authority see Table 2. This complex organization is an extended and growing form of the modern firm based on a small part of intangible assets and specific human capital that goes beyond its legal boundaries.

The production of a specific good or service is vertically fragmented and is made by cooperating firms, often of different nationalities. The hub-firm conceals an ordering power on its subcontractors that is justifiable by its key strategic role in the coordination of the whole network. However, power is not unilaterally distributed in the network-firm. Due to the dependence between the members of a network, power is more widely dispersed and accrues to key actors having made specific investments around a critical resource of the network-firm.

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The complementarity effects are significant in the network-firm. Each legal entity of the network is in a situation of economic dependence with the other, which requires compliance between the actors. The respective attributes of internal and external governances. The different legal entities employees dedicate their key resources to the hub-firm employer and participate to the knowledge-creating process of the entire inter-firm network firm stricto sensu.

The hub-firm initially grants the selected network partners the possibility to put their own resources into the collective entity and to develop the resources of the whole network. The hub-firm allows each individual entity to acquire a part of the power. The exploitation of de facto power is at the origin of the emergence of the network-firm and strengthens its integrity. The term, contract, needs to be used with caution in the analysis of the network-firm so as to not distort the legal nature of the modern firm.

Legally autonomous entities are integrated and coordinated by the controlling and ordering power of the hub-firm that does not originate in explicit contracts but in organization itself.

Property Rights Explained In 10 Minutes

If economic relations take place between legally distinct firms, the firms of the network seem to form together and draw the economic boundaries of a single entity. The economic perimeter of the network-firm transcends the legal boundaries of the firm stricto sensu. Under these aspects, the modern firm extends the boundaries of corporate governance.

Thus, the emergence of the network-firm, particularly in the form of the modern firm, appears to be based on a legal incompleteness as this complex organization goes beyond the legal rights and duties that result from equity ownership and employment contracts. The core features of the modern firm and its associated power structure have important policy implications. The law and economics of the modern firm have highlighted the legal incompleteness that surrounds the emergence of this complex institution of the new capitalism.

The private sphere takes place in the globalized context where public regulation is deemed to be a barrier to progress of the business. However, the current crisis seems to claim for the intervention of the State in economic governance in some circumstances, as is the case for the regulation of financial markets. More clearly, this claims for global worldwide governance in response to economic, social and environmental imperatives. There are urgent needs in the economics of the firm that imply moving toward some new protective rules provided by the law Chassagnon, a.

The two main questions that should be raised are 1 who is the employer and who are the employees of the modern firm? In more general terms, the recent trend toward outsourcing productive modules places the employment relationship beyond the range of employment protection laws Collins, , and the question becomes the following: What is sure is that the development of complex economic organizations, where there are multiple employers, has significant implications for both the legal and the socially constituted nature of the employment relationship Rubery et al.

The relationship between employment and security has to be reassessed because of the unclear line between the de jure employer and the de facto employer. In the modern firm, some employees work for different legally recognized entities. Again, the question becomes the following: There are no de jure sources of liability without equity ownership. However, the law needs to be reconsidered in regard to modern organizations that have become a complex and multilevel phenomenon for lawyers and economists.

Hansmann and Kraakman have explained that disaggregate organizations raise the problem of capital boundaries because the networks benefit from the power to manipulate the capital boundaries in order to reduce or eliminate any potential legal liabilities. There are often plenty of small legal units that are economically linked to the modern firm, which leads one to question whether the whole entity or the legal individual entity should be the relevant unit of analysis.

In this view, because the modern firm is an integrated functional economic unit, it must also be a liability unit. It seems evident that the firm should be bound by the perimeter of its economic and social responsibilities. Firms are institutions of capitalism whose main purpose is to serve social and human needs. Thus, Roberts , p. A growing amount of managerial literature is dedicated to the analysis of CSR.

It has been proposed by Ronald Coase that clearly defining and assigning property rights would resolve environmental problems by internalizing externalities and relying on incentives of private owners to conserve resources for the future. At common law nuisance and tort law allows adjacent property holders to seek compensation when individual actions diminish the air and water quality for adjacent landowners. Critics of this view argue that this assumes that it is possible to internalize all environmental benefits, that owners will have perfect information, that scale economies are manageable, transaction costs are bearable, and that legal frameworks operate efficiently.

In researchers [12] produced an annotated bibliography on the property rights literature concerned with two principal outcomes: They found that better protection of property rights can affect several development outcomes, including better management of natural resources. Despite the overwhelming evidence on the economic relevance of property rights however, only recently economists have begun to study their determinants by looking at the trade-off between the dispersed coercive power in a state of anarchy and the predation by a central authority.

To illustrate, incomplete property rights allow agents with valuation lower than that of the original owners of economic value to inefficiently expropriate them distorting in this way their investment and effort exertion decisions.

When instead, the state is entrusted the power to protect property, it might directly expropriate private parties if not sufficiently constrained by an efficient political process. Carmine Guerriero blends these two different strands of literature by linking property rights protection, transaction costs, and preference heterogeneity.

When the protection of property is weak instead, low-valuation potential buyers inefficiently expropriate original owners. Hence, a rise in the heterogeneity of the potential buyers' valuations makes inefficient expropriation by low-valuation potential buyers be more important from a social welfare point of view than inefficient exclusion from trade and so induces stronger property rights. Crucially, this prediction survives even after considering production and investment activities and it is consistent with a novel dataset on the rules on the acquisition of ownership through adverse possession and on the use of government takings to transfer real property from a private party to another private party prevailing in jurisdictions.

To capture preference diversity, the author uses the contemporary genetic diversity, which is a primitive metric of the genealogical distance between populations with a common ancestor and so of the differences in characteristics transmitted across generations, such as preferences.

Evidence from several different identification strategies suggests that this relationship is indeed causal. The property rights approach to the theory of the firm based on the incomplete contracting paradigm was developed by Sanford Grossman , Oliver Hart , and John Moore. There will be renegotiations in the future, so parties have insufficient investment incentives since they will only get a fraction of the investment's return in future negotiations ; i. Hence, property rights matter, because they determine who has control over future decisions if no agreement will be reached.

In other words, property rights determine the parties' future bargaining positions while their bargaining powers, i. Yet, it has also been applied in various other frameworks such as public good provision and privatization. For instance, some authors have studied different bargaining solutions, [22] [23] while other authors have studied the role of asymmetric information.

Classical economists such as Adam Smith and Karl Marx generally recognize the importance of property rights in the process of economic development, and modern mainstream economics agree with such a recognition. The lack of protection for property rights provided little incentive for landowners and merchants to invest in land, physical or human capital, or technology.

After the English Civil War of and the Glorious Revolution of , shifts of political power away from the Stuart monarchs led to the strengthening of property rights of both land and capital owners. Consequently, rapid economic development took place, setting the stage for Industrial Revolution.

Property rights are also believed to lower transaction costs by providing an efficient resolution for conflicts over scarce resources. Property rights might be closely related to the evolution of political order, due to their protections of an individual's claims on economic rents. Particularly, the legal and political systems that protect elites' claims on rent revenues form the basis of the so-called "limited access order", in which non-elites are denied access to political power and economic privileges.

Universal property rights, along with impersonal economic and political competition, downplay the role of rent-seeking and instead favor innovations and productive activities in a modern economy. From Wikipedia, the free encyclopedia. Part of a series on Economics A supply and demand diagram, illustrating the effects of an increase in demand.

History of economics Schools of economics Mainstream economics Heterodox economics Economic methodology Economic theory Political economy Microeconomics Macroeconomics International economics Applied economics Mathematical economics Econometrics. Economic systems Economic growth Market National accounting Experimental economics Computational economics Game theory Operations research. Alienation property law Bundle of rights Common ownership Commons Economic system Intellectual property Land tenure Land titling Law and economics Means of production Natural and legal rights Open-access Personal property Public property Private property Property income Right to property Social ownership State ownership Taxation as theft.

A property right is a socially enforced right to select uses of an economic good. Concise Encyclopedia of Economics 2nd ed. Library of Economics and Liberty. Archived from the original on Economic behavior and institutions.

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A Bundle of Rights? Prologue to the Symposium. Explicit use of et al. Journal of Law and Economics. What are Transaction Costs?