Chapter

The Property Rights Approach

Oliver Hart

in Firms, Contracts, and Financial Structure

Published in print October 1995 | ISBN: 9780198288817
Published online November 2003 | e-ISBN: 9780191596353 | DOI: http://dx.doi.org/10.1093/0198288816.003.0003

Series: Clarendon Lectures in Economics

 The Property Rights Approach

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The neoclassical, principal‐agent and transaction costs theories cannot by themselves explain firm boundaries. This chapter describes a theory—the incomplete contracting or property rights approach—based on the idea that power and control matter when contracts are incomplete. If the terms of a transaction can always be renegotiated, the incentives of a party to undertake relationship‐specific investments will depend crucially on the ability to control the use of productive assets when renegotiation takes place (the hold‐up problem). In this context, asset ownership becomes an essential source of power and different ownership structures will affect the severity of the hold‐up problem. The author presents a model that illustrates the benefits and costs of integration. In the absence of wealth constraints, firm boundaries are chosen to allocate power optimally among the parties to a transaction. An implication of the theory is that, ceteris paribus, a party is more likely to own an asset if he or she has an important investment decision. The theory also predicts that complementarities make integration more likely and, conversely, that independent assets should be owned separately. Finally, the author considers whether the theory's predictions actually match up with observed organizational arrangements.

Keywords: bargaining power; control; hold‐up problem; incentives; incomplete contracts; investment; ownership structure; property rights; renegotiation

Chapter.  11523 words.  Illustrated.

Subjects: Financial Markets

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