A constitutional interpretation of the firm

When members of a firm make firm-specific investments they will earn rents. Potential rent-seeking on the part of the owner of the firm and other employees reduces the value of an employee's firm-specific investment and, as a result, reduces the level of those investments. In this context the firm can be thought of as a set of interdependent relationships where the actions of any one individual can affect the rents of all others. The owner of the firm will desire to set up an institutional arrangement to protect the individual's property rights in specific investments as part of his effort to maximize profit. Establishing this institutional arrangement is similar to the establishment of a constitution by the state or other organization. This constitution protects the property rights of the members of the firm and as a result encourages the creation of property, that is, the firm-specific investments. The constitution of a firm consists of a set of interdependent explicit and implicit contracts between the firm and its various members, as well as mechanisms for enforcing and monitoring these contracts. As a practical matter, it is obvious that workers normally do not enjoy costless or near-costless mobility, and thus an ordinary “at will” employment contract may no longer be sufficient to induce workers to join a firm. If, in order to function productively within an enterprise, individuals have to accumulate, and pay for, firm-specific capital assets, the simple neoclasical logic fails (Furubotn, 1988: 167).