Reconsider the Question That Why the Firm Exists

It is one of my unpublished papers below.

Reconsider the Question That Why the Firm Exists

Yandong Xiao*

This paper addresses the question that why the firm exists in a rigorous and fundamental manner. It also provides a clear perspective to find the answer.

                                                   I. Coase’s Misleading Argument

Despite the emergence of different versions of firm theories in the past 70 years, the basic question that why the firm exists remains hard to answer. The most well-known paper interpreting why the firm exists may be the one written by Ronald Coase, The Nature of the Firm, which was published in 1937. In this paper, Coase contributed the primary factor determining the existence of the firm to transaction cost, a new concept conceived by him. However, he started out his argument by coming up with some non-primary factors in his own view and then excluded them to reach his conclusion that transaction cost should be the primary factor. No convincing evidence has been provided in his argument that transaction cost is a necessary and sufficient determinant to the existence of the firm.

Furthermore, the concept of transaction cost is extremely ambiguous in that of Coase’s paper (See Coase 1937). Though some important testable implications of the concept (See Williamson 1979, 1985) had been developed by Oliver Williamson a few decades later, the issue that whether transaction cost is a necessary and sufficient determinant to the existence of the firmstill needs to be verified. 

                                                 II. Is There Any Primary Factor?

The problem that whether some primary factor is a necessary and sufficient determinant to the existence of the firm matters much. We firstly take those necessary factors into account. It is not difficult to propose a great many factors. For example, we can ask that whether the firm would still emerge if everyone in the world used to have the same amount of wealth denoted by some specific currency. If everyone had possessed the same amount of money, who would have been employed? If nobody had been employed, how could the firm exist? The apparent disadvantage of most of employees that they had less money leads to our consideration that the difference in wealth may be a necessary factor to the emergence of the firm.

Further, if everyone has had the identical ability on each job involved in any process of production, could the firm emerge? In this circumstance, who should be the manager or worker in the firm? Or there would be no manager and worker? Can the firm coordinate successfully the human resources within it? It is believable that division of labor becomes a tricky issue if everyone has had the same ability. Consequently, we may also consider the difference of ability among employees as a necessary factor to the existence of the firm.

A more interesting example is to ask whether the firm would exist if market trade had been forbidden. If market trade had been forbidden, how could the firm obtain its materials to make their products? Even though they had solved the material supplying problem, who would buy their products? Responding to these issues, it is reasonable to conclude that the permission of market trade is a necessary factor to the existence of the firm.

It is natural to further discuss if there exists any primary necessary factor. Can we single out one factor from the three above factors to be primary? The most probable answer is we are not eloquent enough to select any of them or to propose some other unmentioned factor as a primary necessary factor.

We now turn to discuss those sufficient factors to the existence of the firm. Can transaction cost be a primary sufficient factor to determine whether the firm exists or not? Unfortunately, we find all the proponents of the concept of transaction cost implicitly assume the existence of the firm to expand their arguments (See, e.g., Coase 1937, Williamson 1979, 1985, Cheung 1983). Before a firm exists, we are unable to compare the effectiveness of those inputs integrated within the firm to they are coordinated by the market, because we cannot predict in what manner that the firm as a whole will act. In fact, the concept of transaction cost is always applied to explain the existence of those existing or ever-existed firms. It fails to predict the emergence of any completely new firm advanced by the developing market environment.

In another respect, can contract, property right, reputation or power to be a primary sufficient factor determining the existence of the firm (See, e.g., Alchian and Demsetz 1972, Hart 1995, Rajan and Zingales 1998)? We should admit that these factors are to some extent relevant to the advantages of the firm. But since they all widely influenced human societies before the emergence of the firm, it is hard to believe they are sufficient enough to independently bring about the emergence of the firm.

Regard the above reasoning, we find it is also unlikely to specify some known factor as a primary sufficient factor. Together with the previous reason that no primary necessary factor has been persuasively selected, we sum up to our conclusion that no primary factor has been found necessary and sufficient enough to cause the existence of the firm.

                                        III. A Distinction Between Two Concepts

None of the prevailing firm theories carefully distinguishes the concept of the emergence of the firm from that of the existence of the firm. The former is usually associated with historical facts while the latter, without any time restriction, points directly to general principles. More often than not, it is much harder to deal with the latter than the former. In the above section, we tended to somehow avoid putting our discussion under the background of the concept of existence of the firm. For instance, it is unclear to decide if everyone in the world has had the same amount of wealth then the firm would not exist. Nevertheless, we are more confident to say the firm may not emerge in the past if everyone in the world used to have the same amount of wealth. To precisely address the concept of the existence of the firm, we need to clarify which “firm” definition we take.

                                     IV. A Clear Perspective to Find the Answer

The most significant thing ignored by all the current firm theories is to follow a clear and broad definition of firm to organize their evidences and theoretical arguments. Definitely, these firm theories sound plausible once they restrict the domain of the definition of firm to a narrow scope. However, the most widely acceptable identification for a firm should be to regard it as a profit-oriented organization. Under this definition, it becomes clear that the intersection set of determinants which determine both the existence of profit-oriented behavior and the existence of an organization is what we seek for solving our question that why the firm exists.


Alchian, Armen A., and Harold Demsetz, 1972. “Production, Information Costs and Economic Organization”, American Economic Review, 62(50): 777-795.

Bolton, Patrick, and Mathias Dewatripont, 1994. “The Firm as a Communication Network”, Quarterly Journal of Economics, 115: 809-839.

Cantwell, John and Felicia Fei, 1999. “Firm as the Source of Innovation and Growth: the Evolution of Technological Competence”, Journal of Evolutionary Economics, 9: 331-366.

Coase, Ronald, 1937. “The Nature of the Firm”, Economica, 4: 386-405.

Cheung, Steven, 1983. “The Contractual Nature of the Firm”, Journal of Law and Economics, 26: 1-21.

Conner, Kathleen and C. K. Prahalad, 1996. “Resource-based Theory of the Firm”, Organization Science, 7: 477-501.

Dow, Gregory K., 1993. “Why Capital Hires Labor: A Bargaining Perspective”, American Economic Review, 83: 118-134.

Foss, Nicolai J., 1999. “The Theory of the Firm: an Introduction to Themes and Contributions”, Theories of Firm: Critical Perspectives in Economic Organization,London: Routledge.

Grossman, Sanford, and Oliver Hart, 1986. “The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration”, Journal of Political Economy, 94: 691-719.

Hart, Oliver, 1995. Firm, Contract and Financial Structure, Oxford University Press.

Hart, Oliver and John Moore, 1990. “Property Rights and Nature of the Firm”, Journal of Political Economy, 98(6): 1119-1158.

Holmstrom, Bengt and Paul Milgrom, 1994. “The Firm as an Incentive System”, American Economic Review, 84(4): 927-991.

Jensen, Michael and William Meckling, 1976. “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure”, Journal of Financial Economics, 3:305-360.

Rajan, Raghuram G., and Luigi Zingales, 1998. “Power in a Theory of the Firm”, Quarterly Journal of Economics, 2:387-432.

Williamson, Oliver E., 1979. “Transaction-Cost Economics: The Governance of Contractual Relations”, Journal of Law and Economics, 22(2): 233-261.

______, 1985. The Economic Institute of Capitalism, New York: Free Press.

*E-mail address: 

| Leave a comment

Why I Do Academic Research?


(1) 从事学术研究可能让我流芳百世并被许多人崇拜;

(2) 我对学术问题有强烈的好奇心;

(3) 学术问题充满挑战性,研究它们可能让我对被研究对象甚至周围的世界产生全新的理解;

(4) 我的学术研究可能给许多人带来益处。






| Leave a comment

An Insightful Perspective on Natural Numbers

Consider the Axioms 2.1-2.4 of the Peano Axioms:

Axiom 2.1. 0 is a natural number.

Axiom 2.2. If n is a natural number, then n++ is also a natural number.

Axiom 2.3. 0 is not the successor of any natural number; i.e., we have n++ ≠ 0 for every natural number n.

Axiom 2.4. Different natural numbers must have different successors; i.e., if n, m are natural numbers and n ≠ m, then n++ ≠ m++. Equivalently, if n++ = m++, then we must have n = m.

If we start from the number“0” to create a series of natural numbers, it is simple to find that any of these natural numbers can be represented completely by no more than three basic symbols, “0”, “( )” and “++”. However, assuming the above four axioms, there still exist at least two possibilities to create natural numbers.

(i) One way to create is by defining a symbol such as“0.5”, “1.1”, or “⊙” to be a natural number which distinguishes from any natural number denoted by “0”, “( )” and “++”. We can test the fact that the Axioms 2.1-2.4 still hold. First, the Axiom 2.1 certainly allow “0.5”, “1.1”, or “⊙” to be a natural number. Second, to make our new extended numbers compatible with the Axiom 2.2, we recursively define 0.5++ be the successor of 0.5, (0.5++)++ be the successor of 0.5++, and so forth. Also, we can replace 0.5 with 1.1 or ⊙ and proceed the same procedures. Regard the Axiom 2.3, we still set  n++ ≠ 0 for every n. Though it is not necessary, we can also define n++ ≠ 0.5, n++ ≠ 1.1, or n++ ≠ ⊙ for every n. The Axiom 2.4 doesn’t make any contradiction when we bring in “0.5”, “1.1” or “⊙” and their corresponding successors to be natural numbers. We should note that we have defined 0.5 ≠ 0 in the very beginning. Then, we can define 0.5++ ≠ 0++, (0.5++)++ ≠ (0++)++, etc. Thus, we still satisfy the requirement of the Axiom 2.4 that different natural numbers must have different successors. Similarly, we can define 1.1++ ≠ 0++, (1.1++)++ ≠ (0++)++, …; we can also define ⊙++ ≠ 0++, (⊙++)++ ≠ (0++)++, … . Hence, the new extended numbers would follow the Axiom 2.4. Further, we can define 0.5, 1.1 and ⊙ to be three different natural numbers. By similar procedures shown above,  we can define 1.1++ ≠ 0.5++, (1.1++)++ ≠ (0.5++)++, …, and ⊙++ ≠ 0.5++, (⊙++)++ ≠ (0.5++)++, …, and so forth.

(ii) One may define a different operation from increment to extend the natural number system. For instance, we can define a new operation such as “insert ⊙ forward”, then “⊙⊙”, “⊙⊙⊙”,… are also natural numbers. Similarly, we can define ⊙ ≠ ⊙⊙, ⊙⊙ ≠ ⊙⊙⊙, … .Through the same method shown in (i), we can create a new series of natural numbers from the start number such as  “⊙⊙” , “⊙⊙⊙”.

However, the Axiom 2.5 of the Peano Axioms excludes the above two possibilities (i) and (ii) to create unusual natural numbers. It sums up that only those numbers denoted by “0”, “( )” and “++” can legally be natural numbers.

Axiom 2.5. Let P(n) be any property pertaining to a natural number n. Suppose that P(0) is true, and suppose that whenever P(n) is true, P(n++) is also true. Then P(n) is true for every natural number n.


August 17, 2009

The key point of the correspondence was related to the hint of the Exercise 6.6.5  in one of Terry’s textbooks,  Analysis I. Courteously, he  had  thanked me for the correction of the hint in the following page.

(“— Errata for the second edition(hardback) —”  —>  “p. 151, Exercise 6.6.5”)

| Leave a comment

October 1, 2008

It was a private correspondence between the CEO of the China Merchants Securities and me. Thus, it is not allowed to copy, paste or quote anywhere else.

The key points of my letter can be seen from the following.




一、 市场拓展部



1. 专职和驻点经纪人的选拔与考核


目前招商证券对专职和驻点经纪人的选拔没有一个统一的规范流程,只是由营业部来自主决定程序。而作为营业部来说,不可能有足够强大的人力资源管理系统来对这种选拔流程做规范化的管理,所以在选拔的过程中,必掺杂了许多极主观的看法,片面看重应聘者的某些方面,而缺乏对其进行全面的评价。从营销的实践来看,一个优秀的职业经纪人至少具备以下三方面的特点:一是感兴趣或勤奋;二是有毅力;三是较突出的自学能力。对face to face营销感兴趣对其从事经纪业务是种不小的动力,而勤奋同样能促使其不断拓宽所能接触到的潜在客户及社会关系。有毅力对经纪人在克服从事营销初期待遇低、证券行情低迷而收入速减等困境及抵制其它行业或职业的诱惑方面极为重要。较突出的自学能力有助于其应对证券、基金、期货等从业资格考试,对提升其营销技能和专业知识方面更是必不可少的一种素质。在选拔人员时,学历是常见的考虑之一。就底线来说,能参加从业考试的必须是高中以上学历。就上线,一般限于本科。但重点本科毕业的人大多因自身、家庭、院校及其它关系网的寄望过高,有很大的心理包袱,一般不适合做基层的营销。但可以选拔其作为产品销售的精英小组成员,小组成员应给予比一般经纪人高的基本待遇。招商证券历来有产品(比如FOF)由营业部负责销售的传统,而各营业部却一直不从营销队伍中分离一个专门负责销售产品的精英小组。这是需要提升的,因为产品涉及的专业知识一般比较多,一般经纪人要跟客户解释清楚比较困难。

专职和驻点经纪人的业绩考核是更为重要的一个方面。目前招商证券的基本业绩考核是月新增3个有效户或40万资产。这种不变指标的缺陷在于不能充分反映市场行情对经纪业务的影响。当行情高涨时,这要求太松,经纪人感觉不到压力;当行情低迷时,这要求太高,经纪人感觉缺乏自信。而且也不能用于反映一个经纪人是否具备优秀职业经纪人的特点。市场行情对经纪业务的影响自然是反映在整个行业的经纪业务上。鉴于招商证券已是位列第七的券商,可以用同业前五名券商的平均月新增有效户或资产(注1) 作为参照。这样一来,事先没有特定的指标,鼓励以实力来从事营销。一般来说,一个具备以上提及三个特点的经纪人其月新增有效户或资产必能达到这一参照,如达不到,那问题极可能出在区域经理及营销总监等更高的管理层上。因为随意给经纪人换渠道网点或由驻点变成专职等类型转换都可能对经纪人的业绩造成很大影响。另外,如果这一参照难以或无法得到,那么可在招商证券内部按营业部所属地区建立类似的参照。在专职和驻点经纪人的考核中,还应注重其业绩指标的成长性。因为优秀的经纪人会在客户中逐渐声名远播,营销效果会事半功倍,反映在业绩上必是高成长性。对这类优秀的经纪人,招商证券应为其设立更好更高的平台。

2. 区域经理的选拔与考核



解决这一矛盾的有效方法是设置高级经纪人这一岗位。高级经纪人应享受与区域经理同等的基本待遇,并且独立于区域经理,直接归属营销总监管理。高级经纪人同样采用申请的形式,并应将其考核与一般经纪人的营销培训结合起来。高级经纪人作为经纪人中的优秀分子,在营销技能及专业知识的运用上必有值得学习的地方。在高级经纪人的考核中应加入营销案例演示的要求。比如考核自其提交申请书起三个月内,每两周做一次其营销经历中的案例演示,由营销总监和其他所有一般经纪人充当评委(注2) 。在业绩考核方面,也应要求比一般经纪人高的标准。



3. 营销总监或市场拓展部经理的选拔与考核





二、 客户服务部



三、 柜台业务部



四、 财务部、电脑部和经理室



五、 回顾


肖演东      写于2008年10月1日前

It was her reply below.

小肖;你好。很高兴看到你的这篇非常具有建设性的建议,公司需要更多的像你一样热爱公司,忠于事业,富有激情,肯动脑子,愿为公司发展献计献策的员工。我已把你的文章推荐给熊建涛总,我想他可能会找你聊一聊。同时我也把这篇文章转发给了公司分管研发工作的汤维清总及其他一些部门长。祝你工作愉快。 杨鶤






| Leave a comment

Jian Li Zhuan Ye Jing Ji Ren Dui Wu De Qi Dian

It had been published by the monthly of the China Merchants Securities in August, 2009.


深车公庙    肖演东    2009-7-28






| Leave a comment

Gang Yu Xing Jing Zheng Xu Zhu Yi San Dian

It had been published by Ta Kung Pao (a famous piece of newspaper in Hong Kong) on May 3, 2007.

港與星競爭須注意三點/ 蕭演東

















| Leave a comment