We argue that long-term debt has a role in controlling management's ability to finance future investments. Companies with high (widely held) debt will find it hard to raise capital, since new security-holders will have low priority relative to existing creditors; conversely for companies with low debt. We show that there is an optimal debt--equity ratio and mix of senior and junior debt if management undertakes unprofitable as well as profitable investments. We derive conditions under which equity and a single class of senior long-term debt work as well as more complex contracts for controlling investment behavior.

In this review, I describe how economists have moved beyond the firm as a black box to incorporate incentives, internal organization, and firm boundaries. I then turn to the way that the theory of the firm is treated in Daniel Spulber's book The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations. Spulber's goal is to explain why firms exist, how they are established, and what they contribute to the economy. To accomplish this, Spulber defines a firm to be a transaction institution whose objectives differ from those of its owners. For Spulber, this separation is the key difference between the firm and direct exchange between consumers. I raise questions about whether this is a useful basis for a theory of the firm.

This paper discusses how economists' views of firms' financial structure decisions have evolved from treating firms' profitability as given; to acknowledging that managerial actions affect profitability; to recognizing that firm value depends on the allocation of decision or control rights. The paper argues that the decision or control rights approach is useful, even though it is at an early stage of development, and that the approach has some empirical content: it can throw light on the structure of venture capital contracts and the reasons for the diversity of claims.

This paper provides a framework for addressing the question of when transactions should be carried out within a firm and when through the market. Following Grossman and Hart, we identify a firm with the assets that its owners control. We argue that the crucial difference for party 1 between owning a firm (integration) and contracting for a service from another party 2 who owns this firm (nonintegration) is that, under integration, party 1 can selectively fire the workers of the firm (including party 2), whereas under nonintegration he can "fire" (i.e., stop dealing with) only the entire firm: the combination of party 2, the workers, and the firm's assets. We use this idea to study how changes in ownership affect the incentives of employees as well as those of owner-managers. Our framework is broad enough to encompass more general control structures than simple ownership: for example, partnerships and worker and consumer cooperatives all emerge as speical cases.

We study two parties who desire a smooth trading relationship under conditions of value and cost uncertainty. A contract fixing price works well in normal times because there is nothing to argue about. However, when value or cost is unusually high or low, one party will deviate from the contract and hold up the other party, causing deadweight losses as parties withhold cooperation. We show that allocating asset ownership and indexing contracts can reduce the incentives to engage in hold-up. In contrast to much of the literature, the driving force in our model is payoff uncertainty, rather than noncontractible investments.

A recent literature has shown that asymmetric information about a firm's profitability does not by itself explain strikes of substantial length if the firm and workers can bargain very frequently without commitment. In this paper we show that substantial strikes are possible if (a) there is a small (but not insignificant) delay between offers; and (b) a strike-bound firm may experience a decline in profitability after a certain point. A brief discussion of the ability of the theory to explain the data on strikes is included.

The recent literature on “the reappraisal of Keynes” has viewed Keynesian equilibria as arising when prices are fixed and effective demands and supplies are equilibrated through the adjustment of quantities. One problem with this approach is that it lacks a theory of price determination—in particular, of why prices are fixed. In the present paper, we show that a number of Keynesian features arise in a model in which prices are fully flexible, but where agents have some monopoly power. One advantage of this approach is that it provides a theory of the determination of both prices and quantities.

This paper develops a model of "large group" Chamberlinian monopolistic competition in which (1) there are many firms producing differentiated commodities, (2) each firm is negligible in that it can ignore its impact on, and hence reactions from, other firms; (3) free entry leads to zero profit of operating firms; but (4) each firm faces a downward-sloping demand curve. The existence of a monopolistically competitive equilibrium is established. In a companion paper, more particular questions such as whether the market provides too many or too few products are addressed for a special case of the model.

The Review of Economic Studies has instituted a new series of lectures to be given annually by a "younger" British economist at the Association of University Teachers of Economics Meetings. The choice of lecturer is determined by a panel whose members are currently Professors Hahn, Mirrlees and Nobay. This paper is a revised version of the first lecture in the series. It was presented at the AUTE Meeting held at the University of Surrey in April 1982, and was refereed in the usual way.—MAK.