Why do corporations (firms) exist?

Economists used to wonder, from a theoretical perspective, why "firms" including companies, and especially large corporations, exist (aka theory of the firm). In 1937 Coase thought that while corporations didn't allocate labor and capitol as well as the market, this was offset by lower transaction costs.

Of course transactions costs in the net era are far less than in Coase's time, so this doesn't explain why corporations remain so entrenched.

This still seems like a valid question. Does knowledge work, in particular, scale all that well? Movies seem to be put together by loose coalitions of small to medium sized companies, why aren't more things done like that?

I suspect most people familiar with large corporations would agree that often the company seems much less than the sum of its parts. In particular, the absence of internal markets can make intra-company collaboration less efficient than market based collaboration. Corporations, on the inside, operate like the command economies of the Soviet Empire (or, for that matter, like today's China -- which is doing well for the moment).

I'm trying to put together a list of things that large corporations can do uniquely well. I wasn't at all impressed with the conventional "theory of the firm" list. Here's mine ...

1. Act without the restraints of antitrust law. A large corporation can do many things that would require collusion to be done by smaller entities.
2. Change laws, particularly accounting standards and tax laws, to favor large corporations and lower their cost of capitol. This creates a positive feedback loop where tax laws and accounting rules favor large corporations, which in turn influence laws and rules that favor large corporations and so on.
3. Corporations can buy senators and lesser politicians, again without collusion.
4. Corporations can engage in financial warfare, cutting off suppliers to smaller competitors, blocking access to capitol, and so on.
5. Corporations can capture regulators.
6. Corporations may be able to create and institute processes that allow them to do knowledge work with "average" knowledge workers instead of temperamental and expensive "stars". (I don't think this actually works, but a lot of effort is spent on this.)
7. Corporations can buy A and above ratings from (corrupt) rating agencies.
8. Once a corporation exists, it has an unusual ability to sustain itself even when its mission ends (like the inquisition)

Taking these items as a whole, it's apparent that once corporations are established, they are large and powerful enough to change their ecosystem to suit them. Rather like some primates.

I'll update my list as I get more ideas. Any suggestions?

See also:

My stuff

• The Corporation - what next? (8/2010)
• How big should financial firms be? (3/2009)
• Troubled capitalism: The corporate entity (Iain Banks, 8/2010)
• Self sustaining entities: corporations and the Spanish Inquisition (6/28/2006)
• The corporation as psychopath (Economist book review, 2004 - I've updated the post with a copy of the since lost review)
• Beyond the first cause: Deepwater Horizon and the publicly traded company (6/20/21010)
• Understanding the elections - what's really changed (11/4/2010)
• The morality of markets - and a response to hunger (9/28/2010)

Other people's

• The Nature of the Firm - Wikipedia, the free encyclopedia
• Anti-Dismal: Williamson and the theory of firm (10/16/2009)
• Llamas and my stegosaurus: Artificial Persons (1/22/2010)
• The Corporation Film and The Corporation: The Pathological Pursuit of Profit and Power Joel Bakan (2004)

Update 2/25/11: In a Krugman article I learn that Williamson won the Nobel in 2009 for work in the 70s on the theory of the firm. So Williamson extended Coase ...

Williamson argues that the firm is best regarded as a "governance structure," a means of organizing a set of contractual relations among individual agents. The firm, then, consists of an entrepreneur-owner, the tangible assets he owns, and a set of employment relationships ...

Personally I wasn't that impressed with the descriptions I read of Williamson's work, but Krugman likes it (emphases mine)...

Oliver Williamson shared the 2009 Nobel mainly because of his work on a question that may seem obvious, but is much less so once you think about it: why are there so many big companies? Why not just rely on markets to coordinate activity among individuals or small firms? Why, in effect, do we have a lot of fairly large command-and-control economies embedded in our market system?

Williamson answered this in terms of the difficulties of writing complete contracts; when the tasks that need to be done are complex, so that you can’t fully specify what people should do in advance, there can be a lot of slippage and strategic behavior if you rely on market incentives; in such cases it can be better to do these things in-house, so that you can simply tell people to do something a particular way or to change their behavior.

... there are times when it’s better to rely on central planning than to leave things up to the market...

Krugman's "Central planning" comment sent the usual suspects frothing mad. They've obviously never lived in a large corporation. I have. Krugman is spot on.