Organizations and Markets

Finance and the Nature of the Firm

25 January 2012 at 6:47 am Peter G. Klein Leave a comment

| Peter Klein |

Raghu Rajan’s AFA presidential address is now online as an NBER working paper:

The nature of the firm and its financing are closely interlinked. To produce significant net present value, an entrepreneur has to transform her enterprise into one that is differentiated from the ordinary. To achieve the control that will allow her to execute this strategy, she needs to have substantial ownership, and thus financing. But it is hard to raise finance against differentiated assets. So an entrepreneur has to commit to undertake a second transformation, standardization, that will make the human capital in the firm, including her own, replaceable, so that outside financiers obtain rights over going-concern surplus. I argue that the availability of a vibrant stock market helps the entrepreneur commit to these two transformations in a way that a debt market would not. This helps explain why the nature of firms and the extent of innovation differ so much in different financing environments.

Entry filed under: - Klein -, Entrepreneurship, Financial Markets, Recommended Reading, Theory of the Firm.