The Legal Structure of the Firm

Abstract

The notions of firm and corporation are very often confused in the literature on the theory of the firm. In this paper, the two notions are sharply distinguished: the corporation is a legal entity entitled to operate in the legal system and in particular to own assets, to enter into contracts and to incur liabilities. It is used to legally structure firms for numerous reasons, including the need to locate property rights key for the operation of the firm in the ownership of separate, fictitious, legal persons. This avoids ex post-contracting bargaining by parties which otherwise would hold residual control rights over key assets used in the firms operations. The assets partitioning effect of corporate legal personality has also several economizing properties reviewed in the article. The firm is the economic activity developed as a consequence of the cluster of contracts connecting the corporation owning these assets to various holders of resources required in the firms operations. Numerous consequences deriving from this sharp distinction between corporation and firm are explained in this article, including the need to extend the circle of the beneficiaries of the firm managements fiduciary duties.