Economics of the firm – an overview
0) INFORMATION PROBLEMS
(i) Non-verifiable information
(ii) Asymmetric information
(iii) [Moral hazard]
1) THEORY OF THE FIRM
• WHY DO FIRMS EXIST?
• VERTICAL INTEGRATION
• INCOMPLETE CONTRACTS
Non-verifiable information
• RELATIONSHIP-SPECIFIC INVESTMENTS
Incentives to invest with and without integration
The hold-up problem – underinvestment
• OWNERSHIP OF PHYSICAL ASSETS
Determines the outcome in case the parties fail to reach an agreement
• SPECIAL CASES
Independent assets: No integration
Strictly complementary assets: Integration
Essential parties should own
Tore Nilssen – Overview: Economics of the Firm - 1

2) CORPORATE CONTROL
• The market for corporate control
takeover bidding
the free-rider problem non-pivotal shareholders, no initial shareholding, no dilution of minority shareholders’ value
too few takeovers
bidding when information about firm value after takeover is private uninformative bidding, informative bidding
- management defensive strategies: poison pills, etc.
• The effects of takeover threats
short-term behaviour: firms choose projects with early revelation of information about firm value, in order to have the share price correct in case of a takeover attempt.
• One share – one vote
gain from controlling a firm: public value vs private value
• Bankruptcy
Priority rules: Absolute priority; Me first; etc.
Too many bankruptcies: no uncertainty
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3) FINANCING THE FIRM
• DEBT VS. EQUITY
conflict of interest owners/management
conflict of interest owners/creditors
• FINANCING AS A SIGNAL
the pecking order
equity financing expensive for high-value firms when outside investors do not know firms’ values
underinvestment
private information about project value rather than firm value: no longer underinvestment
money burning
• FINANCING AS STRATEGIC COMMITMENT
Debt may cause firms to compete more aggressively in the product market
• FINANCING AND CONTROL
Essential parties without funds
The relationship entrepreneur/capitalist
Tore Nilssen – Overview: Economics of the Firm - 3

4) MANAGING THE FIRM
• INCENTIVES FOR MANAGERS
Career concerns: too risk averse; herd behaviour
Managers uncertain about own ability to find good projects
It may be better to do what other managers do rather than what own information indicates
5) CORPORATE GOVERNANCE
• Conflict of interest investors/manager
• dispersed ownership
• Fundamental trade-off: managerial discretion vs protection of minority shareholders
• Takeovers
• Blockholding
• The board of directors
• Executive compensation
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