The Theory of Business Organizations

This chapter introduces a property-rights theory of business organizations and contrasts it with the contractual theory that has dominated scholarship in law, economics and finance since the ’70s. Since firms can take different organizational forms, this chapter also discusses how the theory of business organizations relates to the property-rights theory of the firm. It shows that these two theories, although complementary, are based on different notions of property rights. The chapter further unpacks the fundamental features of business organizations, examining their origins, historical evolution and functions in western economies. Two stereotypical organizational forms — the partnership and the corporation — will take center stage in the analysis as two different degrees of separation between a business and its owners. Finally, the chapter examines how the organizational form a firm takes affects its relationship with creditors in the case of default and contractual counterparts in the case of transfer of essential assets, thus shaping the way in which firms borrow on and trade their assets.