Corporate Culture as a Theory of the Firm

Abstract

Markets and firms offer contrasting methods to arrange production. In markets, contracts govern the purchase of parts and services. In firms, the shared values, customs, and norms coming from a corporate culture govern employees’ joint development of parts and services. We argue for this distinction as a theory of the firm. Firms exist because corporate culture at times is more efficient to carry out production than are detailed contracts. The firm’s boundary encircles the areas of production for which a manager optimally chooses corporate culture as the organizing device. Consistent with empirical evidence, the model explains why some mergers and acquisitions fail and why corporate cultures are hard to change.