The Human Side of the Firms∗

This paper explores the role of firm boundaries by abstracting from the property rights approach, which is not applicable to the increasingly important human-capital intensive firms. By focusing on firm boundaries’ role as ‘information barriers’ that blur employees’ individual outside identities, we find that firms boundaries matter because they can alter investment specifity and hence alleviate or aggravate the hold-up problem. Specifically, when there is substantial investment externalities integration is more efficient, and conversely separation is more efficient when investment externality is small. This main result is obtained under both Nash and alternating-offer bargaining, while optimal organization structure is characterized under the former. Finally, we also examine the effect of relational ∗I thank Hongbin Cai, Stephen Chiu, David Levine, John Riley, and participants of the Theory Proseminar at UCLA, Hong Kong University, Lingnan University for helpful commands. All errors are mine.