Competence and contract in the theory of the firm

The Coase±Williamson response to the question `̀ why do firms exist?'' is based on the idea that transaction costs in viable firms are lower than they would be if production was coordinated through the market. The explanatory focus of this argument is on the diminution of costs related to transactions between given individuals. However, this ignores the possibility of activities which are in principle non-contractible, including aspects of the process of production. Further, the reliance on comparative statics in transaction cost theory downplays the distinctive kind and rate of human learning that takes place within firms. This paper argues that work on organizational learning and cultural transmission reinforces a competence-based explanation of the existence and relative efficiencies of firms, and this approach can also provide answers to the original question posed by Coase. Accordingly, the development of a research program involving a conjoint evaluation of both competence-based and transaction cost approaches is proposed. # 1998 Elsevier Science B.V. JEL classi®cation: L20