Adaptive Firm Structure under Market Competition: Efficiency, Incentives, and Risk Control

Abstract

This paper presents a theory on how firm structure responds to market competitiveness. Firms have often been observed to reallocate control rights, sometimes in response to market competition. We develop a theory on the dependence of firm structure on market competition using an incomplete contract approach. We show that a reallocation of control rights can be an effective way of adapting to changing market competitiveness. We find that when market competitiveness changes, depending on demand elasticity, firms may centralize or decentralize control rights to encourage work incentives or to control risk. We present a few case studies in support of this result. We also investigate the effect of changing demand elasticity and production cost on firm structure, as well as the effect of market competition on efficiency, incentives and risk control after taking into account the endogenous, competition-driven firm structure.