On the Foundations of the Strategic Theory of the Firm

This paper is taken up with discussing the extent to which existing economic theories of the firm are helpful for constructing what Rumelt called a "strategic theory of the firm". Such a theory explains the existence, boundaries, organization and competitive advantage of the firm. The modern economics of organization (e.g., agency theory, transaction cost economics, incomplete contracts theory) is characterized by the heuristic of reducing literally all aspects of economic organization to the alignment of incentives. It thus arguably misrepresents many management and strategy issues. On the other hand, the dominant contender, the capabilities perspective, is lacking in several respects, for example, with respect to its lack of crisp microfoundations, and its inability to predict, explain ownership and explain the existence of the firm. The best way forward in the construction of a strategic theory of the firm is probably to draw eclectically on both approaches.