The extent of the firm

The firm boundaries question—why are some economic activities carried out through market contracts and others through the internal organization—tends to cast the problem as a more or less static analysis about obstacles to coordination. The solution depends on a variety of transactions costs, contractual problems, or strategic concerns. By contrast, business historians are more prone to see the boundaries of the firm as determined by a process that works itself out over time and in response to change. To be consistent with a historical picture, we need to think about the development of the firm explicitly in evolutionary terms. I develop an agent-based model showing that the boundary of the firm depends on both coordination technology and the process of market development. I demonstrate that the comparative institutional assessment is dynamic: firms navigate systemic change better, but as this change attenuates markets outperform in the long run, giving support to the theoretical account of the Vanishing Hand interpretation of organizational history (Langlois, Ind Corp Chang 12(2): 351–385, 2003). The analysis consolidates the economics and business approaches to the theory of the firm, arguing that vertical integration is often a necessary step in the extent of a market.