Managerial Economics

Transaction Costs and Boundaries of the Firm

We have discussed several reasons a firm may decide to expand. At first glance, it may seem that expanding a business is often a good idea and has little downside risk if the larger enterprise is managed properly. In fact, during the last century successful businesses often engaged in horizontal and vertical integration and even became conglomerates due to such reasoning.

However, as many of these large corporations learned, it is possible to become too large, too complex, or too diversified. One consequence of a corporation growing large and complex is that it needs a management structure that is large and complex. There needs to be some specialization among managers, much as there is specialization ...