The theory of the new economy firm: A dynamic analysis of human capital investment

In the last decade a major change in the development of firms is that they have become more human capital oriented. Especially the new economy firm attracts talented employees in order to create comparative advantages. Physical assets have become less unique and are not commanding large rents anymore. Increased competition with many independent suppliers has increased demand for quality improvement, which can only be generated by talented employees. The implication is that new firms tend to be non-vertically integrated, human-capital-incentive organizations that operate in a highly competitive environment. This paper analyzes this firm in the setting of “the dynamic theory of the firm”. Human capital is the central state variable, and a framework is designed in which path dependency is accounted for. Optimal long run policies are determined, and it turns out that a quality trap exists, implying that, in order to be able to remain active in the long run, the firm's initial amount of human capital should be sufficiently large as we see in reality: if this amount is too small the firm will cease its operations in the long run and go bankrupt. Mathematically speaking: a multiple equilibria solution arises where the Skiba point separates success and failure.