The Firm as a Socialization Device

Why do firms exist? What is their function? What do managers do? What is the role, if any, of social motivation in the market? In this paper, we address these questions with a new theory of the firm, which unites some major themes in management, principal‐agent theory, and economic sociology. We show that although the market is a superior incentive mechanism, the firm has a comparative advantage with respect to social motivation. We then show that the market is efficient in environments that favor the provision of incentives, such as when subjective risk is low and performance is easy to measure. The firm is efficient in other environments where incentives are costly and/or ineffective. We compare our model and results with the views of Durkheim (1984) and Granovetter (1985).