The Firm as a Means of Concealing Information

The aim of this article is to demonstrate that a firm may owe its continued existence to its attempts to conceal information from its competitors about the unknown characteristics of a certain factor, not just to its savings on market transaction costs, its team-working, risk-sharing or the encouragement of ex ante specific investment. This is because the existence of a firm contract severs the relationship between the factor market and the product market, thereby making it difficult for outsiders to observe the marginal contribution of the intermediate factor and make statistical inferences about the factor’s unknown characteristics. Furthermore, an optimal contract is determined by a trade-off not only between traditional risk-sharing and incentive, but also between the incentive and information concealing. Finally, we show that this latter kind of trade-off also affects the position of the optimal boundary of the firm.