The Changing Firm

Wharton professors are questioning the traditional model of the firm.

In the old days, most companies made products out of raw materials and then sent those goods on to their customers. "The traditional theory of the firm is about the unitary, rational actor that more or less controls all the pieces of the puzzle that it needs in order to produce its outputs," says Kleindorfer. But today, he says, global companies like GM or Toyota don't directly control most of their inputs. "Rather, these organizations are a part of a huge set of interlinked networks across the planet.

"All of that reflects fundamental changes not just in globalization but in the multi-party, diffused ownership of these new value chains," Kleindorfer says. "Whether it's in credit, in logistics, in risk, in operations, in marketing, you name it, this is a different ballgame." Yet although this is how the world works today, most intermediate economics textbooks still use the old definitions of the firm, according to Kleindorfer. "We haven't caught up with the fact that the world is a different place now."

Another participant at the SEI meeting, business theorist Kenichi Ohmae, argues in his forthcoming book, The Global Stage, that the root of the problem is ultimately that today's most popular economic ideas were formed at a time when most countries' economies weren't intimately linked with the outside world.

Interesting, but so what? Will a change in views have any effect on how companies do business? Yes. Accounting is one field that could be significantly affected by a new paradigm.

Wharton professors say that the cracks in the theory have led to challenges for various disciplines. In accounting, for instance, a better theory of the firm might help lead to better ways to measure value. Such measures as customer retention, employee turnover, and environmental success aren't included in traditional financial accounting, yet they can be essential aspects of a company's value, and sometimes even serve as leading indicators to firm performance, says David Larcker, a professor of accounting who serves on the SEI Center's advisory board.

"Eventually everything shows up in earnings and cash flow, but it shows up late," he says. In accounting, theorists are now trying to find some measures of value, such as customer retention, that can be monitored earlier than the balance sheet, when an understanding would be more useful, according to Larcker – a kind of dashboard that would monitor the most important factors in creating value.

I agree that part of the problem with economics today is that people are too wrapped up in old models. Given the interconnectedness of everything, it is difficult to analyze countries or companies as discrete units in many areas of measurement. I am glad to see this type of thinking, and I really believe it will make valuable contributions to the future of business.

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