A BRIEF DEION OF THE THESIS
The firm is the typical organizational form of the market economy. The most significant characteristics of the firm are the asymmetric contractual arrangements between different participants（factor-owners）in both distribution of returns and control rights. Within the firm， some participants are called“employers”， while others are called“employees”. Employers hold“authority”over employees and are entitled to claim the residual returns， while employees are obliged to obey the authority of employers within certain limits and are entitled to fixed wages. In the terminology of principal-agent theory， employers are principals and employees are agents. This“micro”asymmetry between employers and employees directly determines a“macro”asymmetry. In society， employers belong to an upper-class， while employees belong to a lower-class. For this reason， this topic about the firm attracts attention not just from economists but also from sociologists， political scientists， politicians and， in particular， social reformers.
The employment relationship takes place between capital and labour. An important question which has puzzled economists as well as others for long time is： why does capital hire labour rather than labour hire capital？ This question is specially relevant today for two reasons. First， almost all socialist countries have experienced the failure of the socialist planned economy and have now begun a market-oriented reform program. Although Yugoslavia’s experiment has shown that a labour-managed economy cannot be an efficient option， there is no guarantee that other socialist countries will not be attracted by the labour-hiring-capital system when they begin to deviate from the traditional planned economy. In particular， for ideological reasons， the labour-hiring-capital economy may be thought to be the only“acceptable”choice for some socialist countries. Secondly， in the joint-stock company，“ownership”is separated from management and the traditional conception of the employer is no longer as relevant as in the owner-managed firm. Instead， shareholders hire the management who in turn hire workers. That is， the traditional single agency relationship between a capitalist-entrepreneur and the workers has been replaced by an agency-chain between capitalists and management， and management and workers. Many economists have focused their attentions on how capitalists as the principal make an optimal incentive scheme to induce the management（agents）to act in their best interests， or how the managerial behaviour deviates from shareholders’ interests； but the most fundamental question is why the principalship should be assigned to capitalists rather than management in the first place. The logic behind this question is， if the firm’s output does not directly depend on the actions taken by capitalists， why could not the incentive problem associated with the separation of ownership and management be solved by assigning the principalship to the management and let the management work for themselves？ Or more generally， why do we need capitalists？
This thesis is intended to explore the elements determining the assignment of principalship within the firm： Why does capital hire labour rather than labour hire capital？ Why does the entrepreneur monitor workers rather than workers monitor the entrepreneur？ Why do capitalists rather than workers select the management of the firm？ What factors determine who will be the entrepreneur in equilibrium？ We are concerned with an economy in which all economic actions fall into two types： marketing and producing. By“marketing”we mean the activities of“discovering the relevant prices”[Coase（1937）， p. 390] including speculating about profitable opportunities， forecasting market demands and making“judgemental decisions”[Casson（1982）] of“what to do， and how to do it”[Knight（1921）]， in Schumpeter‘s words， setting up a production function. By“producing”we mean all the activities of transforming inputs into outputs“physically”under the given production function（technology）and according to marketing decisions.
Individuals in the economy are assumed to differ in（1）their marketing ability（entrepreneurial ability）， denoted by θ；（2）personal assets ， denoted by WO； and（3）risk-attitudes， denoted by R. Because individuals differ in their marketing ability， it may be profitable for them to cooperate by setting up a“firm”through which individuals who have advantages in marketing specialize in making marketing decisions， while those who are not good at marketing specialize in producing（note that we assume that individuals are identical in their producing ability）. Because of“uncertainty”[Knight（1921）] and“team production”[Alchian and Demsetz（1972）]， the firm involves an agency problem-some member may take actions（e. g. ， shirking）which benefit himself but cost others. The key organizational issue is to design a contractual arrangement between different participants of the firm so as to make each member as responsible for his own actions as possible. We will argue that the member who does marketing should be assigned to be the principal to claim the residual return and to monitor others， not just because he is the major“risk-maker”but mainly because his actions are the most difficult to monitor. Thus he becomes the entrepreneur while those who do producing become the workers.
