This paper develops a resource-based--knowledge-based-theory of the firm. Its thesis is that the organizational mode through which individuals cooperate affects the knowledge they apply to business activity. We focus on the polar cases of organization within a firm as compared to market contracting. There will be a difference in the knowledge that is brought to bear, and hence in joint productivity, under the two options. Thus, as compared to opportunism-based, transaction-cost theory, we advance a separate (yet complementary) answer to the question: why do firms exist? Our aim is to develop an empirically relevant and complementary theory of why firms are formed: a theory based on irreducible knowledge differences between individuals rather than the threat of purposeful cheating or withholding of information. We assume limited cognitive abilities on the part of individuals (bounded rationality), and assume that opportunistic behavior will not occur. The latter allows us to determine whether resource-based theory has independent force, as compared to the opportunism-based, transaction-cost approach. The paper predicts choice of organizational mode, identifying whether firm organization or market contracting will result in the more valuable knowledge being applied to business activity. The resource-based predictions of organizational mode are compared and contrasted with corresponding opportunism-based, transaction-cost ones. A principal point is that knowledge-based considerations can outweigh opportunism-related ones. The paper also establishes the relation of a theory of the firm to a theory of performance differences between competing firms.
