Profit and the theory of the firm
I [originally called] this LJ Thinking Out Aloud because it is a way of exploring and grappling with issues. So, continuing on from this post, profit and loss can be looked at usefully from the basis of the theory of the firm. The Coasian analysis of the boundary of the firm being set by the relative transaction costs of doing things within the firm or purchasing outside the firm and the further development of that, for example by Yoram Barzel, of firms as bundles of attributes.
As I noted previously, profit and loss are two sides of the same thing and have to be analysed together. This residual income (the balance after income is received and costs are paid) is not either the return to risk or the return to capital. I said it was “not just one thing” because many factors could influence the size of the residual income. While many factors influence the size of the residual income, I would now say that the residual income is the return to coordination.
The owner is the person who bears the profit or loss: not quite the same as the contributor of capital - capital can be borrowed, for example. Having the owner be the receiver of profit or loss conjoins incentive with power. The person making the decisions (including hiring managers) is the person who benefits or loses from them. The other input-providers get paid their share, and the net effect of the common activity is born by the person responsible for coordinating said activity (including any delegating of such coordinating). Who is also therefore, as Yoram Barzel says, the final guarantor of income variability for the firm.
In other words, it is a rights-and-decisions matter, not a factor-of-production one.
If one has a cost theory of value (such as the labour theory of value), there is a mystery where this profit or loss “comes from”. However, if one has a subjective theory of value (such as Austrian or neoclassical economics), there is no mystery. Unsuccessful coordination can destroy value, successful coordination can create value: hence residual income as the return to coordination.
As someone who is an active part-owner of a business, that is certainly how it looks from the doing of it.
As I noted previously, profit and loss are two sides of the same thing and have to be analysed together. This residual income (the balance after income is received and costs are paid) is not either the return to risk or the return to capital. I said it was “not just one thing” because many factors could influence the size of the residual income. While many factors influence the size of the residual income, I would now say that the residual income is the return to coordination.
The owner is the person who bears the profit or loss: not quite the same as the contributor of capital - capital can be borrowed, for example. Having the owner be the receiver of profit or loss conjoins incentive with power. The person making the decisions (including hiring managers) is the person who benefits or loses from them. The other input-providers get paid their share, and the net effect of the common activity is born by the person responsible for coordinating said activity (including any delegating of such coordinating). Who is also therefore, as Yoram Barzel says, the final guarantor of income variability for the firm.
In other words, it is a rights-and-decisions matter, not a factor-of-production one.
If one has a cost theory of value (such as the labour theory of value), there is a mystery where this profit or loss “comes from”. However, if one has a subjective theory of value (such as Austrian or neoclassical economics), there is no mystery. Unsuccessful coordination can destroy value, successful coordination can create value: hence residual income as the return to coordination.
As someone who is an active part-owner of a business, that is certainly how it looks from the doing of it.