Are corporations essential components of a free market economy?

Question

There seems to exist a rarely-stated assumption that somehow corporations are an essential element of a free-market economy, and that they benefit a nation's economy. However, I wonder if this is really true.

Here, I am speaking of the US form of a corporation which allows a small number of people to control capital contributed by a large number and also allows those same people to disavow responsibility for the debts and liabilities of the corporation.

In the Wealth of Nations, Adam Smith deprecated any kind of joint stock companies, writing that a man would be much more careless with other people's money than his own. By this logic one might see corporate law as a way for elites to exploit society parasitically and corporate law as a damage to the economy instead of a benefit.

Is there any theoretical validity to this kind of view?

Answer 1

A classic reference that is somewhat related is Ronald Coase's "The Nature of the Firm". Coase set out to address the following puzzle: since markets are efficient, why do we need to organize into firms? Couldn't we just have each individual acting alone and rely on the market to put the pieces together into complete products? Coases answer to why this wouldn't work well was transaction costs. If there is a (small) cost to engaging in market transactions then the aggregate cost of the many transactions needed to assemble complicated products will be prohibitive. The solution, argues Coase, is to form an organization (a firm) within which all of these transactions can take place without recourse to the market.

Coase's reasoning has been expanded in the 80 years since its publication. Notably, Oliver Williamson did important work to dig into the details of the conditions that make organizing work within a firm especially attractive. He argued that firms should be most likely to form when work is relationship-specific and when there are significant difficulties in writing and enforcing contracts. A great summary of Williamson's work can be found here.

Both Coase and Williamson received the Nobel prize for this work.

Answer 2

Corporations are essential and they do provide benefits to the overall economy.

Corporations are essential in the sense than individuals, when given the freedom to choose, do choose to invest their capital in corporations. And these corporations, in turn, use this capital to produce products and services which other people voluntarily purchase.

Corporations are a net benefit to the economies in which they operate because they produce products which customers voluntarily purchase for prices which allow the corporations to return a profit to their shareholders.

To the extent there are exceptions to this vis-a-vis crony corporations and government subsidies, the previous paragraph is notwithstanding.