Why Do Firms Exist?


Firms exist to minimize costs and, as a result, profit maximization is achieved. There are three general ways of categorizing firms: sole proprietorship, partnership and corporation. These forms differ with respect to their constitution and the extent of their liability to creditors.

According to Barry Haworth from the Department of Economics at the University of Louisville, a sole proprietorship is a firm where the owner directly operates it and has unlimited liability. Partnerships are formed when two or more individuals come together to start a firm, and this firm has unlimited liability, meaning the extent to pay a firm's debts exceeds the investments of the owner's personal assets. Corporations are run by appointed managers and are owned by a group of investors who in turn have limited liability, meaning the investors cannot be held personally accountable for debts unless they signed a personal guarantee.

Problems that arise for all types of firms include switching costs related to the internal commitment of resources focused on specific tasks, monitoring costs that safeguard against opportunistic behavior by securing a return on the investment into the firm and information costs geared toward obtaining costly information for developing contingencies in an effort to adapt to future problems.