How should we understand why firms exist? A prevailing view has been that they serve to keep in check the transaction costs arising from the self-interested motivations of individuals. We develop in this article the argument that what firms do better than markets is the sharing and transfer of the knowledge of individuals and groups within an organization. This knowledge consists of information (e.g., who knows what) and of know-how (e.g., how to organize a research team). What is central to our argument is that knowledge is held by individuals, but is also expressed in regularities by which members cooperate in a social community (i.e., group, organization, or network). If knowledge is only held at the individual level, then firms could change simply by employee turnover. Because we know that hiring new workers is not equivalent to changing the skills of a firm, an analysis of what firms can do must understand knowledge as embedded in the organizing principles by which people cooperate within organizations. Based on this discussion, a paradox is identified: efforts by a firm to grow by the replication of its technology enhances the potential for imitation. By considering how firms can deter imitation by innovation, we develop a more dynamic view of how firms create new knowledge. We build up this dynamic perspective by suggesting that firms learn new skills by recombining their current capabilities. Because new ways of cooperating cannot be easily acquired, growth occurs by building on the social relationships that currently exist in a firm. What a firm has done before tends to predict what it can do in the future. In this sense, the cumulative knowledge of the firm provides options to expand in new but uncertain markets in the future. We discuss at length the example of the make/buy decision and propose several testable hypotheses regarding the boundaries of the firm, without appealing to the notion of “opportunism.”

The capabilities of a firm, or any organization, lie primarily in the organizing principles by which individual and functional expertise is structured, coordinated, and communicated. Firms are social communities which use their relational structure and shared coding schemes to enhance the transfer and communication of new skills and capabilities. To replicate new knowledge in the absence of a social community is difficult. A classic demonstration is the well-studied problem of the transfer across country borders of manufacturing capabilities that support production of new product innovations. We show in this article that the degree of codification and how easily capabilities are taught has a significant influence on the speed of transfer. What makes the question of knowledge codification particularly interesting is that firms compete not only through the creation, replication, and transfer of their own knowledge, but also through their ability to imitate the product innovations of competitors. The capacity to speed the internal transfer of a production capability to new markets (e.g., those in other countries) is, consequently, of fundamental significance in a competitive environment. In the attempt to speed the internal transfer of knowledge, the dilemma arises that capabilities which can be easily communicated within the firm are more likely to be easily imitated by competitors. This relationship is tested by analyzing the effects of the ease of codifying and communicating a manufacturing capability not only on the time to its transfer, but also on the time to imitation of the new product. 'The determinants of the time to imitation are found to be the extent to which knowledge of the manufacturing processes is "common" among competitors, and the degree of continuous recombination of capabilities leading to improvement of the product or the manufacturing process. We support this interpretation by a discussion of the results from field research. A wider implication of these findings is the proposition that the transfer and recombination of organizational capabilities are the foundation of an evolutionary theory of the

Abstract. Firms are social communities that specialize in the creation and internal transfer of knowledge. The multinational corporation arises not out of the failure of markets for the buying and selling of knowledge, but out of its superior efficiency as an organizational vehicle by which to transfer this knowledge across borders. We test the claim that firms specialize in the internal transfer of tacit knowledge by empirically examining the decision to transfer the capability to manufacture new products to wholly owned subsidiaries or to other parties. The empirical results show that the less codifiable and the harder to teach is the technology, the more likely the transfer will be to wholly owned operations. This result implies that the choice of transfer mode is determined by the efficiency of the multinational corporation in transferring knowledge relative to other firms, not relative to an abstract market transaction. The notion of the firm as specializing in the transfer and recombination of knowledge is the foundation to an evolutionary theory of the multinational corporation.The study of the multinational corporation has tended to be divided by perspectives ranging from economics, to organizational theory, and history and politics. These perspectives are complementary insofar that the multinationalcorporationis an economic organizationthatevolves from its national origins to spanning across borders. The cornerstone of this evolutionary

Firms are organizations that represent social knowledge of coordination and learning. But why should their boundaries demarcate quantitative shifts in the knowledge and capability of their members? Should not knowledge reside also in a network of interacting firms? This line of questioning presents the challenge to state an alternative view to the “theory of the firm,” a theory that has moved from Coase's early treatment of what firms do to a concern with ownership, incentives, and self-interest. We return to Coase's original insight in understanding the cost and benefits of a firm but based on a view that individuals are characterized by an “unsocial sociality.” Does the perception of opportunism generate the need to integrate market transactions into the firm, or do boundaries of the firm lead to the attribution of opportunism? This basic dichotomy between self-interest and the longing to belong is the behavioral underpinning to the superiority of firms over markets in resolving a fundamental dilemma: productivity grows with the division of labor but specialization increases the costs of communication and coordination. The knowledge of the firm has an economic value over market transactions when identity leads to social knowledge that supports coordination and communication. Through identification, procedural rules are learned, and coordination and communication are facilitated across individuals and groups of diverse specialized competence. A firm is distinct from a market because coordination, communication, and learning are situated not only physically in locality, but also mentally in an identity. Since identity implies a moral order as well as rules of exclusion, there are limitations and costs to relying upon a firm for exchange as opposed to the market. These costs are not necessarily those traditionally assigned to the category of decreasing returns to hierarchy. For example, an identity implies that some practices, and businesses, may be notionally inconsistent with each other. Norms of procedural justice that are identified with a firm imply that not all technically feasible complements are permissible within the logic of a shared identity. There is consequently a cost to an identity that offsets the benefits. Because the assemblage of elements that compose an organization are subject to requirements of consistency, identities rule out potentially interesting avenues of innovation and creativity. We illustrate these ideas by returning to the original prisoners’ dilemma game and by an analysis of the coherence of a firm as a search for complements that are consistent with norms of procedural justice. We argue that the underlying dynamic of a prisoners' dilemma game reveals the problems of coordination, communication, and conflicts in norms of justice when players are deprived of social knowledge and shared identity. Similarly, the determination of a firm's coherence arises out of the demand for a moral and notional consistency in the “categorization” of its activities, as opposed to a technological necessity. These ideas are illustrated through an empirical examination of logical complements in high performance work systems.

Firms are social communities that specialize in the creation and internal transfer of knowledge. The multinational corporation arises not out of the failure of markets for the buying and selling of knowledge, but out of its superior efficiency as an organizational vehicle by which to transfer this knowledge across borders. We test the claim that firms specialize in the internal transfer of tacit knowledge by empirically examining the decision to transfer the capability to manufacture new products to wholly owned subsidiaries or to other parties. The empirical results show that the less codifiable and the harder to teach is the technology, the more likely the transfer will be to wholly owned operations. This result implies that the choice of transfer mode is determined by the efficiency of the multinational corporation in transferring knowledge relative to other firms, not relative to an abstract market transaction. The notion of the firm as specializing in the transfer and recombination of knowledge is the foundation to an evolutionary theory of the multinational corporationJournal of International Business Studies (2003), 34, 516–529. doi:10.1057/palgrave.jibs.8400058