Partnership as Experimentation

Abstract

Abstract Recent research disputes the view that the joint-stock corporation played a crucial role in historical economic development, but retains the idea that the costless firm dissolution implicit in non-corporate forms deterred investment. A multi-armed bandit model demonstrates the benefits of costless dissolution in an environment where potential business partners are not fully informed. Experimentation creates a spike in dissolution rates early in firms’ lives, as less productive matches break down and agents look for better matches. Many of the better matches adopt the corporate form, whose higher dissolution cost functions as a commitment device. We test the model’s predictions using firm-level data on 12,000 enterprises established in Egypt between 1910 and 1949. The partnership reflected a trade-off between committing to a partner and sorting into potentially better matches, fostering the formation of more productive enterprises (JEL D21, D22, L26, N15, O16).