Specialization, Firms, and Markets: The Division of Labor Within and Between Law Firms

What is the role of firms and markets in mediating the division of labor? This paper uses confidential microdata from the Census of Services to examine law firms' boundaries. We find that firms' field scope narrows as market size increases and individuals specialize, indicating that firms' boundaries reflect organizational trade-offs. Moreover, we find that whether the division of labor is mediated by firms differs systematically according to whether lawyers in a particular field are mainly involved in structuring transactions or in dispute resolution. Our evidence is consistent with hypotheses in which firms' boundaries reflect variation in the value of knowledge-sharing or in the costs of monitoring, but not in risk-sharing. Our findings show how the incentive trade-offs associated with exploiting increasing returns from specialization lead the structure of the industry to be fragmented, but highly-skewed.