The Governance of Contractual Relations: Contracting Traditions

There is widespread agreement that the discrete transaction paradigm— “sharp in by clear agreement; sharp out by clear performance (Macneil, 1974, p. 738)—has served both law and economics well. But there is also increasing awareness that many contractual relations are not of this well- defined kind. A deeper understanding of the nature of contract

The Governance of Contractual Relations: Efficient Governance

As discussed above, the principal dimensions for describing transactions are asset specificity, uncertainty, and frequency. It will facilitate the argument in this section to assume that uncertainty is present in sufficient degree to pose an adaptive, sequential decision requirement and to focus on asset specificity and frequency. Three frequency classes—one-time, occasional, and recurrent—and three

The Governance of Contractual Relations: Uncertainty

The proposed match of governance structures with transactions considers only two of the three dimensions for describing transactions: asset specificity and frequency. The third dimension, uncertainty, is assumed to be present in sufficient degree to pose an adaptive, sequential decision problem. The occasion to make successive adaptations arises because of the impossibility (or costliness)

The Governance of Contractual Relations: Measurement

The cognitive map of contract set out in Figure 1 -1 (Chapter 1) distinguishes between two branches of transaction cost economics: the governance branch and the measurement branch. The former is concerned mainly with organizing transactions in such a way as to facilitate efficient adaptations. The latter is concerned with the ways by which

The Governance of Contractual Relations: The Distribution of Transactions

The study of contractual relations plainly involves more than an examination of discrete markets on the one hand and hierarchical organization on the other. As Llewellyn observed in 1931, the exchange spectrum runs the full gamut from pure market to hierarchy and includes complex “future deals” located between market and hierarchy extremes (1931, p.

Vertical Integration: Technological Determinism

Ours is indisputably a technologically advanced society. That complex orga- nization is needed to serve a complex technology is surely common sense. In particular, comprehensive integration—backward into materials, laterally into components, and forward into distribution—is widely believed to be the organizational means by which complex products and services are created, produced, and efficiently brought

Vertical Integration: A Heuristic Model

As discussed in earlier chapters and sketched in section 1 above, the principal factor to which transaction cost economics appeals to explain vertical integration is asset specificity. Without it, market contracting between successive production stages ordinarily has good economizing properties. Not only can production economies be realized by an outside supplier who aggregates orders,

Vertical Integration: Further Implications

1. Asset Specificity Distinctions  Additional implications of a transaction cost economizing kind can be derived by recognizing that asset specificity takes a variety of forms and that the organizational ramifications vary among these. Four types of asset specificity are usefully distinguished: site specificity—e.g. successive stations that are located in a cheek-by- jowl relation to

Vertical Merger Guidelines

The cognitive map of contract set out in Chapter 1 (Figure 1-2) identifies two main approaches to the study of contract: monopoly and efficiency. Of the two, the monopoly approach was the more fully developed and more widely favored through the early 1970s (Coase, 1972). Vertical integration is one of the areas to which

Vertical Integration: Types of Evidence

There is no single correct unit of analysis for addressing issues of economic organization. Which units are most appropriate depends on the questions being asked. The issues of interest in this book require a semi-microanalytic level of analysis—more microanalytic than received price theory, but less microanalytic than many sociological and social psychological studies of

Vertical Integration: Mundane Integration

Vertical integration, and the evidence that relates thereto, of two kinds is usefully distinguished. The first, which 1 will refer to as mundane vertical integration, involves integration of successive stages within the core technology. (These are the on-site stages referred to as SI, S2, and S3 in Figure 4-3.) The second, which is more

Vertical Integration: Forward Integration into Distribution

1. The Observed Transformation  The principal development that induced forward vertical integration into dis- tribution to occur in the second half of the nineteenth century was the appearance of the railroads (Porter and Livesay, 1971, p. 55). To be sure, there were other significant technological developments, including the telegraph (Chandler, 1977, p.189), the development

Vertical Integration: Lateral Integration

The distinction between lateral and backward integration is somewhat arbitrary. 1 shall include in the former the supply of components, body panels, and the like and reserve backward integration for more basic materials. 1. A Case Study  Klein, Crawford, and Alchian’s (1978, pp. 308-10) treatment of the bilateral exchange relationship between Fisher Body and

Vertical Integration: Backward Integration

1. Backward Integration Backward integration into raw materials may occur for three main reasons: (I) to realize prospective transaction cost economies; (2) for strategic purposes; or (3) for-mistaken reasons. Transaction cost economies will warrant integration where the parties are tightly joined in a bilateral exchange relation, making problems of harmonizing the interface crucial, and

Vertical Integration: Some Remarks About Japanese Manufacture

The Japanese rely much more extensively on subcontracting than is true in the United States. The experience of Toyota Motor Company, which has crafted an unusual relationship with its parts suppliers, is frequently cited in this connection. What explains Toyota’s success with subcontracting? What is the Japanese experience more generally? Definitive answers to neither

Vertical Integration: Some Alternative Explanations

The leading alternative theories that have been offered to explain organizational changes are domination theory, market power, technology, life cycle, pecuniary economies, and strategic behavior. 1 shall consider them seriatim. 1. Domination Theory  Domination theory focuses on human actors. There are those who possess economic power and those who do not. The organization of

Vertical Integration: Concluding Remarks

Although characterizing the firm as a production function is a convenient and useful abstraction, such an approach suppresses much of the interesting action that accounts for the high performance features of an enterprise economy. It facilitates marginal analysis within a given institutional framework at the expense of organization and comparative institutional features. The firm

The Limits of Firms: A Chronic Puzzle

Frank Knight made early reference to the limitations to firm size puzzle when, in 1921, he observed that the “diminishing returns to management is a subject often referred to in economic literature, but in regard to which there is a dearth of scientific discussion” (1965, p. 286, n. 1). And in 1933 he elaborated

The Limits of Firms: Integration of an Owner-Managed Supply Stage

The obvious answer to the puzzle of why firms do not comprehensively integrate is that selective intervention is not feasible. But why should that be? If the reasons were obvious, the puzzle of what is responsible for limitations on firm size would not persist. I attempt here to identify some of the main reasons

The Limits of Firms: Acquisition of a Supply Stage in Which Ownership and Management Are Separated

Suppose, arguendo, that vertical integration of the kind described above experiences the incentive disabilities that are ascribed to it. It is nevertheless noteworthy that the conditions described above are very special. In particular I have assumed that ownership and management are joined in the preacquisition supply stage. What if that condition does not obtain?