The size of transaction costs depends on the extent to which the trading environment facilitates opportunistic behavior. This, in turn, depends on the attributes of the transactions, the most important of which is asset specificity. Other features facilitating opportunistic behavior include asset indivisibility and fungibility, uncertainty and externalities, and problems of recognition, disclosure, and team organization associated with inter-market transfers of human knowledge, expertise, and information. A desire to safeguard trade secrecy or to transfer excess capacity of a specific nature can be associated with high transaction costs (Moschandreas, 1994).
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The attenuation of opportunism reduces TCs providing the efficiency rationale for the emergence of national and international firms with vertical MNEs occurring when international transactions are supported by dedicated assets and horizontal MNEs attributed to uncertainty, externalities, or the transfer of expertise.
The same theoretical apparatus is utilized to explain a variety of other phenomena, such as the organization of work (Williamson 1975), the cost of capital, privatization, the role of the state, and divestment.
The creation of firms is intrinsically associated with the “employment relation.” The establishment of an employment relation involving what Simon (1957,183-195) called an “authority relation” can have substantial cost economizing effects compared to individualistic labor contracting modes. It alleviates the need for long-term contingent contracts and mitigates against opportunism. The scope for opportunistic behavior, although reduced, is, however, still present and to an extent dependent on human asset specificity (HAS) (Williamson, Wachter, and Hams, 1975) and on the effectiveness of governance structures to deal with it (Williamson, 1984).
The significance of trade secrecy is acknowledged by Williamson (1985), but he insists that internalization is efficiency induced since trade secrecy is required if competition by emulation is to be limited in situations in which property rights are not well-defined. Admittedly, the absence of well-defined property rights can induce opportunistic behavior in the form of rival emulation of business activity, as the existence of patents verifies. To claim, however, that internalization is always induced by efficiency considerations–either due to the presence of dedicated assets or to the lack of well-defined property rights–is at best misleading and at worse tautological. Property rights cannot, in reality, be so fine-tuned as to safeguard all business activity from competitive emulation. Legal protection of every aspect of organizational know-how and other business activity would be prohibitively expensive to implement. Besides, even if feasible, such legal protection would be undesirable as inefficient. Curtailing any form of emulation would impede the process of “creative destruction,” stifling competition and hindering economic growth. Furthermore, Dragun (1987) suggests that when property rights are not well defined, other institutional forms may be more efficient than hierarchies.
Clearly, opportunism may exist whether property rights are or are not well defined. But other motives cannot always be presumed away. Thus, to focus on opportunism to the exclusion of any other behavioral influences carries the risk that internalization is tautologically explained by opportunism. To presume that any transfer of transactions from the market to internal structures is necessarily efficiency induced compromises our ability to understand business behavior, which limits the explanatory and predictive power of the theory.
Thus, if focusing on opportunism as the single motivational power can be seriously misleading, other behavioral motives must be examined. A step in the direction of admitting motivational diversity, and the influence of the trading atmosphere, is to allow for the possibility that market transactors may behave somewhat differently to individuals working as a team.
Our contention that the motivation of individual market participants may differ significantly from the motivation of employees working as a team under an “authority relation” is consistent with Williamson’s (1992) claim that the behavior of market transactors is based on “higher power motives” (the pursuit of profit), while that of employees within a firm is induced by “lower power motives” (wages and other remunerations). This implies that transaction costs are present in both cases but vary in size. Traders motivated by profit create different transaction costs compared to employees who work as agents and predominantly in teams. Employees may behave opportunistically. The influence of group dynamics with its characteristics of a mixture of selfish and selfless behavior and cooperative behavior cannot, however, be ruled out. The extent of cooperation may vary according to the ethics of a country or the corporate culture adopted, but its presence must be acknowledged. Ethical considerations and the dilemmas they cause are important for a better understanding of many economic phenomena, but they are particularly significant in labor relations, wage determination, determining the extent of cooperation or conflict within firms, and influencing productivity and industrial efficiency.
In brief, human behavior and the role of opportunism in the make-or-buy decision must be contrasted with its role within internal administrative structures. This is consistent with Coase’s (33-47) claim that comparing the costs of organizational cooperation within firms to the costs of the market is sufficient to explain the emergence of the firm but cannot explain why the costs of organizing are lower for some firms than for others.
Although TCE allows for the presence of non-opportunists, it neglects the adverse impact that hierarchical structures may have on their behavior. Moreover, some theoretical weaknesses in the use of opportunism remain. Significant among these is a failure to admit that self-interest-seeking individuals in positions of authority may behave opportunistically toward their subordinates. That is, TCE fails to acknowledge that the “authority relation” itself may create novel forms of opportunism. Ignoring this possibility impress that institutional structures fail to give subordinates (workers) appropriate control mechanisms intended to safeguard against such abuse. This compromises the efficiency of hierarchical structures.
Moreover, the claim that the existence of multidivisional firms significantly improves resource allocation cannot be substantiated since its validity depends on the assumption that either top officers pursue a profit objective or that their behavior is controlled by the market in corporate control. Both assumptions are inconsistent with the notion of opportunism. For if humans are motivated by “self-interest seeking with guile,” top M-form firm officers are not necessarily motivated by profit, and their inclination to “free ride” tends to undermine the efficiency of the market in corporate control.
In brief, the efficiency of hierarchy is seriously compromised by (1) the possibility that systems built on the assumption of opportunism may adversely affect the behavior of non-opportunists, (2) the possibility that the “authority relation” may create novel forms of opportunism, (3) the lack of mechanisms controlling for subordinate exploitation, and (4) the absence of the benefits derived from participatory behavior. Therefore, the TCE presumption that democratic structures are always too costly and hence inefficient cannot be substantiated. Both a priori arguments and empirical evidence indicate the possibility of net benefits from participatory behavior lending support to the efficiency view for the emergence of more participatory modes of work organization.
- Coase, R. H. “Lecture on: The Nature of the Firm.” Journal of Law, Economics and Organization 4 (1988): 33-47.
- Dragun, A. K. “Property Rights in Economic Theory.” Journal of Economic Issues 21, no. 2 (1987): 859-868.
- Moschandreas, M. Business Economics. London and New York: St. Martin’s Press, Routledge, 1994.
- Simon, Herbert. Models of Man. New York: John Wiley and Sons, 1957.
- Williamson, O. E. “Markets, Hierarchies and the Modern Corporation: An Unfolding Perspective.” Journal of Economic Behavior and Organization 17 (1992): 335-352.
- Williamson, O. E. “The Economics of Governance: Framework and Implications.” Zeitschrift fur diegesamte Staatswissenschaft 140 (1984): 195-223.
- Williamson, O. E. Markets and Hierarchies: Analysis and Antitrust Implications: A Study in the Economics of Internal Organization. New York: Free Press, 1975.
- Williamson, O. E. The Economic Institutions of Capitalism. New York: The Free Press, 1985.
- Williamson, O. E., M. L. Wachter, and J. E. Harris. “Understanding the Employment Relation: The Analysis of Idiosyncratic Exchange.” Bell Journal of Economics (1975): 250-278.