471. Transaction Costs

Why do firms / organizations exist? Why not many atomized individuals (market)?

Why are there hierarchies (firms / organizations) in markets?

Hierarchy or Market? Make or Buy? Which transactions should be included in the hierarchy, which transactions should be left to the market?

Unit of analysis: Transaction Relation (networks)

Traditional assumption: Using the market has no cost (frictionless)

If trust there would be no cost But the risk of opportunism, shirking exists

Therefore, there are costs:

• Search
• Bargaining
• Monitoring / Enforcement: ensuring that the terms of the agreement are being fulfilled (inspection, quality control, and supervision)
• Information: expenses incurred in acquiring, processing, and disseminating information relevant to the transaction
• Coordination
• Adaptation

Costs are a function of:

• Asset Specificity
• Uncertainty
• Frequency

Efficient alignment hypothesis: Transactions, which vary in their characteristics, should be matched with governance structures that differ in their costs and competencies. Alignment aims to minimize transactions costs.

Questions:

• For you which transactions should be included in the hierarchy and which should be left to the market?
• Furthermore, which transactions included in hierarchies should be in public hierarchies and which in private hierarchies?
• How can this transaction sort approaches be used to predict end symbiosis?

Let the set of transactions be For each transaction , define:

• : transaction cost if done via Market
• : transaction cost if done via Hierarchy

Then the total cost across all transactions is:

We want to choose the governance for each that minimized total transaction cost

Transaction costs can be modeled as a function of key characteristics

Where:

• : asset specificity
• : Uncertainty
• : frequency
• : governance structure (, )

Assumptions

Where coefficients reflect how sensitive each governance mode is to specificity, uncertainty, and frequency. For instance:

• Market is cheap for low specificity, low uncertainty, low frequency
• Hierarchy becomes cheaper as specificity, uncertainty, or frequency increase

Then the optimal governance for transaction is:

So, for each transaction, compute the three potential costs and pick the governance mode with the lowest cost

Symbiosis prediction

Symbiosis arises when two transactions are co-dependent and jointly internalized in the hierarchy:

• Let and be linked transactions
• Joint transaction cost:

If this inequality holds, hierarchy creates a net benefit, predicting stable interdependence, i.e., symbiosis