Transaction Costs

475. 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 $𝑇 = {1, 2, \dots, 𝑛}$ For each transaction $𝑖 \in 𝑇$ , define:

$𝐶_{𝑖}^{𝑀}$ : transaction cost if done via Market
$𝐶_{𝑖}^{𝐻}$ : transaction cost if done via Hierarchy

Then the total cost across all transactions is:

𝑇 𝐶 = \sum_{𝑖 = 1}^{𝑛} min {𝐶_{𝑖}^{𝑀}, 𝐶_{𝑖}^{𝐻}}

We want to choose the governance $𝑔_{𝑖} \in {𝑀, 𝐻}$ for each $𝑖$ that minimized total transaction cost

Transaction costs can be modeled as a function of key characteristics

𝐶_{𝑖}^{𝑔} = 𝑓^{𝑔 (𝑆_{𝑖}, 𝑈_{𝑖}, 𝐹_{𝑖})}

Where:

$𝑆_{𝑖}$ : asset specificity
$𝑈_{𝑖}$ : Uncertainty
$𝐹_{𝑖}$ : frequency
$𝑔$ : governance structure ( $𝑀$ , $𝐻$ )

Assumptions

\begin{aligned} 𝐶_{𝑖}^{𝑀} & = 𝛼_{𝑀} + 𝛽_{𝑀} 𝑆_{𝑖} + 𝛾_{𝑀} 𝑈_{𝑖} + 𝛿_{𝑀} 𝐹_{𝑖} \\ 𝐶_{𝑖}^{𝐻} & = 𝛼_{𝐻} + 𝛽_{𝐻} 𝑆_{𝑖} + 𝛾_{𝐻} 𝑈_{𝑖} + 𝛿_{𝐻} 𝐹_{𝑖} \end{aligned}

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 $𝑖$ is:

𝑔_{𝑖}^{*} = arg min_{𝑔 \in {𝑀, 𝐻}} 𝐶_{𝑖}^{𝑔} (𝑆_{𝑖}, 𝑈_{𝑖}, 𝐹_{𝑖})

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 $𝑖$ and $𝑗$ be linked transactions
Joint transaction cost:

𝐶_{𝑖 𝑗}^{joint} < 𝐶_{𝑖}^{𝑀} + 𝐶_{𝑗}^{𝑀}

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