1、Chapter 8 Transaction and influence costsGeorge HendrikseEconomics and Management of Organisations:Co-ordination,Motivation and Strategy What is a firm?Coase(1937)What is the difference between the employer-employee relationship and the customer-grocer relationship?According to Alchian and Demsetz t
2、here is no difference.“I can punish you only by withholding future business or by seeking redress in the courts for any failure to honour our exchange agreement.This is exactly all an employer can do.He can fire or sue,just as I can fire or sue my grocer by stopping purchasing from him or sue him fo
3、r delivering faulty products.”A realistic organisation theory is not possible with complete(contingent)contractse.g.customer grocer relationshipFigure IV.2:Positioning Part IV:Nexus of incomplete contracts Bounded rationalityThe gap between the cognitive capabilities of the decision maker and the co
4、mplexity of the activity.ImplicationContracts are incomplete,i.e.circumstances may emerge which are not covered by the contract.Incompleteness is due to:Unforeseeable circumstances Costs of writing contracts Ambiguity of language Costs of enforcing contractsProblemWho decides in unforeseen contingen
5、cies?SolutionThe incomplete contract is completed by allocating the authority to decide in unforeseen contingencies to somebody.There are two behavioural assumptions in TCE Opportunism Bounded rationalityThere are three environmental variables Asset specificity Frequency UncertaintyTransaction costs
6、 Costs of collecting information Time spend on enforcing contracts Costs of preventing non-compliance Organisational solutions are chosen to minimise transaction costs,i.e.to limit the hazards associated with incomplete contracts.Figure 8.5:Transaction costs economics Specificity of investmentsDegre
7、e of uncertaintyFrequencyOpportunismLimited rationalityChoice of governancestructurePossible governance structures Market Hierarchy,e.g.firm,cooperative Hybrid,e.g.long term contract,franchiseAsset specificityInvestments which have a higher value within a specific relationship than outside it.Types
8、of asset specificity Physical asset specificity Human asset specificity Location specificity Dedicated assets Brand name Time specificitySunk costsNon-recoverable costsRelationship specific investments are vulnerable for ex post opportunistic behaviour.Fundamental transformationA situation with many
9、 potential sellers/buyers ex ante is changed in a bilateral monopoly ex post because only one party really invests in the(specific)relationship.Hold-up problemAn investor puts himself in a vulnerable position,i.e.low bargaining power,by investing ex ante in relation-specific assets.The other party i
10、s able to receive improved contractual conditions at the expense of the investor by threatening ex post to end the relationship.Quasi-surplusValue of an investment in the current relationship minus the value of an investment in the best alternative use.Example:Developing softwareCost of investment:2
11、00Sunk costs:KValue of investment:240Surplus=value costs=240 200=40Quasi-surplus=surplus+sunk costs=40+KFigure 8.1:Composition of the revenues 40 Surplus K Sunk costs 200-K Recoverable costs Figure 8.2:Reservation prices/threatpoints before and after the fundamental transformation ex ante ex post Up
12、stream inventor 200 140 Downstream party 240 240 Suppose K=60Figure 8.3:Contract prices before and after the fundamental transformation Suppose that the governance structure is such that the(quasi-)surplus is divided 50-50.Strategic situation(ex ante)(ex post)yesno2020-10 50yesno00Upstream partyDown
13、stream partyobeying contract?payment upstream investorpayment downstream partyInnovate?What is efficient?Innovate,because it generates a surplus of 40,while not innovating results in a surplus of 0.What will happen?Determine SPEHold-up(ex ante)(ex post)yesno2020-10 50yesno00hold-upUpstream partyDown
14、stream partyobeying contract?payment upstream investorpayment downstream partyInnovate?Subgame perfect equilibriumUpstream party:?Downstream party:NoHold-upIs hold-up bad?No.Hold-up entails just a redistribution of the surplus.Yes.The prospect of hold-up may have an effect on investment behaviour.Ho
15、ld-up problem(ex ante)(ex post)yesno2020-10 50yesno00hold-uphold-up problemUpstream partyDownstream partyobeying contract?payment upstream investorpayment downstream partyInnovate?Subgame perfect equilibriumUpstream party:NoDownstream party:NoEquilibrium payoffsUpstream party:0Downstream party:0This
16、 equilibrium is inefficient because each party can earn 20.Conclusion/problemThe governance structure 50-50(Market exchange)results in underinvestment due to the prospect of(opportunistic)hold-up.The efficient(surplus maximising)investment is not chosen.SolutionChoose an organisational solution,i.e.
17、another governance structure,which results in the efficient choice of investment.Consider vertical integrationMarket governance,i.e.the buy mode,results in problems.Vertical integration governance,i.e.the make mode,may result in fewer problems.Vertical integration entails that the contract will be h
18、onoured,according to Williamson.Strategic situationyesyesNoNoUpstream investorInvest?200200020020MarketVertical integration Governance structure choiceDownstream party-10 50Honor contract?yesNoyesyesNoNoUpstream investorInvest?200200020020MarketVertical integration Governance structure choiceDownstr
19、eam party-10 50Honour contract?yesNoSubgame perfect equilibriumImplicit assumption:the efficient governance structure will emerge(Efficiency is used as a normative concept in TCE.)yesyesNoNoUpstream investorInvest?200200020020MarketVertical integration Governance structure choiceDownstream party-10
20、50Honour contract?yesNoSubgame perfect equilibriumFigure 8.7:Governance structure as a function of asset specificity and the degree of uncertainty Degree of uncertainty Low High Asset Low Market Market specificity High Long-term contract Hierarchy Figure 8.8:Governance structure as a function of the
21、 level of asset specificity and frequency Asset specificity Low Medium High Low Trilateral governance Frequency Market structure High Bilateral governance structure Unilateral governance structure Figure 8.9:Governance structure choice and asset specificity Cost of organisational governance structur
22、e Asset specificity k 0 k 1 k 2 M(k)X(k)H(k)ApplicationCoal mines and power generators:Quality of coal Design of combustion ovenCoal miningPower generationPower distributionGovernance of the production column?Suppose there is a market between every stage in the production column,i.e.each stage has c
23、omplete authority,i.e.no vertical integration.Indicate authority by an X.Coal miningPower generationPower distributionXXXMarket governanceCoal miningPower generationPower distributionXXExample of vertical integration?Coal miningPower generationPower distributionXXXXXXXWhat is horizontal integration?
24、Governance regarding coal mines and power generators depends on the number of alternative sources of supply.Comparative analysis East coast USA:mines underground,many small mines,many transportation possibilities,coal relatively homogeneous.West coast USA:surface mining,large economies of scale(smal
25、l number of companies),few transportation possibilities,coal quality differences substantial.What does TCE predict?Governance choices East coast:Spot contracting West coast:Long term contractsPositioning of TCE regarding Fundamental welfare theorem Coase theorem Law of comparative advantagesTCE emph
26、asizes the disadvantages of markets,while the disadvantages of hierarchies receive hardly any attention.Disadvantages of hierarchy Bureaucratic costs Non-integration,i.e.the choice for market exchange,is a commitment to not intervene Incentives are less intense in a hierarchy than in a market,i.e.th
27、e equal compensation principleInfluence costsHow to assign stewardesses to flights?Asset specificity is not very helpful in addressing the question regarding the assignment of stewardesses.Internal labour marketsThe incompleteness of contracts prevents that all kinds of specific characteristics of a
28、 job are not included and rewarded in labour contracts.These imperfections give rise to influence costs.Examples of influence costs Political activities Lobbying Distorting or manipulating information(performance padding,window dressing)There are attractive as well as unattractive jobs in organisati
29、ons(because it is too expensive for the employer to design a complete contingent labour contract for each position).(Attractiveness has no meaning in a world with complete contingent contracts.)Each employee has an interest in influencing the decision-making process such that he obtains the attracti
30、ve position.Influence costsInfluence costs are the costs of activities aimed at capturing organisational rents.There are three types of influence costs1.Non-productive use of time and effort2.Bad decisions for the organisation due to distorted information and advice3.Costly organisational precaution
31、s in order to limit rent seeking activitiesThere are two requirements for the occurrence of influence activities Somebody has to have power Interested organisational members have to have access to means in order to influence the decision makersOrganisational responses1.Abandon the policy of selectiv
32、e intervention by divesting certain departments2.Limiting the access to the decision-making process3.Reducing the rents for which the parties compete1.Selective interventionLaw of forbearanceCourts refuse jurisdiction over internal disputes except where fraud,illegality or conflicts of interests are
33、 shown.Firms therefore have access to fiat.Selective interventionSelective intervention entails that the employer can decide to a certain extent what the employee has to do.Problems of selective intervention Opportunism,bribes Persuade or manipulate top managementBureaucracy may be attractive from a
34、n influence perspective because it discourages rent-seeking activities.ResultAn efficient organisation limits the freedom of choice of(local)decision makers when choices have hardly an impact on the organisation,but are important from the perspective of individual organisation members.2.Access to th
35、e decision making processFigure 8.14:Optimal decision processesIndividual effectsOrganisational effectsopen processesclosed processesApplication:assigning stewardesses to flightsPersonnel submits a list of desired flights every month.Management has no discretion regarding the assignment of flights.C
36、onflicts are resolved by seniority.This discourages influence activities.3.Reducing the rentsApplication:wage inequalityLimit the wage difference between attractive and unattractive jobs.More general:Limit wage inequality,i.e.wage compression.Remarks1.What limits the size of the firm?Fundamental wel
37、fare theoremNothing(Production function view)Complete contractingNothing(Nexus of complete contracts view)Property rights theoryA larger entity implies reduced incentives for various parties.(Nexus of incomplete contracts view)Influence costsThe number of information flows grows rapidly when the org
38、anisation expands.(Nexus of incomplete contracts view)Figure 8.13:Influence costs and the size of the firmInfluence costs will increase much faster than the benefits when the organisation expands.2.TCE versus influence costs TCE focuses on asset specificity Influence costs highlights bargaining costs and the costs of centralised decision making TCE takes a market failure perspective,while the influence costs approach takes an organisational failure perspective
