The Costs of Organization Scott E. Masten; James W. Meehan, Jr.; Edward A. Snyder Journal of Law, Economics, & Organization, Awais A Khuhro

Overview Article focuses on the role of internal organization costs Internal organization costs play a role in decision to integrate. Due to issues in direct measurement of transaction costs, reduced-form relationships between observed and organizational forms can be used.

Overview and Data These indirect tests can’t distinguish between changes in cost due to market transaction or from the cost incurred due to organizing. Econometrics method are applied to analyze a large naval construction project. The nature of data allowed them to isolate the effects of transaction on the costs of organizing and to provide dollar estimates.

Estimation of Transaction costs Important Hypothesis of TCE Transactors min {transaction costs} I o if G o < G m I* I m if G m ≥ G o Such costs are difficult to observe and measure directly. Selection problem: organization costs cannot be directly observed for organizational forms not chosen. Best case: cost of institution chosen directly compared to cost of alternative institution is not possible. Institutions minimize transaction cost; easy to claim difficult to measure.

Reduced form analysis To address issue of direct measurement above, the observable characteristics were related to the incidence of transaction costs. Base hypotheses on the sign of estimated parameters of linear model of the costs G m and G o, and their relative magnitude; rather than the costs themselves. Linear model of the costs, relate the exogenous variables of the organization.

Direct Tests Firms chose lower cost organization alternative and we could observe the transaction cost incurred under the institution adopted. To test integration decision, we need to know the selection process and data that captures the transaction cost. Application of switching regression techniques could provide estimates for both costs G m and G o. Use of censored regression model, reduces the burden of data.

Data: Naval Ship Building Difference in construction and manufacturing operations influence the circumstances that give rise to opportunism and determine the level of organization cost. Temporal specificity: Despite skills and assets necessary to perform task is fairly common, difficulty of identifying and arranging to have alternate supplier on short notice creates a holdup.

Hypotheses Shipbuilding like other construction operation, mainly involves organizing and coordinating a variety of low technology and labor intensive activity involved in assembly of final product. Hypothesis: The internal organization costs will be smaller and thus the likelihood of integration greater, the more labor intensive and less engineering intensive the production process.

Estimation Results: Make or Buy Decisions

Estimation Results: Costs of Organization

Findings Supports some standard transaction cost arguments. Temporal specificity can be major determinant of organizational form in some settings. Integration becomes more likely in the presence of relationship-specific human capital and for at least very complex components. Effects of physical asset specificity on both organization costs and integration vary across specifications of the equations. The probit estimations indicate that the particular firm we studied is less likely to integrate engineering-intensive activities and more likely to internalize labor-intensive ones.

Criticism Institution chosen Market exchange Reduced form analysis Cost of each alternative Latest cost – for example inflexibility Resulting estimate provides only ordinal measure of the costs