CONTRACTUAL COMMITMENTS, BARGAINING POWER, AND GOVERNANCE INSEPARABILITY: INCORPORATING HISTORY INTO TRANSACTION COST THEORY NICHOLAS S. ARGYRES JULIA PORTER LIEBESKIND University of Southern California Academy of Management Review, 24(1): 49-63 Presented by Thomas DeBerge, Fall 2017

The Argument Basic Assumption of TCE: Organizational form can be predicted using an individual transaction as the unit of analysis (Williamson, 1985). Authors’ extension of TCE: The characteristics of an individual transaction cannot always explain the scope of the firm, since the governance of a new transaction may be constrained by the governance of transactions in which the firm is already engaged. This is called governance inseparability – “a condition in which a firm's past governance choices significantly influence the range and types of governance mechanisms that it can adopt in future periods.” The basic behavioral assumptions of TCE (such as bounded rationality and opportunism) need not change in order to incorporate governance inseparability; rather, the use of the individual transaction as unite of analysis needs to be “tempered”

Governance Inseparability Types of Governance Inseparability “Causes” of Governance Inseparability Constrained Governance Switching: (Cannot switch from type x to type y governance) Constrained Governance Differentiation: (Cannot enter into another type x governance arrangement) Contractual Commitments: “an agreement between two or more parties that is binding on those parties, to the degree that to renege on the agreement will be costly.” Formal and Informal By necessity, usually long-term in nature and always incomplete Examples: Franchising agreements and exclusive dealerships Coca-Cola and independent bottling companies New venture division in a corporate structure Single transfer pricing rules Bargaining Power: “the ability of one party to a contract to be able to influence the terms and conditions of that contract or subsequent contracts in its own favor” Power increases unexpectedly and, often times, gradually (long-term) Uncertain legal decisions/environment Interrelated factors that affect relative power of contracting parties Unionized labor attempts to restrict outsourcing UAW strike against GM in 1996 Franchising and the growth of francisee organizations (AFA and AAFD) Long-distance trucking companies seeking to enter short-haul industry American Airlines seeking to establish short-route subsidiary, American Eagle

Implication : Use of alternative Governance mechanism Proposition 1: Different firms may govern identical transactions in different ways, as long as each firm is also a party to other types of transactions. Proposition 2a: Compared with younger firms, older firms more often will be obligated to use market contracting to govern transactions featuring asset specificity for the same level of firm bargaining power. Proposition 2b: Compared with younger firms, older firms more often will be obligated to use hierarchical mechanisms to govern generic transactions for the same level of firm bargaining power. Proposition 3: Firms operating in jurisdictions in which labor unions are accorded more bargaining power will be obligated more often to use hierarchical mechanisms to govern generic transactions than will firms operating in jurisdictions in which labor union power is more restricted.

Implication; Limit to firm scope Proposition 4: The greater the difference is between a transaction’s optimal governance mechanism and a firm’s governance arrangements in place, the greater the cost will be to the firm of internalizing that transaction. Proposition 5: Greater uncertainty will reduce the vertical and horizontal scope of the firm.

Implications for TCE theory Predicting the relationship between individual transactions and the governance mechanisms If governance options are constrained by the governance of past transactions, suboptimal governance would be occur than if the transaction were considered alone. Hence, we would observe increased empirical variation in a given transaction. Hence, Proposition 1 Older firms have more constraints than younger firms. Hence, Propositions 2a and 2b The legal jurisdiction in which the firm operates will have a considerable effect. Hence Proposition 3

Implications for TCE theory 2. Understanding the limits of the scope of the firm “firms will become specialized to both particular types of governance arrangements and to particular types of transactions.” Vertical integration and diversification may be constrained by transaction costs if internalizing the required transactions cannot be governed efficiently by the existing arrangements. Hence, Proposition 4 Uncertainty will reduce the scope of the firm since it engenders the existence of governance inseparability.

Implications for TCE theory Forging a relationship between TCE theory and competition/industrial evolution theories Suboptimal governance does not necessarily mean that the transactions will not be profitable, even in a competitive environment. Though long-term adjustments will take place Amendment of Organizational Inertia: “organizations will be inert according to the degree that the contractual commitments they entered into in earlier periods constrain their subsequent governance options, either by directly engendering governance inseparability or by exposing the firm to changes in bargaining power that result in governance constraints.”

Discussion What are other examples – specific or general - of governance inseparability not mentioned in the paper? What replaces the “individual transaction” as the unit of analysis for Argyres and Liebeskind (1999)? What other theories could possibly make use of the concept of governance inseparability?