The Costs of Organization Masten, Meehan & Snyder 1991 Journal of Law, Economics & Organization 7(1): 1-25 Jeff Savage

Theory Firms internalize operations to mitigate imperfect contract problems due to uncertainty, bounded rationality and opportunism. However, when firms attenuate the residual claimant status of upstream transactors, they sacrifice the high-powered incentive advantages of market exchange; this demands greater investment in monitoring and administration. In the past, theorists hadn’t paid attention to factors which influence the level of these internal organization costs. The authors show whether and to what extent variations in internal rather than market organization costs are responsible for observed variations in organizational form.

Setting—Naval Construction Construction (as opposed to manufacturing) involves building of a single or small number of finished units. Asset Specificity is lower—capital & equipment is less specific to a particular transaction. The unique design & location of construction projects limits the ability to hold inventories of work in progress. Thus, temporal specificity* may be an important source of holdups. *The original four are physical asset specificity, site specificity, human asset specificity, and dedicated assets (Williamson)

The sharp distinction often drawn between internal and market organization costs, while expedient, is artificial. In reality, organization entails a multiplicity of activities independent of the governing institution. Planning, bargaining, contracting, monitoring, enforcing, and so on are common to both internal and market exchange. What the choice of organization form does is influence the allocation of effort across the elements of this list.

Results

Results cont.

Summary The results support some but not all of the standard transaction-cost arguments. Temporal Specificity Can be a major determinant of organization form. The prospect of holdups (where timeing of performance is critical) represents a significant hazard of contractual exchange. What other industries might be characterized by temporal specificity holdup problems? A: Food, publishing (newspaper vs. book),

Discussion How distinct are internal and market organization costs? Now that we are looking at internal organization costs, what effect would forming a labor union have on a firm? On an industry? How does this paper connect with the Argyres and Liebeskind 1999 paper? Ouchi 1979? In summary, it is important to look at both the internal organization costs, as well as the market transaction costs when we are analyzing the integration decision. The sharp distinction often drawn between internal and market organization costs, while expedient, is artificial. In reality, organization entails a multiplicity of activities independent of the governing institution. Planning, bargaining, contracting, monitoring, enforcing, and so on are common to both internal and market exchange. What the choice of organization form does is influence the allocation of effort across the elements of this list. A labor union could raise the cost of internal organization for the firm; across the industry, it could also make it less efficient. This supports Ouichi’s framework of control (Market/Bureaucracy/Clan); each type may have a different internal organization cost structure. A&L 1999 say that internal organization costs of the past have an effect on future ability to VI based on their effect on the current internal org costs.