The Network Economy Session Five February 24, 2010 Information, Transaction Costs & Organizational Change

What Concerns to Beniger & Williamson Have In Common? The Role and Cost of Information in the Economy.

How Do Beniger’s and Williamson’s Solutions Differ Williamson Looks to Organizational Governance Structures. Beniger Looks to Information Technology Infrastructure. Internal vs. External economies

How Does Williamson Differ from Neo-classical Economists? Information is impacted. Rationality is bounded. Institutions matter.

What Are the Origins of the New Institutional Economics? Kenneth Arrow—economies are subject to ‘information failures.’ Karl Llewellyn—contracts are governance structures. Frederick Hayek—the role of idiosyncratic knowledge at the local level.

Origins, cont. John R. Commons—business organizations as governance structures. Frank Knight—the problem of moral hazard. Chester Bernard—organizations are conscious, deliberate and purposeful.

Origins (cont.) Herbert Simon—the notion of ‘bounded rationality.’ Alfred Chandler—organizational form is a determinant of economic performance. Karl Polanyi—local knowledge is created within different organizational contexts. Ronald Coase—if markets work, why organizations?

What Was Williamson’s Unique Contribution? The notion of transaction costs as the central explanatory variable of economic performance and governance structures.

What is Williamson’s Unit of Analysis? Transactions, Contractual Man, & the Governance Frameworks that Order Them! Markets Classical and neoclassical contracts. Bilateral vs. trilateral & relational contracts Vertically integrated firms

What Puzzle Led Williamson to His Investigation? What accounts for governance structures & how they are organized?

How Does Williamson Answer This Question? Organizational forms are best conceived of as means of addressing transaction costs. Governance forms differ, depending on the nature of the transaction and its costs. Explanations are local in nature.

What Are Transaction Costs? The information-related costs of doing business. They include: search costs exchange costs enforcement costs Credit Cards from Andres RuedaAndres Rueda

What Are the Origins of Transaction Costs? Bounded rationality Opportunism with guile Asset specificity

In What Ways Can Assets Be Specific? Site specificity Physical asset specificity Human asset specificity Dedicated assets

How Does Timing Affect Transaction Costs? Adverse selection—an ex ante problem of determining risks. Moral hazard—an ex post problem of assuring that agreements are kept. One needs to look at this in their entirety Agency theory—efforts to reduce these ex post uncertainties through ex ante contracts—i.e. credible commitments, which allow bargaining and contracting beyond the ex ante stage

The Interdependence of Technology, Contract, & Price K>0 A p1s S=0 B p2 S>0 C p3 Contracting for general vs. special purpose technologies

Can Transaction Costs Explain the Company Town? Uncertainties associated with remote location and low skill nature of the job, workers unwilling to build their houses. Mine owners needed to be assured they could cover the costs of their investment by limiting competition.

The Company Town (cont.) Change the situation and the bargain changes. What happens when mobility is assumed—auto, mobile homes, etc.? A means of exploitation – One needs to consider all aspects of the local situation. Ghost Town of Coronet Worker House... from Mike Woodfin Mike Woodfin

What About the Vertically Integrated Firm Backward integration-asset specificity related to location and physical plant. Forward integration—asset specificity related to product differentiation, and specialized consumer durables. Anti-trust implications.

What Are the Choices of Governance Structures? Planning Promise Competition Governance

Matching Situations & Governance Structures Bounded Rationality Opportunism Asset Specificity Contracting Process 0++ Planning +0+ Promise ++0 Competition +++ Governance

In What Ways Can We Characterize Transactions? Standardized or idiosyncratic Occasional or frequent Certain or uncertain

When Do Bureaucratic Solutions Justify Their Costs? For transactions supported by considerable investments in transaction-specific assets. In cases where there is high uncertainty. The costs of specialized governance structures will be easier to recover for large transactions of a recurring type. A trade-off between economizing transaction costs and neoclassical production costs.

When Are Bureaucratic Solutions Inappropriate? When governance costs of internal organizations exceed those of market organization, and there is little asset specificity. When hierarchy creates problems of bounded rationality. Problems of management integrity. The market is less forgiving.

What Governance Structures are Likely Given the Prospect of Future Conditions Blogging Question!