Contractual Commitments, Bargaining Power, and Governance Inseparability: Incorporating History into Transaction Cost Theory Argyres & Liebeskind (1999) – AMR Awais A Khuhro PhD – IB – 1 st YEAR

Abstract: Conditions made by a firm can limit its ability to differentiate or change its governance arrangement in the future: A condition they term governance inseparability (GI).  Prior contractual commitments  Changes in bargaining power between a firm and its exchange partners.

Motivation:  Extend TCE: Which is Behavioral theory of firm.  Characteristics of isolated transactions can be insufficient to explain the scope of the firm.  Constrain a firm’s governance option in two ways  Switching – rely same kinds of transactions.  Governance differentiation – move forward by using same governance.  TO extend TCE  By incorporating two factors that serve to produce governance inseparability ( i.e., prior contractual commitment and changes in bargaining power).  They are costly

Theory development TCE theory of the firm, an individual transaction is the unit of analysis for predicting organizational form (Williamson, 1985). Isolated transactions can be insufficient to explain the scope of the firm. Bring in - Governance Inseparability Constraints Governance Switching Governance Differentiation Factors Contractual Commitments Changes in Bargaining Power

Factors explanation Governance Inseparability Contractual Commitment (formal & Informal) Changes in Bargaining Power *Governance Differentiation *Governance Switching *– ve Relationship

Contractual Commitments and Constraints on Governance Switching When a firm cannot efficiently enter into a governance arrangement of Type Y in future periods for a particular transaction because it already has a governance arrangement of Type X in place with another party for that transaction. Exclusive Franchising Agreement COKE COMPANYINDEPENDENT COMPANIES “Restricts forward integration.”

Contractual Commitments and Constraints on Governance Differentiation (Governance Inseparability) – When a firm is obligated to enter a governance arrangement of type X with one part because it already has a governance arrangement of type X in place with another party. Commonly arises when the firm wants different internal organizational arrangements. Institutional theory also asserts that certain types of contractual arrangements can become difficult to change overtime, hence difficult to differentiate on a transaction by transaction basis.

Is Governance Inseparability Avoidable? BIG NO. Reasons Contractual Commitments: Firms cannot exist efficiently without commitments Contractual commitments are necessary for a firm to earn economic rents. Changes in Bargaining Power: Due to the large number of interrelated factors that affect the relative power of contracting parties, changes in bargaining power are difficult to foresee.

Implication of Governance Inseparability Governance Inseparability has important implications for Transaction cost theory. Predicting the relationship between the characteristic of individual transactions and the mechanism that are used to govern them. Implication of the theory of the limits to the scope of firm. Theoretical relationship to be forged between transaction cost theory and theories of competition & Industry evolution.

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.

We conclude Rational/main ideas: Most firms will become constrained over time by their existing arrangements in place, which will limit both their scope and their strategic flexibility. TCE: (long-term) contract makes both firms adapted effectively (Williamson, 1985) Social Views: e.g., Social mechanism: social norms(Joshi & Arnold, 1997; Clan (Ouchi, 1980); mutual trust (Dyer & Chu, 2003;Hedlund, 1994) can help both firms adapt better.

We conclude Rational/main ideas: Continue 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. Governance inseparabilities often have an important impact on governance choices and must therefore be accounted for in a “positive” (i.e., descriptive) theory of governance.