Opportunistic Behavior

Conceptual Overview

Self-interest and the maximization of individual outcomes is a major assumption of neoclassical microeconomics, which has been around since about 1870. The assumption of opportunistic behavior, which, together with bounded rationality, represents the central assumption in the argument of transaction cost economics, aggravates the concept of individual utility maximization. Williamson, one of the leading figures of the transaction cost perspective, argues that individuals are not only utility maximizers but do so with guile and deliberately mislead, disguise, obfuscate, and confuse if this is in their interest.

There are two forms of opportunism: ex ante and ex post. Ex ante opportunism is also called adverse selection, which implies the inability of agents to assess the characteristics of other agents and the unwillingness of these other agents to disclose their true characteristics. Ex ante opportunism results from precontractual information asymmetries. Ex post opportunism, or moral hazard, includes self-interested misbehavior by agents to the detriment of others when the agents do not bear the full consequences. Ex post opportunism in the case of transactions involving transaction-specific investments is also called a holdup problem. Asset specificity is the degree to which an asset can be redeployed to alternative uses and by alternative users without sacrifice of value. High asset specificity implies high vulnerability of the party that makes the investment because there is a danger that the second party will try to change the terms of the transaction in its favor once the first party has committed itself. For example, if a firm has incurred sunk costs in developing equipment that is specifically designed for a particular client, the client might try to negotiate a lower price, knowing that the supplier has invested in a specific asset with no alternative use.

Williamson stresses that assuming opportunistic behavior does not imply that all human agents are continually given to opportunism. Rather, it is assumed that some individuals are opportunistic some of the time and that it is costly to ascertain the trustworthiness of individuals ex ante. Thus, human agents have to be aware of the existing danger of opportunistic behavior and have to make ex ante screening efforts and put in place ex post safeguards, such as laws, contractual agreements, and specific governance instruments in order to prevent opportunistic behavior. Otherwise, those who are more opportunistic will be able to exploit those who are less opportunistic. The function of safeguards is to increase the costs of opportunistic behavior and as a result to make it less profitable for human agents. Reputation represents one such safeguard. In a world of costly and incomplete [Page 1005]contracts, trust and reputation are crucial to realizing many transactions. Thus, concern with getting a bad reputation that reduces future possibilities for profitable transactions can limit reneging and, effectively, reduce the incentives for opportunistic behavior by creating costs offsetting the short-term gains of such behavior. Consequently, people do not always behave opportunistically, because of the existence of penalties and safeguards.

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