Organizational Economics

Transaction Cost Economics

Underlying the aforementioned insights is the notion that transaction costs describe organizations as governance structures. That is to say, transaction cost economics sees and describes firms as governance structures in organizational forms and not as production functions. Transaction cost economics focuses on transactions and the costs of carrying them out. The transaction is defined loosely as a transfer of good or service and is the unit of analysis. In a world of imperfect information, transaction costs are positive and rising, exchanges are governed, and some forms of governance are more efficient than others.

Organizations are then seen as hierarchical institutions in response to the presence of positive and rising transaction costs in the market. Certain costs are saved by removing them from the sphere of the market and bringing them within the boundary of the organization. The efficiency criterion of the transaction cost model determines the boundaries of the organization by internalizing transactions within the hierarchy (firm) when they are too costly to be carried out in the market. The key concepts that form the basis of transaction cost theory include bounded rationality (limitations on the individual's information processing abilities, i.e., cognitive abilities), opportunism (selfinterest seeking with guile), and asset specificity (specialization of assets with respect to use or users, assets whose value is higher in their current use than in alternative uses). These are also conditions inherent within organizations. The coexistence of these conditions poses efficiency problems for the price mechanism, thus leading to the emergence of the firm. Combining these conditions with environmental characteristics, uncertainty, and frequency, Williamson has elaborated on how different governance structures such as markets, hybrids, and firms can emerge. These governance structures are seen as responses to the nature and types of contract agreements. They are also employed to guard against the hazards of contracting and will vary depending on administrative controls, contract laws, and incentives.

...