Firm Presence, Involving in Activities, and Who to Trust. Flashcards
Transaction Cost Theory
Division of Labour requires coordination and that induces cost
Transaction cost =/= financial costs
Two Natural Coordination Mechanism
Markets (External)
Organization (Internal)
Types of Transaction Cost
Search and information costs
Bargaining cost
Policing and enforcement costs
cost minimization by the organization
Whether a particular transaction is allocated to the market, or the job is done
Internally, it is a matter of cost minimization by the organization.
Transaction Cost Economics
- Activities are internalized when the transaction costs of internalization are lower than the cost of outsourcing
- It’s outsourced when the internalizing cost is higher than the outsourcing cost.
Source of Transaction Costs
Bounded Rationality
Bounded Reliability
Bounded Rationality
The capacity of human beings to formulate and solve complex problems is limited. Our decisions are ‘bounded’. Hiring the ‘best’ cleaner or entering the ‘best’ market requires us to make a boundedly rational decision and the efforts to do so constitute a transaction cost. The more complex something is, the higher the transaction cost.
Bounded Reliability
This is considering the human nature of a self-interested creature. Opportunistic behavior damages your reputation and makes the partner lose out. To counter this, we enforce and try to correct this behavior, the effort and cost to do so is Transaction Cost. Reputation only matters when the number of partners/competition is high and therefore the risk of opportunistic behavior is lower. The higher the number of partners/competition involved the lower the risk of transaction cost due to the market automatically culling out bad players, thus lower transaction cost.
The dynamic of transaction cost
The more complex and varied options are for solutions, the higher the transaction cost.
The more trading partners or competition there are the lower the transaction cost.
Three Factors of Particular Transaction Cost
Asset Specificity
Asset Specificity means an asset with a specific use case. Computers have low asset specificity while a newspaper printing press is high.
High Asset specificity implies fewer potential suppliers which implies higher rental costs, which implies that the transaction should be done internally.
Uncertainty/Complexity
High uncertainty/complexity implies higher contracting costs etc. Such transactions are cheaper and done internally.
Frequency
High frequency of use implies that costs can be spread. High-frequency transactions are cheaper when done internally
Agency Theory
This is to describe the problem that arises when the managers and shareholders have different goals.
The agency cost is the sum of
Cost of setting up the relationship
The difference between what the agent did and what the principal would have done
The costs incurred by the principal to mitigate the loss caused by the agent.
Situation where agency theory arises
The principal, the owner usually, pays the agent for performing certain acts that are useful to the principal and costly to the agent.
Agent wants it done while the principal wants it done right.
There are elements of the performance that are difficult for the principal to observe.
The principal has difficulties distinguishing between good and bad agents, done and done right.
Dynamics of Agency Cost
Agency costs increase when there is Information Asymmetry, when one party has more or better information than the other, and Uncertainty when neither party can know everything.
Mitigating and Minimizing Agency Cost
Fully Specify all Contracts
Monitor all agents of the firm
