Transaction cost economics (TCE)

Question 1

Two challenges with market transactions:

Answer 1

1. Hold-up problem

2. Adaption problem

Question 2

What is the hold-up problem?

Answer 2

The hold-up problem is a situation where two parties may be able to work most efficiently by cooperating but refrain from doing so because of concerns that they may give the other party increased bargaining power and thus reduce their own profits. When party A has made a prior commitment to a relationship with party B, the latter can ‘hold up’ the former for the value of that commitment. The hold-up problem leads to severe economic cost and might also lead to underinvestment.

Question 3

What is the adaption problem?

Answer 3

Circumstances may require parties to change
previously planned courses of action (i.e., uncertainty, E.g., changing in customer preferences and changing moves by
competitors). Organizing for adaptation (e.g., contingency contracts) is non-trivial.

Question 4

Institutions of governance

Answer 4

A perfectly functioning legal system for defining contract laws and enforcing contracts does not exist (costless court ordering is a fiction)
• Much of the contract management and dispute settlement
action is dealt with directly by the parties – through private ordering
• Governance is an effort to create order, thereby to mitigate conflict and realize mutual gain
• A governance structure reshapes (ex ante and ex post) incentives (Gibbons 2005)

Question 5

Institutions of governance - three key steps:

Answer 5

1. Explicate the principal dimensions with respect to which transactions differ (e.g., asset specificity, uncertainty)
2. Explicate the principal attributes for describing
   governance structures (formal and informal rules of
   exchange; e.g., markets, firm…)
3. Effect a discriminating match according to which transactions are aligned with governance structures so as to promote cooperation (and minimize costs)

Question 6

Hierarchical governance. Why and how?

Answer 6

Cost of contracting (including opportunity costs)
may make hierarchical governance the
preferred organizational response (despite it’s
inefficiency).
• Hierarchical governance:
−Ownership grants authority
−Ownership increases detection ability (behavioral control)
−Ownership creates “atmosphere”

Question 7

Combination of hold-up and adaption problem

Answer 7

Hold-up/Adaption

1. Low-Low (Market-switch)
2. Low-High (Market-switch)
3. High-Low (Contract)
4. High-High (Integrate)