Why do Firms Exist? Flashcards
Two types of Trade Governance?
Market governance of transactions (competitive natures, market prices and free trade)
Hierarchy governance where there is direct control of transactions within the firm.
Explain TCT?
Transaction Cost Theory, coined by Williamson, explains why firms exist and defines how efficiency is achieved by coordinating activities within the firm.
What are the problems/issues with market transactions?
Bounded Rationality - uncertainty in the transaction means you cannot predict every possible outcome. this leads to incomplete contracts.
Opportunism - moving on own self interest, one party may try to maximise their gain at the expense of the other.
When is Opportunism in Market governed trades most likely?
When the Asset is investment specific. such as a supplier entering a contract to produce a specific type of good for customer.
Explain the make or buy problem within firms
Costs on the Y axis
Number of tasks on the X axis.
Base of the TC curve is the optimal number of transactions in the firm. with cost of management rising gradually and transaction costs falling gradually as more tasks are brought inside the firm.
Explain the concept of AQR
Appropriable Quasi-Rents are the excess returns that can be captured through dealing in asset specific investments rather than the open market.
when AQR is high what should happen?
Transactions should be integrated into the firm as issues of opportunism and hold up problems may arise due to AQR.
Bottom Line of TCT
The more uncertainty + the more AQR. the better it is to bring the transaction into the firm and less likely to use market governed trades.
Explain PRT?
Property Rights Theory states that the ownership of the asset confers its right to use and therefore investment incentives in the asset depend on its ownership.
PRT assumes the party gets what?
P = V + 1/2AQR
How do you work the optimal level of investment?
Maximise I1 and I2 od the => Total Value - Cost of Investment. F.O.C and then equate I1 and I2 together.
what is the actual level of investment
Getting the Pi = vi + 1/2 AQR, solving for AQR and then maximising I1 and I2.
Baker and Hubbard (2004)
If driver ownership increases with distance what is this consistent with?
PRT where owners of the asset will have an incentive to use them how they see fit. In long haul driving case, longer trips are driver-owned as a result of moral hazard and wanting more efficiency in driving.
Baker and Hubbard (2004) - Driver Ownership is higher in unidirectional trips, why is that?
Consistent with the idea of PRT in which driver-owned trucks may not look for backhauls compared to carrier owned. As they own the trucks there is less rent-seeking opportunities whereby carrier owners would extract extra journeys for their drivers.
Company Trucks adopted more OBC why is that?
This is the case as the OBC gave company-owned trucks monitoring capabilities. This meant the limitation of moral hazard within their drivers.
