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The Costs of Organization

The Costs of Organization. Masten , Meehan & Snyder 1991 Journal of Law, Economics & Organization 7(1): 1-25. Jeff Savage. Theory. Firms internalize operations to mitigate imperfect contract problems due to uncertainty, bounded rationality and opportunism.

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The Costs of Organization

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  1. The Costs of Organization Masten, Meehan & Snyder 1991 Journal of Law, Economics & Organization 7(1): 1-25 Jeff Savage

  2. Theory • Firms internalize operations to mitigate imperfect contract problems due to uncertainty, bounded rationality and opportunism. • However, when firms attenuate the residual claimant status of upstream transactors, they sacrifice the high-powered incentive advantages of market exchange; this demands greater investment in monitoring and administration. • In the past, theorists hadn’t paid attention to factors which influence the level of these internal organization costs. • The authors show whether and to what extent variations in internal rather than market organization costs are responsible for observed variations in organizational form.

  3. Setting—Naval Construction • Construction (as opposed to manufacturing) involves building of a single or small number of finished units. • Asset Specificity is lower—capital & equipment is less specific to a particular transaction. • The unique design & location of construction projects limits the ability to hold inventories of work in progress. • Thus, temporal specificity* may be an important source of holdups.

  4. Results

  5. Results cont.

  6. Summary • The results support some but not all of the standard transaction-cost arguments. • Temporal Specificity Can be a major determinant of organization form. • The prospect of holdups (where timeing of performance is critical) represents a significant hazard of contractual exchange. • What other industries might be characterized by temporal specificity holdup problems?

  7. Discussion • How distinct are internal and market organization costs? • Now that we are looking at internal organization costs, what effect would forming a labor union have on a firm? On an industry? • How does this paper connect with the Argyres and Liebeskind 1999 paper? Ouchi 1979? • In summary, it is important to look at both the internal organization costs, as well as the market transaction costs when we are analyzing the integration decision.

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