5 - Entrepreneurship, transaction-cost economics, and the design of contracts

Summary

Introduction

As a result of Williamson's pioneering work in relating the theoretical concept of transaction costs to real-world organizational and contractual activities, the field of transaction-cost economics (TCE) emerged and became the central force driving the development of the New Institutional Economics (NIE). Certainly, there can be no doubt about the importance of TCE in influencing neoinstitutional thought. TCE took the analysis of the capitalist firm well beyond the abstractions of neoclassical theory and focused attention on actual institutional arrangements. In particular, it became possible to throw light on how variations in certain characteristics of transactions can operate to bring about differences in the specific contractual designs and organizational structures adopted by business units. Moreover, since transaction-cost analysis is deliberately oriented toward observable relationships, various hypotheses concerning such subjects as the internal organization of firms, the properties of contractual agreements, the role of vertical integration, etc. have become amenable to empirical testing. Thus, today, there exists a large and growing body of factual studies that provides greater understanding of many previously neglected aspects of enterprise behavior.

Despite the valuable insights that TCE has made possible, questions can be raised about the adequacy of the approach as a means for addressing the full range of issues that have relevance for contracting and the theory of the firm. In the standard presentation, TCE offers a somewhat specialized view of the capitalist firm's motivations and adaptive behavior. As Masten has put it: “The central tenet of transaction-cost economics is that the efficiency of alternative organizational arrangements turns on a comparison of the costs of transacting under each” (Masten 1996, 4).