Theories Of Transaction Cost Theory

Transaction cost theory is one of the main approaches to organisational governance structures. It emphasises economic efficiency by economising transaction costs of the market, which are ‘costs of using the price mechanism’ such as costs of searching and information and those of enforcing and monitoring contracts (Coase, 1937: 390; Jones, 1996: 11). Importantly, this theory hypothesises that no perfect competition exists; with propositions of market imperfection and substitutability between firms and markets, when it is more efficient for transaction to be done within the firm than in the market, firms tend to internalise that transaction (Coase, 1937; Argyres and Zenger, 2010: 12). Thus, transaction costs can be decision variables for governance …show more content…
In his theoretical framework, firms will vertically expand until costs of organisational activities within the firm is equalised to costs of the same transaction in the market or other firms; it is a ‘make-or-buy’ decision for entrepreneurs which is a cost-benefit analysis between using market and performing the same tasks within firms (Coase, 1937: 395; Bössmann, 1981: 675; Williamson, 1981: 550). However, this idea was ‘often cited but little utilised’; finally transaction cost theory was laid by Oliver E. Williamson by addressing the question about why transaction costs occur (Ricketts, 2002: 504 Williamson, 1975: 3). He characterised transactions by three factors: ‘asset specificity’, ‘uncertainty’ and ‘frequency’. These potentially raise transaction costs and generate market failure by possibly bringing further …show more content…
In the traditional approach of organisation, under the presupposition of market perfection, the firm was considered as a production function to maximise profits and production costs based on technology were focused, whereas in transaction cost theory, firm is seen as an ‘efficiency-inducing administrative instrument’ to analyse organisational and strategic issues (Langlois, 1992: 100; Leiblein, 2003: 939; Williamson, 1981: 548). Consequently, this theory can attain more microanalysis than the classical approach (Williamson, 1975: 253). Japanese ‘lifelong employment’ system seems to be one example assimilated this analysis; respecting efficacy, firms tend to conclude long-term employment contracts to avoid potential cognitive discrepancy of corporate shared-values and overhead costs. Also, it has become able to deal with privatisation issues which was one of the limitations of traditional microeconomics and carbon-emissions trading by advancing this theory inducing ‘Coase theorem’ that the economic efficiency of an economic allocation and outcome in the presence of externalities (Drakić, 2007). Furthermore, this approach has played a crucial role in consideration of boundaries of firm and marketing strategies by providing several options of governance structures. Indeed,