Contractual Commitments, Bargain-ing Power, and Governance Insepa-

rability: Incorporating History into Transaction Cost Theory

Nicholas S. Argyres and Julia Porter Liebeskind (1999)Academy of Management Review, 24(1): 49-63.

Jae Kyun Yoo

Foundations of Strategy Research (Fall 2013)

Introduction – Transaction Cost Theory (TCE)

Nicholas S. Argyres and Julia Porter Liebskind (1999)“Contractual Commitments, Bargaining Power, and Governance Inseparability: Incorporating History into Transaction Cost Theory.” Academy of Management Review, 24(1): 49-63.

Firms are a particular form of organization for administering exchanges, or “transac-

tions,” between one party and another (Coase, 1937).

Markets

Managerial Hierar-chy

No manage-rial over-

sight

Theory Development

In the TCE theory of the firm, an individual transaction is the unit of analysis for predicting organizational form (Williamson, 1985).

Isolated transactions can be insufficient to explain the scope of the firm.

Governance Inseparability: A condition in which a firm’s past governance choices significantly influence the range and types of governance mechanisms that it can adopt in future periods.

Nicholas S. Argyres and Julia Porter Liebskind (1999)“Contractual Commitments, Bargaining Power, and Governance Inseparability: Incorporating History into Transaction Cost Theory.” Academy of Management Review, 24(1): 49-63.

Constraints• Governance Switching• Governance Differenti-

ation

Factors• Contractual Commit-

ments• Changes in Bargaining

Power

Contractual Commitments and Governance Inseparability

Contractual CommitmentsAn agreement between two or more parties that is binding on those parties, to the degree that to renege on the agreement will be costly.① Formal contracts② Informal or non-legally enforceable contracts (examples:

self-bonding, and social contracts)

Nicholas S. Argyres and Julia Porter Liebskind (1999)“Contractual Commitments, Bargaining Power, and Governance Inseparability: Incorporating History into Transaction Cost Theory.” Academy of Management Review, 24(1): 49-63.

• Contractual Commitments and Constraints on Governance Switching

• Contractual Commitments and Constraints on Governance Dif-ferentiation

Contractual Commitments and Governance Inseparability cont.

Contractual Commitments and Constraints on Governance Switching

When a firm cannot efficiently enter into a governance arrangement of Type Y in future periods for a particular transaction because it already has a governance arrangement of Type X in place with an-other party for that transaction.

Nicholas S. Argyres and Julia Porter Liebskind (1999)“Contractual Commitments, Bargaining Power, and Governance Inseparability: Incorporating History into Transaction Cost Theory.” Academy of Management Review, 24(1): 49-63.

Coca-Cola Independent Bottling Compa-nies

Exclusive Franchising Agreements

“Restricts forward integra-tion.”

Contractual Commitments and Governance Inseparability cont.

Nicholas S. Argyres and Julia Porter Liebskind (1999)“Contractual Commitments, Bargaining Power, and Governance Inseparability: Incorporating History into Transaction Cost Theory.” Academy of Management Review, 24(1): 49-63.

Permitted to retain a higher proportion of its

profits

Contractual Commitments and Constraints on Governance Dif-ferentiation

When a firm is obligated to enter into a governance arrangement of Type X with one party because it already has a governance ar-rangement of Type X in place with another party.

Firm Venture

Incentive contracts hon-ored

Corporate Manage-ment

Managers of Established Divi-sion

Bargaining Power and Governance Inseparability

Nicholas S. Argyres and Julia Porter Liebskind (1999)“Contractual Commitments, Bargaining Power, and Governance Inseparability: Incorporating History into Transaction Cost Theory.” Academy of Management Review, 24(1): 49-63.

Bargaining PowerThe ability of one party to a contract to be able to influence the terms and conditions of that contract or subsequent contracts in its own favor.

Buyer Seller

Buyer Seller

When unionized labor uses its bargaining power to restrict outsourcing: Deere, Ameritech, McDonnell Douglas, Boeing, United Parcel Service, Chrysler, and General Motors.

Bargaining Power and Constraints on Governance Switching

Bargaining Power and Governance Inseparability cont.

Nicholas S. Argyres and Julia Porter Liebskind (1999)“Contractual Commitments, Bargaining Power, and Governance Inseparability: Incorporating History into Transaction Cost Theory.” Academy of Management Review, 24(1): 49-63.

Differentiate its orga-nizational arrange-ments to suit this new market.

Bargaining Power and Constraints on Governance Differentiation

Short-haul

Trucking

Short-haul Jets

Union bargaining power prevented a firm from carrying out a change in or-ganization that it was seeking.

Implications - Use of Alternative Governance Mechanisms

• Proposition 1: Different firms may govern identical transactions in different ways, as long as each firm is also a party to other types of transactions.

• Proposition 2a: Compared with younger firms, older firms more often will be obligated to use market contracting to govern transactions fea-turing asset specificity for the same level of firm bargaining power.

• Proposition 2b: Compared with younger firms, older firms more of-ten will be obligated to use hierarchical mechanisms to govern generic transactions for the same level of firm bargaining power.

• Proposition 3: Firms operating in jurisdictions in which labor unions are accorded more bargaining power will be obligated more often to use hierarchical mechanisms to govern generic transactions than will firms operating in jurisdictions in which labor union power is more re-stricted.

Nicholas S. Argyres and Julia Porter Liebskind (1999)“Contractual Commitments, Bargaining Power, and Governance Inseparability: Incorporating History into Transaction Cost Theory.” Academy of Management Review, 24(1): 49-63.

Implications - Limits to Firm Scope

• Proposition 4: The greater the difference is between a transaction’s optimal governance mechanism and a firm’s governance arrange-ments in place, the greater the cost will be to the firm of internalizing that transaction.

• Proposition 5: Greater uncertainty will reduce the vertical and hori-zontal scope of the firm.

Nicholas S. Argyres and Julia Porter Liebskind (1999)“Contractual Commitments, Bargaining Power, and Governance Inseparability: Incorporating History into Transaction Cost Theory.” Academy of Management Review, 24(1): 49-63.

Implications and Conclusions

• Governance inseparabilities often have an important impact on gov-ernance choices and must therefore be accounted for in a “positive” (i.e., descriptive) theory of governance.

Nicholas S. Argyres and Julia Porter Liebskind (1999)“Contractual Commitments, Bargaining Power, and Governance Inseparability: Incorporating History into Transaction Cost Theory.” Academy of Management Review, 24(1): 49-63.

• Lippman and Rumelt’s (1982) model of competition: Firms are “locked in” to a particular cost function that is drawn randomly from a given distribution. → Lock-in, in part, results from contractual com-mitments.

• Organizational Inertia → Organizations will be inert according to the degree that the contractual commitments they entered into in earlier periods constrain their subsequent governance options.