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    Organizational Economics: Notes on the Use of Transaction-Cost Theory in the Study ofOrganizationsAuthor(s): James A. RobinsSource: Administrative Science Quarterly, Vol. 32, No. 1 (Mar., 1987), pp. 68-86Published by: Johnson Graduate School of Management, Cornell UniversityStable URL: http://www.jstor.org/stable/2392743 .

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    OrganizationalEconomics: Notes onthe Use of Transaction-Cost Theory in the Studyof OrganizationsJames A. RobinsUniversity of California,Los Angeles

    (? 1987 by CornellUniversity.0001 -8392/87/3201-0068/$1 .00.Iwould like to thank RichardDaft, Scott Ed-mundson, GarethJones, Michael Masuch,and the anonymous ASQ reviewers for in-sightful comments on earlier drafts of thispaper. The ideas presented in italso owe agreat deal to discussion and debate amongmembers of the Organizationand StrategicStudies group of the UCLAGraduateSchool of Management, including (amongothers) Jay Barney, WilliamOuchi, andRichardRumelt. None of these individualsbears any responsibility for errors or idio-syncratic opinions that remain inthe paper.An earlier version was presented at theAcademy of Management Annual Meetingin 1985.

    Transaction-cost theory has helped to give new life to someof the classic issues of organization studies through the useof microeconomic models. However, the assumptions un-derlying these models have not been examined carefully,and this has produced serious logical and empirical weak-nesses in recent works. This paper reviews transaction-costapproaches to organizational analysis, examines their useof microeconomic theory, and identifies some importantflaws in the work. It concludes by arguing that transaction-cost theory can be a powerful tool for organizational andstrategic analysis but that it must be set within the frame-work of more general organization theory.The last decade has witnessed rapidgrowth of interest ineconomics among students of organizations. The developmentof what has been called the new institutional economics(Williamson, 1979) has helped to renew concern for some ofthe central questions of organizationtheory. Issues such as theanalysis of vertical integration have turned the attention ofeconomists to traditionalproblems of the definition of organiza-tional boundaries, and their work has begun to have an impor-tant impact on the field of organization studies. Recent re-search in the field has recast the organization as a "stablepattern of transactions" (Ouchi, 1980: 140) and employed con-cepts from economics to analyze internalexchange.The influence of economics on organization studies has been amixed blessing. Ithas had the positive effect of pushing thefield in the direction of greater rigor by encouraging theorists touse more precise definitions and to buildsystematic theoryfrom general axioms about social behavior. But it also has car-ried with it the liabilities of any effort to step outside the field insearch of new concepts or metaphors. Ithas been conducive tothe sort of incautious borrowing of ideas that Pinder and Bour-geois (1982) identified as an endemic weakness of organiza-tional research.Some of the recent work inorganization studies reflects thisweakness. A growing body of research has attempted to applyconcepts borrowed from areas such as the economics of law oreconomics of industrialorganization to analysis of the originsand structure of complex organizations (Williamson, 1975;Ouchi, 1980; Jones, 1983). The uncritical use of market modelshas led to serious logical and empirical flaws in much of thiswork.The principalpurpose of this paper is to review these flaws andlook at their implications for the development of organizationstudies. This entails discussion of three general issues. First,the paper will examine how recent work on transaction costs isshaped by concepts borrowed from economics. Second, it willidentify assumptions that are criticalto the use of these con-cepts in neoclassical economics. And third,the paper will indi-cate ways in which transaction-cost analysis of organizationsfails to meet some of the fundamental assumptions of the mi-croeconomic logic.Iwill argue that the weaknesses of the work on transactioncosts are not due to inherent flaws in the approach but stemfrom an excessively ambitious objective: the attempt to explainthe causes or origins of organization structure. There are press-

    68/AdministrativeScience Quarterly,32 (1987):68-86

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    Formaldefinitions of transaction costs areremarkablyrare in the literature.The defini-tion suggested here has the virtue of high-lightingthe relationship between transac-tion costs and market imperfection.Transaction cost is a residual category es-sentially composed of the factors that pro-duce idiosyncratic prices, i.e., prices thatvary across purchasers of a good (see Dahl-man, 1979, for a discussion of alternativedefinitions of transaction costs).

    Organizational Economicsing reasons for this attempt, but the attempt proves to be theAchilles heel of the current literature. As the conclusion of thepaper will suggest, the fact that transaction-cost analysis hasbeen yoked to causal explanation has resulted not merely inflaws in the current work, but in the loss of important oppor-tunities for the development of research on strategic organiza-tion. Iftransaction-cost analysis is relieved of the burden ofcausal explanation, it may provide valuable tools for organiza-tional and strategic analysis.THE TRANSACTION-COST LOGICIN ORGANIZATIONSTUDIESAlthough transaction-cost theory has been used to analyze awide variety of organizationalactivity, including bureaucracy(Williamson, 1979), vertical integration of production (William-son, 1971; Klein,Crawford, and Alchian 1978), clan-like rela-tions within firms (Ouchi, 1980), and organizationalculture(Jones, 1983), its underlying concepts are not complex. Inbasicterms, transaction costs are those costs associated with aneconomic exchange that vary independent of the competitivemarket price of the goods or services exchanged.1 They includeall search and information costs, as well as the costs ofmonitoring and enforcing contractual performance. Althoughthese costs are independent of the competitive market price ofthe goods or services, they are determined by the nature of theexchange. Issues such as the difficultyof setting prices or mea-suring the performance of services are instrumental indeter-mining transaction costs.The determination of transaction costs and their effect on ex-change have been explored at some length by Williamson(1975, 1979) buildingon the earlierwork of Coase (1937).Williamson (1979) cited factors such as uncertainty in deter-mining appropriate (competitive) prices, difficulty in monitoringand enforcing postcontractual performance, and the necessityof specialized (transaction-specific) investments as majorsources of transaction costs. He argued that these costs maybe reduced by the organization of exchange through a variety ofnonmarket mechanisms, including bureaucratic administration.While administered transactions may involve higher costs thanmarket organization ina purelytheoretical world with friction-less exchange, costs of administration inthe realworld oftenare outweighed by reductions that administered exchangeachieves in transaction costs.Bureaucratic organization, for example, involves both the costof maintainingan administrative apparatus and a potential lossdue to the (theoretically)greater efficiency of the market intransmitting information. However, these costs may be smallerthan the alternative costs that would be associated with con-tracting for complex labor skills on a task-by-task basis. Re-duced to essentials, the argument is a simple one; wheremarket organization of economic exchange is cumbersome andcostly, other forms of transaction governance (such as con-tingent contracting, third-partyarbitration,or bureaucratic orga-nization) may prove efficient. Nonmarket forms of exchangewill arise in situations in which markets "fail,"that is, when al-ternative forms possess greater efficiency.Ouchi(1980) carried his line of reasoningone step furtherandarguedthat there also are situations n whichbureaucratic d-691ASQ,March 1987

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    ministration of exchange is extremely costly. Inthose situa-tions, clan-likeforms of organization may be efficient. Complexforms of work, for example, may requirea degree of flexibilityand innovation that precludes standardized monitoring andmerit-reward systems. Under those circumstances, compen-sation must be based on other criteria,such as tenure inthe organization or group performance. Strong norms of organi-zational solidarityare required for these incentives to be effec-tive in