The Cost of Organization

1
The Cost of Organization

• Scott E. Masten James W. Meehan, Jr. Edward A.
  Snyder
• Journal of Law, Economics, Organization, Vol.
  7, No. 1. (Spring, 1991), pp. 1-25

2
Interorganizational Costs

• Internal organization costs play a role in
  decision to integrate.
• Due to issues in direct measurement of
  transaction costs, reduced-form relationships
  between observed and organizational forms can be
  used.
• These indirect tests cant distinguish between
  changes in cost due to market transaction or from
  the cost incurred due to organizing

3
Estimation of Transaction costs

• Main Hypothesis of TCE
• Transactors min transaction
  costs
• Io if Go lt Gm
• I
• Im if Gm Go
• Such costs are difficult to observe and measure
  directly
• Selection problem organization costs cannot be
  directly observed for organizational forms not
  chosen.
• Best case cost of institution chosen directly
  compared to cost of alternative institution is
  not possible.
• Institutions minimize transaction cost easy to
  claim difficult to measure

4
Reduced form analysis

• Reduced form analysis
• To address issue of direct measurement above, the
  observable characteristics were related to the
  incidence of transaction costs
• Base hypotheses on the sign of estimated
  parameters of linear model of the costs Gm and
  Go , and their relative magnitude rather than
  the costs themselves.
• Linear model of the costs, relate the exogenous
  variables of the organization.
• Direct Tests
• Firms chose lower cost organization alternative
  and we could observe the transaction cost
  incurred under the institution adopted.
• To test integration decision, we need to know the
  selection process and data that captures the
  transaction cost.
• Application of switching regression techniques
  could provide estimates for both costs Gm and Go
  
• Use of censored regression model, reduces the
  burden of data.

5
Transaction Cost Differentials

• Perquisite to apply censored regression technique
  is the need to distinguish the cost of internal
  and market exchange and then relate the incidents
  of each to the attributes of transaction. Not
  easy!!!
• Contracts not explicit in internal organization
• Little attention has been paid to the factors
  that effect the level of these costs. Exception
• Ronald Coase Understanding the effect of
  activities in which the firm is already engaged
  on the cost of undertaking additional activities
  is essential to explain why particular operation
  are organized within specific firms.
• Internal organization costs are higher for
  differentiated (by location or characteristics)
  transaction cost for which there is uncertainty.
• Higher levels of uncertainty and complexity on an
  average leads to larger probability of
  integration.
• However similarity in transaction, could not
  effect costs of market exchange since
• Transactors care about the final outcomes and not
  the production process
• In addition to familiarity of transactors with
  each others techniques making it easy to detect
  opportunistic behavior , does not imply
  successful enforcement.
• Similar transactions are integrated.

6
Data Naval Ship Building

• Difference in construction and manufacturing
  operations influence the circumstances that give
  rise to opportunism and determine the level of
  organization cost.
• Temporal specificity Despite skills and assets
  necessary to perform task is fairly common,
  difficulty of identifying and arranging to have
  alternate supplier on short notice creates a
  holdup.

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Hypothesis

• Shipbuilding like other construction operation,
  mainly involves organizing and coordinating a
  variety of low technology and labor intensive
  activity involved in assembly of final product.
• Hypothesis the internal organization costs will
  be smaller and thus the likelihood of integration
  greater, the more labor intensive and less
  engineering intensive the production process.

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Estimation Results Make or Buy Decisions
9
Estimation Results Costs of Organization
10
Findings

• Supports some standard transaction cost
  arguments.
• Temporal specificity can be major determinant of
  organizational form in some settings
• Integration becomes more likely in the presence
  of relationship-specific human capital and for at
  least very complex components.
• Effects of physical asset specificity on both
  organization costs and integration vary across
  specifications of the equations.
• The probit estimations indicate that the
  particular firm we studied is less likely to
  integrate engineering-intensive activities and
  more likely to internalize labor-intensive ones.

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Implications of the findings

• While transaction-cost theory has emphasized the
  ways in which attributes of the transaction
  influence costs of market or contractual exchange
  (for which the probit results are supportive),
  the independent variables in our estimations,
  with the exception of SCHEDULE, have their
  principal influence on the costs of internal
  organization. This both illustrates the hazards
  of testing transaction-cost hypotheses using
  reduced-form equations and argues that greater
  attention should be paid to the determinants of
  internal organization costs as Ronald Coase has
  long contended.
• The findings regarding the effects of engineering
  effort on the integration decision raise
  questions about the interpretation of this
  variable in previous studies.
• The costs of dealing across a market interface,
  and hence the incentive to integrate, rise the
  greater the potential for holdups in a given
  transaction
• The evidence indicates that variations in the
  level of internal organization costs also play an
  important role in integration decisions.

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Questions

• ?