Contractual Commitments, Bargaining Power, and
Governance Inseparability:
Incorporating History into Transaction Cost Theory
Argyres & Liebeskind (1999) – AMR
Awais A Khuhro
PhD – IB – 1st YEAR
Abstract:
• Conditions made by a firm can limit its ability to
differentiate or change its governance arrangement in
the future: A condition they term governance
inseparability (GI).
 Prior contractual commitments
Changes in bargaining power between a firm and its
exchange partners.
Motivation:
 Extend TCE: Which is Behavioral theory of firm.
 Characteristics of isolated transactions can be
insufficient to explain the scope of the firm.
 Constrain a firm’s governance option in two ways
 Switching – rely same kinds of transactions.
 Governance differentiation – move forward by using same
governance.
 TO extend TCE
 By incorporating two factors that serve to produce
governance inseparability ( i.e., prior contractual
commitment and changes in bargaining power).
 They are costly
Theory development
• 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.
• Bring in - Governance Inseparability
Constraints
Governance Switching
Governance Differentiation
Factors
• Contractual Commitments
• Changes in Bargaining
Power
Factors explanation
Governance
Inseparability
Contractual Commitment
(formal & Informal)
Changes in Bargaining Power
*Governance
Switching
*Governance
Differentiation
*– ve Relationship
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 another party for
that transaction.
“Restricts forward integration.”
Exclusive Franchising Agreement
COKE COMPANY
INDEPENDENT COMPANIES
Contractual Commitments and Constraints on
Governance Differentiation
• (Governance Inseparability) – When a firm is
obligated to enter a governance arrangement of type
X with one part because it already has a governance
arrangement of type X in place with another party.
• Commonly arises when the firm wants different
internal organizational arrangements.
• Institutional theory also asserts that certain types of
contractual arrangements can become difficult to
change overtime, hence difficult to differentiate on a
transaction by transaction basis.
Is Governance Inseparability Avoidable?
BIG NO.
• Reasons
Contractual Commitments:
Firms cannot exist efficiently without commitments
Contractual commitments are necessary for a firm to
earn economic rents.
Changes in Bargaining Power:
Due to the large number of interrelated factors that
affect the relative power of contracting parties,
changes in bargaining power are difficult to foresee.
Implication of Governance Inseparability
Governance Inseparability has important implications for
Transaction cost theory.
• Predicting the relationship between the characteristic of
individual transactions and the mechanism that are used to
govern them.
• Implication of the theory of the limits to the scope of firm.
• Theoretical relationship to be forged between transaction
cost theory and theories of competition & Industry
evolution.
Implication : Use of alternative Governance
mechanism
• 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 featuring asset specificity
for the same level of firm bargaining power.
• Proposition 2b: Compared with younger firms, older firms more often 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 restricted.
Implication; Limit to firm scope
• Proposition 4: The greater the difference is between a transaction’s optimal
governance mechanism and a firm’s governance arrangements in place, the greater the
cost will be to the firm of internalizing that transaction.
• Proposition 5: Greater uncertainty will reduce the vertical and horizontal scope of the
firm.
We conclude
Rational/main ideas:
Most firms will become constrained over time by their existing
arrangements in place, which will limit both their scope and their
strategic flexibility.
•
TCE: (long-term) contract makes both firms adapted
effectively (Williamson, 1985)
• Social Views: e.g., Social mechanism: social norms(Joshi &
Arnold, 1997; Clan (Ouchi, 1980); mutual trust (Dyer & Chu,
2003;Hedlund, 1994) can help both firms adapt better.
We conclude
Rational/main ideas: Continue
• 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.
• Governance inseparabilities often have an important impact on
governance choices and must therefore be accounted for in a
“positive” (i.e., descriptive) theory of governance.