Risk Propensity, Trust, and Transaction Costs in Relational Contracting

By Masters, John K.; Miles, Grant et al. | Journal of Business Strategies, Spring 2004 | Go to article overview

Risk Propensity, Trust, and Transaction Costs in Relational Contracting


Masters, John K., Miles, Grant, D'Souza, Derrick, Orr, John P., Journal of Business Strategies


Abstract

Critics of transaction cost economics (TCE) argue that TCE is not able to explain variations in governance arrangements between the extremes of market and hierarchy. They further dispute the assumptions of opportunism and risk neutrality underlying the theory. While TCE proponents have developed approaches that address each of these criticisms separately, we propose that combining the approaches to simultaneously address both challenges alters the nature of the predictions. We explore the roles of risk propensity and trust within a TCE framework. We then test the ability, of these variables to predict variations in governance between the extremes of market and hierarchy.

**********

The increasing prevalence of a broad class of organizational forms that are neither market nor hierarchy has challenged traditional notions of organizational relationships. Perhaps nowhere are these challenges more clearly seen than within the study of transaction cost economics (TCE) (Coase, 1937; Williamson, 1975). Critics have challenged both the market/hierarchy dichotomy that originally served as the foundation for TCE and the behavioral assumptions that underlie the theory.

In response to these challenges, researchers have proposed modifications to the basic TCE theory. Proposed adjustments include moving from a dichotomy to a continuum, where hybrids fall between the end points of market and hierarchies (Williamson, 1985; 1991), and the inclusion of behavioral variables as moderators within the model rather than as underlying assumptions (Chiles and McMackin, 1996). While each of these proposed modifications is built on a reasonable logic, there has been little, if any, empirical assessment of the predictions. More importantly, because each modification was proposed independently, the effect of concurrently including both of the modifications within the model has not been considered. When they are, the predictions of the model may be very different from what either would individually propose.

To help advance our understanding in this area, then, the current study includes trust and risk propensity in a TCE framework and examines their influence on the form of governance taken within a particular exchange relationship between firms. We begin by briefly reviewing TCE and its assumptions regarding opportunism, risk, and the role of trust. Next, we explore alternative ways that these concepts might be handled within a TCE context and develop hypotheses regarding the role of each of the variables. We then describe an empirical test of the hypotheses and discuss the results. A discussion of the implications of the results both for TCE in particular and for organizational forms in general concludes the paper.

Literature Review

In transaction cost economics (TCE), three characteristics of a given transaction are purported to influence the choice between market and hierarchical governance mechanisms: the need for transaction-specific investment, the likelihood of repetition, and uncertainty of performance (Coase, 1937; Williamson, 1975). As the level of each characteristic increases, the transaction becomes more likely to be governed using hierarchical rather than market governance mechanisms. Three assumptions regarding human nature are critical to this calculus. Bounded rationality addresses managerial behavior which is "intendedly rational, but only limitedly so" (Simon, 1961 : xxiv). Under bounded rationality, decision makers do not possess or are not able to process complete information. Opportunism, defined as "self-interest seeking with guile" (Williamson, 1975: 26), requires not that all actors behave opportunistically, only that some do and that it is difficult or costly to determine which actors will behave opportunistically. Risk neutrality means that decision makers are indifferent between certain and uncertain returns as long as the expected value of the uncertain returns is equal to that of the certain returns over the longer term (Aoki, 1984).

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Risk Propensity, Trust, and Transaction Costs in Relational Contracting
Settings

Settings

Typeface
Text size Smaller Larger
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.