The Economics of Contracts: Theories and Applications

By Eric Brousseau; Jean-Michel Glachant | Go to book overview

3
Contract and economic organization
Oliver E. Williamson

1 Introduction

As discussed elsewhere, the New Institutional Economics works predominantly at two levels: the institutional environment, which includes both the formal (laws, polity, judiciary) and informal (customs, mores, norms) rules of the game, and the institutions of governance (markets, firms, bureaus) or play of the game (Williamson 1998). The transaction-cost economics approach to economic organization is concerned principally with the latter, with special emphasis on the governance of contractual relations. As it turns out, this approach to economic organization has wide application, generates a large number of refutable implications to which the data are broadly corroborative, and has many public policy ramifications – especially to anti-trust and regulation but to include labor, corporate governance, corporate finance, privatization, and the list goes on.

That the study of governance has such broad application is because any issue that arises as or can be reformulated as a contracting problem can be examined to advantage in transaction-cost economizing terms. Many issues present themselves naturally in this form – the mundane make-or-buy decision being an example. The comparative contractual choice to be made here is whether a firm should contract out for the provision of a good or service or take the transaction out of the market and manage it internally. The contractual nature of other transactions is more subtle – as with the corporate finance decision, where the choice needs to be made between debt and equity. Ordinarily debt and equity are treated as strictly financial instruments, but they are also usefully viewed as alternative modes of governance – where debt is the more market-like mode of contracting for project finance and equity is the more administrative form and is akin to hierarchy. Still other transactions need to be reformulated to bring out their contractual nature, the oligopoly problem being an example. The contractual issues surface here not when the problem is posed in Cournot or structure–conduct–performance (SCP) terms

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