Page info: *Author: Mathiesen, H. *Document version: 2.3. *Copyright 1997-2012, ViamInvest. Legal notice.

Table: Four basic contracts - Market bargain firm and government Introduction: This table tries to characterize the four most elemental kinds of contractual modes in capitalistic countries. Readings of Alchain and Demsetz [1972], Coase [1937, 1960], Macneil [1974], and Williamson [1975, 1985] have inspired this production. Generally

“Law making” by private- and legal agents rule exchange

Law making by public agents rule exchange

Contract mode

Market

Bargain

Firm

Government

Contract definition and synonymous

Simple market contract. Classical contract. Market governance. Transactional contract. Normal sales relationship. Contingent claim contract. Spot contract. Discrete contract. Short-term contract. Open exchange contract.

Complex market contract. Neoclassical contract. Trilateral governance (low freq.). Bilateral governance (high freq.). Obligational market contract. Long-term contract. Arbitrage contract. (Franchising, joint venture)

Conditions under which the mechanism minimizes transaction costs: Note that independent of contract mode TCE always assumes that agents are boundedly rational and opportunistic.

Market is ‘fat’. Buyer and seller transactionfrequency and identity is unimportant. Standardized, durable or non-durable, simple or complex goods and services. Uncertainty is small or high, and few measurement problems. Symmetric information. Small asset specificity.

Bundle of simple and complex market and non-market contracts now including employment contracts. Relational contract. Transaction-specific governance. Vertical integration. Authority relation. Nexus of contracts. Closed exchange. Employer and employee transact frequent on bundles of services. Identity is ex post important. Customized often complex, non-durable good and services. Uncertainty is often high. Measurement problems. Asymmetric information. High asset specificity.

Other aspects

Exchange is voluntary. Relevant conditions are seldom naturally found in modern societies. However they are often artificially simulated by governmental institutions. E.g. warranty laws, public approval of medical products, safety and quality standards. But these procedures are costly and then the regime is not necessary cost dominant.

Market is ‘thin’. Buyer and seller transact seldom or often. Identity is ex post important. Customized often complex, durable good and services. Medium uncertainty. Measurement problems. Asymmetric information. Medium to high asset specificity. Exchange is voluntary. Exchange is voluntary.

Bundle of simple and complex market and non-market contracts, plus the powers to make the law, and the sanction powers to enforce it. Narrow definition 1; Super firm. Public governance. Broad definition incl. norms, habits, culture 2: Social contract Social matrix. Social context. Socioeconomic structure. For reasons of competitiveness governments will at best do no worse than private business in governing commercial transactions. But government’s minimizes transaction cost by making ‘the rules of the game’ played by the private agents. E.g. property-, contract law and regulation.

The costs of transacting: Note that increased specialization of labor decreases transformation cost and increase the need for exchange. This latter increase transaction cost. This

COORDINATION: Moderate search cost. Cheap to draft. Few contingencies and they are clear. Low cost of monitoring. Litigation is not likely, but when it does occur costs are low. MOTIVATION:

Exchange may be mandatory. E.g. tax Relevant conditions Relevant conditions are payments and national service. are common in common in modern modern society. society. The cost of bargain The cost of firm increases with: exchange increase with Specificity, complexity number of diverse of contract, activities within the uncertainty, frequency firm, and weakness of and difficulty of legal competitive check. This enforcement. This push for splitting up the pushes for merging firm in smaller less the business of the diversified firms. buyer and the seller.

COORDINATION: COORDINATION: Moderate search cost. Low ex post search cost. Low cost of Expensive to draft and negotiate. Many drafting employment contract, and adapting contingencies and they may be unclear uncertainty. High cost of administrating, or unpredictable. monitoring, processing High cost of information, training monitoring and employees.

arbitraging.

Only commercial: See above. COORDINATION: Same as firm. MOTIVATION: Very high cost of shirking and political efforts because the competitive check is very slow. E. g. it took 70 years to find out

tradeoff is latent in all TCE reasoning.

No shirking or under performance because of the instant competitive check. Note: Transaction cost dominant.

Litigation is expensive or simply MOTIVATION: High cost of shirking not possible. MOTIVATION: High ex post cost of under performance and political bargaining. Cost is moderate due to competitive check.

and political efforts. Competitive check is weakened. It takes time to discover inefficiency. E. g. the day of bankruptcy.

Price setting: The most vital focus of both coordination and motivation.

Invisible Hand: The law of demand and supply determines the price. Parties only capable of making small price adjustment without jeopardizing competitiveness. Economics is predominant although A. Smith notes the trading spirit of human nature.

Bargaining Theory: The final price is negotiated and depends on the information of the parties, the facts of the thing being exchanged, the norms of price in the business, the threat values (substitutes) and the skill of the bargaining parties.

Visible Hand: Normally no specific prices on every identifiable service from the employee. The labor relation is a complex bundle of services bought for a salary set by the employer. Non-economic issues are now important to.

The means of coordination: Deals with the substantive and procedural aspects of contracts.

1) Standards in the contract. E.g. costs and prices are tied to an outside price index. Or the product has to satisfy some quality code set up by a private or governmental agency. 2) The courts. Rare. Contract so clear that court outcome is known ahead. Monetary damage.

1) Standards and rules in the contract. Ditto market. Rules; damage clauses, good faith deposits, mark up clauses. 2) A private arbitrage system specified in advance. One or third party control of terms. Agreement to agree clause. 3) The courts. Should award specific performance.

1) Mutual work adjustment. 2) Direct work supervision. 3) Standardization of work output, e.g. quality control. 4) Standardization of work process, e.g. job design. 5) Standardization of input, e.g. educational requirements. 6) Standardization of norms, e.g. corporate culture.

The means of motivation: Note that for reward or sanction to have any effect on behavior they must be related. This is only possible through some kind of monitoring. The efficiency on monitoring increase: 1) The smaller the profit unit it is possibly to distinguish and, 2) The more social competitive is the prices that make up the profit.

By competing on terms of contract: Price. REWARD: Buyer: His surplus of the exchange. That is the value he attaches to the good he receives less the value he attach to the good he give up (e.g. money price). Seller: His surplus of the exchange. That is the value he attaches to the good he receives (money price) less the value he attach to the good he give up (e.g. cost of producing it). SANCTION: To buy or sell from somebody else.

By competing on terms of contract: Price, quality, delivery accuracy, dispute resolution system. REWARDS: Buyer: Same as under market but now the good bought is more complex. Seller: Same as under market but now the good sold is more complex. SANCTIONS: Stop of future exchange. Included non-punitive sanctions for breach in contracts. Court sanctions: Monetary damage or specific performance.

By competing on terms of contract: Salary, working environment. REWARDS: Employer; Get the value of the labor services. Employee: Salary, promotion possibilities, status, and bonuses. SANCTIONS: Get fired. Loose status. Reduced salary. Loss of prospect for promotion. Degradation. Court sanctions: Monetary damage or specific performance.

Note furthermore that only sign often differentiates rewards and sanction.

that socialism was uneconomical. Non-commercial; COORDINATION: The cost of making the law and enforcing it is e. g, courts, police, army, regulating agencies, monetary system. MOTIVATION: There is huge scope for bribing officials, judges, and politicians, especially in socialist economies. Many laws are inefficient. They make prices less social competitive e. g. trade restrictions, concessioned monopolies (public utilities), and the entire tax and transfer system. Democracy: We may usefully view politicians as selling a social contract that among other thing include budget decisions determining tax and public services available for the voters. The voters elect the political team believed to offer the best deal. Economics is only one of several important aspect of the social contract. 1) Administrative means of control such as: Physical planning, prohibitions, commands, permissions, norms, rationing. 2) Traditional economic means of control such as: Subsidies, taxes, and user payment. 3) New economic means of control such as: Mortgage systems, mandatory insurance, and transferable pollution rights. Options 4) Information campaigns. By competing on terms of contract: E.g. Taxes, public services, environment-, family-, social-, and crime-policy. REWARDS: Voters; Broadly their surplus is the value they place on stability, safety, environment, freedom to speak, right to doing business and so on, less their tax payment. Politicians; Broadly their surplus is the value from salary, idealism, and support and status from interest groups. SANCTIONS: Politicians risk votes for breach of promises. But the issue is more the sanctions the citizens face for breaking the law: No limits: From fines to death penalty.

Efficiency: Transaction cost economics relies on competition to sort out the inefficient modes of organization, Williamson [1985, p.23]

Potentially short run efficient. A matter of days.

Potentially medium short-run efficient. A matter of months.

Potentially long run efficient. A matter of years. At worst to day of bankruptcy.

Potentially very long run efficient. A matter of many years. E.g. it took 70 years before the communist system broke down.

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