Some Methodological Considerations
Transactions cost analysis attempts to account for or explain a wide variety of phenomena found in contemporary free enterprise systems by understanding these phenomena as efficient responses to the objective and subjective conditions for exploitation identified in the last chapter.
Theorists proceed on the supposition—informed by Alchian’s general evolutionary hypothesis—that the common or widespread organizational forms, policies, and procedures found in free enterprise systems are efficient responses to asset specificities, informational asymmetries, and opportunism found in the economic environment. Their task is to identify or elucidate these efficiencies. The presumption of efficiency functions much like the presumption of simplicity and order that guided planetary astronomy in the era of Kepler and Galileo. The theorist proceeds on the supposition that it is there to be discovered. However, as indicated in chapter 4, this is a presumption only, which means that it might be false in any particular case. For example, a commonly observed feature of all existing free enterprise systems might be explainable by some element of the tax codes that is common to all of the associated political systems. In general, there are a host of other potential confounding factors that might explain various features of existing economic systems. The proposition “If it exists, it must be efficient” is a Panglossian assumption that cannot be sustained when the object of discussion is the real world and not some economist’s model.How can the danger this assumption represents be guarded against? One way is for the theorist to elucidate the transactions cost efficiency in such a way that it supports the corresponding Counterfactual conditional about what would happen if some other organizational form, policy, or procedure were to coexist. For example, Alchian and Demsetz’s account of the superior monitoring properties of the classical capitalist firm makes an implicit comparative claim to the effect that if organizations with other monitoring arrangements existed and were in competition with classical capitalist firms, they would not survive.1 The reason that this Counterfaetu- al supports the explanatory claim has to do with the nature of the fact to be explained.
What is to be explained in these explanations—the explanandum—is the persistence of some phenomenon. In this instance, it is the persistence of a certain form of monitoring in a competitive environment in which people are free to experiment with alternative organizational forms. If a case can be made that alternative monitoring arrangements would be at a competitive disadvantage, that provides some reason to believe that existing monitoring arrangements persist because of their efficiency advantages. Relatedly, one can construe the explanatory claim as involving an appeal to some law that covers the phenomenon; one of things that distinguishes genuine laws from mere accidental generalizations is that the former—but not the latter—support Counterfactual conditionals (Goodman 1965, chap. 1).Plausible stories involving Counterfactuals do not suffice to prove that a transactions cost explanation is correct, however. The reason is that while a transactions cost efficiency might be one factor in explaining some phenomenon, it may not be the only one. The phenomenon may be overdetermined, in which case there are a number of factors sufficient to produce the phenomenon, only one of which is the efficiency of the arrangement. For example, one factor responsible for the concentration of economic roles (monitor, entrepreneur, primary provider of capital, residual claimant) in the classical capitalist firm might be the transactions cost efficiencies of that concentration. But in America, the culture of rugged individualism might also be a factor in explaining the persistence of this organizational form. If this is true, the phenomenon would be overdetermined.
Yet another possibility (probably more common) is that there are a number of contributing factors that are singly insufficient, but together sufficient, to explain the phenomenon. In this sort of case, transactions cost advantages may be only one factor in accounting for the facts to be explained and possibly not a very important one.
For example, the reputedly low incidence of shirking among Japanese workers may be partially explained by the superior monitoring arrangements of the predominant organizational forms in the Japanese economy. However, broader cultural forces may be at work; indeed, these forces may be more important than the monitoring properties of the organizations in explaining the work habits of the Japanese. Both of these examples cite noneconomic factors in explaining the facts to be explained; indeed, sociologists have criticized transactions cost analysis for ignoring noneconomic factors in its explanations of various features of organizations.2These ways in which a transactions cost explanation could go wrong can never be ruled out once and for all. This is a simple consequence of the underdetermination of theory by the data. However, there are ways in which those who offer transactions cost explanations can reduce the likelihood that other factors are, in fact, significant in the true explanation of some phenomenon. Telling comparative stories about the inefficiencies of alternatives is one—though not the only—way to do this. Unfortunately, other ways require transactions cost analysts to do they have not yet done enough of—detailed empirical work. Key concepts need to be operationalized, testable hypotheses must be formulated, and real empirical data that would differentially support their hypotheses need to be gathered. This sort of work is not easy. Testing hypotheses about shirking in the workplace, for example, would be challenging and possibly dangerous. To date, transactions cost analysis has largely been an armchair enterprise of identifying the asset specificities, informational asymmetries, and so on and explaining how the policy or procedure in question is an efficient response to the situation so described. A related deficiency of this research program is that alternative hypotheses are often not explicitly considered and rejected. Some of the requisite critical work has been done (e.g., Williamson 1985, chap.
9), but more systematic comparative analyses and evaluations are needed.On the other hand, the main strength of transactions cost analysis is that it offers a systematic and unified explanation for a wide range of phenomena that heretofore have either been ignored by economists or have not been adequately explained by other, more traditional approaches. In addition, the stories it tells usually have great intuitive appeal because they explain the phenomenon in question as a rational and efficient response to the expropriation hazards that asset owners face in various kinds of contractual relations—the kind of response one would expect to persist in a competitive environment in which transactors can experiment with different types of contractual relations. The explanation of the up-or-out system for associates in law firms discussed in chapter 4 is a good illustration of this point, as is the Alchian-Demsetz-Barzel explanation of the distinctive features of the classical capitalist firm.3
Fortunately, the aforementioned potential problems and deficiencies of this research program have a minimal impact on the discussion that follows, mainly because this chapter is only concerned with the predominant organizational forms to be found in a free enterprise system. As such, it is pitched at a very high level of abstraction, focusing only on the distinctive pattern of exchanges that define these widespread or common organizational forms. In other words, the explanandum is not some idiosyncratic fact about the shoe industry in recent years or even some distinctive feature of the American version of the free enterprise system. Instead, what is to be explained are phenomena that are common to all free enterprise systems. This reduces the likelihood that other, extraneous factors are wholly or even largely responsible for the phenomenon in question. This likelihood is further reduced to the extent that plausible stories can be told in support of the relevant Counterfactual conditionals.
Of course, this does not rule out the possibility that other factors are partly responsible for these organizational forms. In addition, there is no assurance that existing organizational forms are optimal. One reason for this is that though each of the distinctive features of these organizational forms may be more efficient than alternative ways of doing things, these individually efficient features may interact in such a way that the organizational form itself is less than optimal. This means that there might be other, superior organizational forms that would win out in a competitive struggle for survival. It is just that they have not been invented yet; or, perhaps they have been invented, but there is something preventing them from taking root and spreading in existing free enterprise systems. However, for the purposes of this study, the common organizational forms found in a free enterprise system need not be optimal; they need only do better in their transactions cost attributes than the organizational forms that would be found in a market socialist system. Proving this is the burden of chapters 6 and 7.The plan for this chapter is as follows: The next section discusses more systematically and in more detail the transactions cost efficiencies of the classical capitalist firm. It explains how and why the structure of this type of organization economizes on transactions costs. Contained in this exposition (as well as in the discussions in subsequent sections) are indications of how the classical capitalist firm precludes opportunities for exploitation or makes it difficult for persons to take advantage of whatever opportunities for exploitation do exist.
The third section of this chapter discusses the transactions cost efficiencies of the open corporation. Recall from the first section of the previous chapter the distinctive features of this type of organization: Capital requirements are substantial,' much larger than can be met by one individual.
Those who provide most of the firm’s capital are the ultimate decision makers and have the status of residual claimants.4 These individuals are called stockholders or equity owners. Managers (i.e., those who exercise monitoring and entrepreneurial functions) are hired by a board of directors who are in turn answerable to the stockholders. Though managers may own stock, they are not substantial equity owners. Finally, the liability of the stockholders is limited to their original investment, and ownership shares are freely alienable on securities markets. There are transactions cost efficiencies associated with all of these features of the open corporation. The main purpose of this section is to explain these efficiencies and to indicate how they preclude or limit opportunities for exploitative exchange between and among occupiers of the various economic roles that were identified in the first section of chapter 4.This section also contains a brief discussion of the transactions cost efficiencies of three other types of organizations found in a free enterprise system: the multidivisional corporation, the closed corporation, and the partnership. The multidivisional corporation is an important variant on the open corporation. It consists of Semiautonomous profit centers in which operational control is delegated to division heads and top management exercises only high-level monitoring and broad strategic (i.e., entrepreneurial) functions. In the closed corporation, nearly all the stock is held by a small group of individuals (usually family members), and the firm is managed by one of those stockholders. The closed corporation is a kind of hybrid of the classical capitalist firm and the open corporation. Partnerships are characterized by profit sharing and collective management by the partners. If there is a managing partner, he or she is elected by the other partners and answerable to them. A partnership is not a cooperative because not all workers are partners. This third section ends with a brief discussion of the transactions cost efficiencies of these organizational forms.
These four types of firms do not exhaust all the organizational possibilities of a free enterprise system. For instance, there are mutual associations, such as savings and loans; nonprofit institutions, such as hospitals, universities, and charities; and, of course, there are state-owned enterprises. However, what distinguishes a free enterprise system from a market socialist system is that free enterprise systems have the four basic types of organizational forms (and one variant) just identified, two of which predominate. By contrast, in a market socialist system, the worker cooperative predominates, and the other types of organizations discussed in this chapter would be both uncommon and generally prohibited by law. For these reasons, only these four organizational forms will be discussed.
The fourth and final section of this chapter discusses the employment of labor in free enterprise systems. This topic warrants separate treatment because of the systematic differences between the types of contracts or exchanges between firms and workers in free enterprise systems and market socialist systems. This section investigates some of the transactions cost efficiencies of labor contracts as they have evolved in free enterprise systems. It also investigates the question whether or not workers in a free enterprise system are systematically exploited by the firms that hire them. The second section of chapter 6 contains a corresponding discussion of the possibility of the exploitation of labor in the market socialist cooperative.