Firm Boundaries and Production Capabilities: Endogenizing Transaction Costs
Posted: 3 Mar 2009
Date Written: March 2, 2009
We propose a theory of firm boundaries where transaction costs are endogenous and vary with the level of production capabilities. Our framework develops a better understanding of the institutional structure of production by outlining how transaction costs differ between related and unrelated inputs, apart from production costs. Thus it extends theories of why firms exist to explain what activities they perform compared to markets, and why economic activity is conducted mainly within related firms rather than in conglomerate enterprises. In addition the framework offers two unique testable implications compared to received theory (1) rather than a monotonically increasing relationship, there will be a U shaped relationship between production capabilities and the firm's propensity to choose internal organization over markets (2) since transaction costs are endogenous, the optimal point of asset specifity when internal organization becomes attractive is determined in part by the level of production capabilities, and varies in an inverted U shaped manner with these capabilities.
Keywords: Transaction costs economics, capabilities, theory of the firm, vertical integration
JEL Classification: D23
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