A New Role for Money as Hostage Against Opportunism
24 Pages Posted: 15 Feb 2010
Date Written: February 15, 2010
We propose a new role for money as a self-commitment device (in effect, a hostage against opportunism, after Williamson (1983)) in a bilateral exchange relationship such as a strategic alliance. Consider two firms who desire to exchange services over time. When a single unit of one service is worth more than a unit of the other, a trade imbalance inevitably arises before accounts are settled: at some point in the transaction cycle, one side has received more than it has given -- a shift in bargaining power caused not by an unforeseen circumstance but by the natural rhythm of the trade between the firms. If this imbalance is large enough, it is tempting for the firm with the temporary trade deficit, who has received benefit from her trading partner but not yet reciprocated, to exit the relationship before delivering her part of the bargain. Rational anticipation of this deliberate breach can, of course, lead to unraveling of the alliance, since neither side wishes to incur costs to provide benefits without receiving any in return. We show that a small amount of money (in our example, less than the value of the smallest tradeable item) can overcome this problem and thus support repeated, balanced trade and the alliance containing it. This money acts as a hostage against opportunistic exit from the alliance (in the spirit of the variety of both monetary and nonmonetary exchanges, cross-ownership, and reciprocal investments in relationship-specific capital examined by Williamson (1983), Perotti (1992), and Ahmadjian and Oxley (2006) respectively); such a minimal amount of money is necessary (and, in some cases, sufficient) to sustain the alliance and support trade.
Keywords: transactions costs, hostages, commitment, collateral, exchange
JEL Classification: D23, E41, F10, L14
Suggested Citation: Suggested Citation