Oliver Williamson's Research on the Role of FirmsYesterday's post dealt with the work of Elinor Ostrom, one of this year's recipients of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel. Today, I'll highlight the work of Ostrom's co-winner, Oliver Williamson, an emeritus professor of business, economics, and law at the University of California-Berkeley.
(The Seoul Times)
The basic question Williamson has examined in his research is what determines when the market is the best mechanism for handling business transactions, and when the firm is best.
Answering this question required Williamson to investigate what sorts of transaction costs make use of the firm structure a hierarchical structure more economical, relative to depending on market dealings.
As the Royal Swedish Academy of Sciences explains in its summary for the public,
... Williamson expects hierarchical organizations to emerge when transactions are complex or non-standard [making it hard to write complete and enforceable contracts], and when parties are mutually dependent. Perhaps the most typical case of mutual dependence is that parties have assets, either physical assets or knowledge, which are only valuable inside a relationship.For example:
The value of a coal mine in case the owner cannot agree on the terms of trade with a nearby power plant depends on the distance to the second-nearest buyer of coal, which is usually another power plant. Likewise, the value of a coal-burning power plant in case it cannot trade with the nearby coal mine depends on the distance to the second nearest mine. The larger the distances, the greater is the mutual dependence, and according to the theory the more likely the mine and the plant are vertically integrated. This is precisely what is observed. When there are other nearby mines and power plants, firms are typically incorporated separately and trade under relatively short and simple contracts. As the distance to alternative trading partners increases, contract duration and complexity also increase. According to one of the studies, a coal-burning power plant that is located next to a coal mine is about six times more likely to be fully integrated than is any other coal-burning power plant.For further coverage of Williamson's work, touching upon the evidence for the validity of his theory, its policy implications, and how it has been expanded and deepened by other researchers, you can read the Academy of Sciences' Scientific Background (pdf about six pages each on Williamson and Ostrom).