O. Williamson: Markets and Hierarchies and the Contractual Man

In these papers Williamson develops his ideas on transaction cost analysis, his methodology to compensate for the human limitations and non-realism inherent in classical economic action theory.

In Markets and Hierarchies, Williamson addresses the question "Why do organizations exist?" by concluding that organizations are a tool to reduce uncertainty and opportunism in the marketplace . Unlike classical economic assumptions, transaction costs analysis assumes that:

* individuals and groups do not have "perfect" knowledge of all potential options

* opportunism is not unavoidable, especially in situations where there are small numbers of players

* there is often an imbalance of information between parties in an exchange

These human and environmental factors challenge traditional assumptions of rational economic behavior. Organizations form to internalize and reduce those aspects of uncertainty and opportunism present in the market. Organizations can reduce opportunism by:

* formalizing a sanction system against those who exploit group goals for individual gain

* monitoring individual actions in this "internal market"

* mediating disputes and information imbalances among internal members that could facilitate opportunism


Organizations thus help groups of individuals collectively reduce market uncertainties and prevent opportunism in few-player situations.

In Contractual Man, Williamson refines his transaction model to better account for the important role of social behavior in real-world market transactions. He rejects the traditional economic assumption of perfect rationality for a more realistic "bounded rationality". Likewise he reiterates that humans are capable of opportunism as well as simple self-interest behavior.

Williamson also expands on the typology of real world transactions. Unlike classical transactions where goods exchanges occur instantaneously at fair market price, transaction cost theory observes that real transactions have a social component in the following dimensions:

* asset specificity that can "lock-in" a relationship between exchange partners over time

* opportunism uncertainties that favor trading with partners you know and trust

* low frequency of transactions that favor more informal governance structures between partners (i.e. social relationships)

Williamson introduces the idea of the fundamental transformation to show how an initial transaction between exchange partners creates a "transaction residual" that favors a continued trading relationship (over other potential traders). If a firm acquires specialized assets (capital, knowledge, skills) through the transaction, they are better prepared than other firms for further transactions.

Through transactions exchange partners build social and business interdependencies that shape future behavior.