Environmental Engineering Reference
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Nature of the Firm', Coase (1937) discussed why i rms exist and sowed
the seed of the concept of transaction costs in the economics literature.
Coase underlines the important role of transaction costs in the organiza-
tion of i rms and other contracts. Coase's theory was later developed by
many scholars (Coase, 1960; Cheung, 1969, 1983; Alchian and Demsetz,
1972; Williamson, 1985). Coase (1960) observed that identifying relevant
parties, collecting information, undertaking negotiation, enforcing agree-
ments and so on could be sui ciently costly to prevent many transactions
from being achieved. When two or more parties agree to exchange or
transfer goods or services, the transaction can be seen as a form of con-
tract (Drennan, 2000). Arrow (1969) dei nes transaction costs as the costs
of running the economic system. Transaction costs are the costs of arrang-
ing, monitoring, or enforcing agreements; the cost associated with all the
exchanges that take place within an economy (Eggertsson, 1990; North,
1990). North (1997, p. 150) points out, 'the study of transaction costs, in
addition to giving us insights into static economic analysis, also holds the
key to unlocking the doors to an improved understanding of economic
and societal performance through time'.
The importance of transaction costs can be studied through 'transaction
cost economics (TCE)', which is a new type of economics i rst mentioned
in Williamson (1991). According to him, TCE is focused on reducing
maladaptation costs through ex ante selection of governance structure
for the antecedent conditions. Its working hypothesis is that economic
organization is really an ef ort to 'align transactions, which dif er in their
attributes, with governance structures, which dif er in their costs and com-
petencies, in a discriminating (mainly, transaction cost economizing) way'
(Williamson, 1991). TCE tries to explain how trading partners choose,
from the set of feasible institutional alternatives, the arrangements that
of er protection for their relationship-specii c investments at the lowest
total cost (Shelanski and Klein, 1995). TCE maintains that in a complex
world, contracts are typically incomplete because agents are boundedly
rational, or because certain quantities or outcomes are unobservable. Due
to this incompleteness, parties who invest in relationship-specii c assets
expose themselves to a risk: if circumstances change, their trading partners
may try to expropriate the rents accruing to the specii c assets. A variety
of governance structures could be adopted in order to avoid this risk.
Nevertheless, the appropriate one depends on the particular character-
istics of the relationship. In this respect, TCE can be seen as the study of
alternative institutions of governance.
Transaction costs are incurred in dif erent stages of production and
exchange. Dahlman (1979) separates transaction costs into three broad cat-
egories: (1) search and information costs, (2) bargaining and decision costs
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