Transaction Cost

Transaction cost economics (TCE) posits that organizations emerge when exchanges between individuals become too numerous, too uncertain or too complex to be completed in the context of the market (Williamson, 1975). Such situations result from the combination of particular human factors (e.g., bounded rationality, opportunism), and environmental characteristics (e.g., uncertainty, asset specificity, and frequency of exchange) (Williamson, 1975).

Among the human factors, bounded rationality refers to the fact that in transaction cost economics, the principal actor is not the omnicient "economic man" of classical economic theory, but rather has less than perfect knowledge of the choices available (Pitelis, 1993). Thus, whereas microeconomics postulates that a transacting partner has full knowledge of the market and will complete transactions in such a way as to maximize a utility function, the transacting partners described in TCE either incur costs to gain additional information, or simply make decisions (transaction choices) from a base of imperfect knowledge. The assumption of opportunism also departs from traditional economic theory because in transaction cost economics, actors are not dispassionate utility maximizers, but guileful individuals seeking to advance their own interests at the expense of those with whom they transact (Pitelis, 1993). The combined effect of bounded rationality and opportunism is that actors realize that their knowledge is limited, further realize that those with whom they transact are not to be trusted, and thus incur costs, transaction costs, as they try to mitigate those factors.

The environmental factors pertain to the context and terms of transactions themselves, as opposed to the motives or characteristics of the exchange partners. Thus, uncertainty refers to the fact that circumstances change in unpredictable ways, and such changes may disrupt existing patterns of transactions (Williamson, 1975).

Uncertainty is distinct...