Transaction Cost Theory

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Overview This report critically reviews the empirical literature on transaction cost theory and the associated motives for strategic growth in core and non-core business areas. 1) Analyse the concept of transaction costs Transaction cost refers to the costs associated to the exchange of rights and is the total cost incurred in making an economic exchange. More succinctly transaction costs refer to the following sub-categories: ▪ Search and information costs ▪ Bargaining and decision costs ▪ Policing and enforcement costs Transaction costs play a crucial role in determining how rights are allocated in the economy (Coase 1988). Therefore, in dealing with costs of transactions the first aspect to consider is that what is really transacted is not a good or an object, but instead, a complex bundle of rights. To discuss transaction costs in more detail, this paper will briefly examine the works of Coase and Williamson. Coase and Williamson The foundations of Transaction Cost Theory were laid by Coase (1937, 1960). The starting point for a transaction cost approach to governance and organisational issues is Coase’s (1960) insight that if it weren’t for transaction costs, all gains to trade would be exhausted and this could take place under any organisational arrangement. Coase notes that a firm’s interactions with the market may not be under its control (e.g. due to sales tax etc), but its internal allocation of resources are. Coase (1937) states that within a firm, market transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur who directs production. The question then arises of what determines the size of the firm, why the entrepreneur organises the transactions the way he does and why no more or less? Since the reason for the firm’s being is to

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