8/17/2023 0 Comments Transaction cost economics theoryTCE seeks to describe and to understand two kinds of heterogeneity. For example, a complex, risky, and recurring transaction may be very expensive to manage through a buyer-supplier contract internalizing the transaction through vertical integration offers an economically more efficient approach than market exchange. TCE is therefore not only a theory of the firm, but also a theory of management and of governance.Īt its foundation, TCE is a theory of organizational efficiency: how should a complex transaction be structured and governed so as to minimize waste? The efficiency objective calls for identifying the comparatively better organizational arrangement, the alternative that best matches the key features of the transaction. In its history spanning now over five decades, TCE has expanded to become one of the most influential management theories, addressing not only the scale and scope of the firm but also many aspects of its internal workings, most notably corporate governance and organization design. Coase, in 1937, was the first to highlight the importance of understanding the costs of transacting, but TCE as a formal theory started in earnest in the late 1960s and early 1970s as an attempt to understand and to make empirical predictions about vertical integration (“the make-or-buy decision”). These questions may appear different on the surface, but they are all variations on the same theme: how should a complex contractual relationship be governed to avoid waste and to create transaction value? Transaction Cost Economics (TCE) is one of the most established theories to address this fundamental question. Which components should a manufacturing firm make in-house, which should it co-produce, and which should it outsource? Who should sit on the firm’s board of directors? What is the right balance between debt and equity financing?
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