governance structure and transaction cost - scielo · nova economia_belo...

nova Economia_Belo Horizonte_17 (3)_443-468_setembro-dezembro de 2007

Governance structure and transaction cost:

relationship between strategy and asset specificity

Christian Luiz da SilvaProfessor da UniFAE

Maria Sylvia M. SaesProfessora da FEA/USP

Abstract

This article presents a theoretical discussionof the determining factors of governancestructures, using the transaction costapproach. The coexistence of distinctstructures in the same production chain,whose assets show no difference in termsof specificity, is a problematic challenge fortransaction cost economics, since itpredicts a convergence towards the mostefficient structures. The research is pureand explanatory and seeks to identify thedetermining or contributing variablesto the occurrence of the phenomena.Thus, the research source is documental,encompassing the literature discussing therelation between governance structure andtransaction cost.

Resumo

O objetivo do artigo é discutir teoricamente quais os

fatores que determinam as estruturas de governança

a partir da abordagem dos custos de transação. A

coexistência de estruturas distintas numa mesma

cadeia de valor, em que os ativos não apresentam

diferenças em termos de especificidade, é uma

importante problemática para a Economia dos

Custos de Transação, que prevê uma convergência

para as estruturas mais eficientes. A pesquisa é

pura e de nível explicativo e pretende identificar os

fatores que determinam ou que contribuem para a

ocworrência dos fenômenos. Desta forma, a fonte de

pesquisa é documental, abrangendo bibliografias e

artigos que discutem a relação entre estrutura de

governança e custo de transação.

Key words

governance structure,transaction cost, strategies.

JEL Classification B25, D23,R30.

Palavras-chaves

estrutura de governança, custo de

transação, estratégias.

Classificação JEL B25, D23,

R30.

1_ Introduction

In 1937 Ronald H. Coase changed theway people saw economic organizationswhen he published “The Nature of theFirm” (1937). Half a century later,Williamson and Winter (1993)published a collection of writingsshedding new light on contemporaryissues and creating tools that allowedCoasean ideas to be tested. Theirdiscussion focused on the search foreconomic efficiency. Transaction costswere the explanatory basis for the wayin which economic relations wereorganized. Since then several authors,including Williamson, have reviewedand applied the core concepts ofTransaction Cost Economics (TCE).The controversial definition of transactioncosts permeates the governance modeamong economic actors.

The original model conceived byWilliamson (1991) analyzes thegovernance modes, seen as the resultsof the search for gains through thechoice of cost-minimizing factors,basically as a function of the transactiondimensions (asset specificity, uncertaintyand frequency). Joskow (1993)emphasizes the difficulties in datacollection and the problems ofmeasurement in empirical research,

which caused theoretical testing toprogress only very gradually. Empiricalevidence allowed Joskow (1993) torestate his proposition that thegovernance of contractual relationssystematically varies according to thedegree of asset specificity. However,the author highlights the fact that thereare factors that relativise the univocalintegration trend directly relatedto the existence of the high specificityof the assets. In this sense, the costtransaction discussion and its relation tothe definition of governance structureare at the core of the Coasean debate.Thus it is relevant to revisit theliterature and some empirical proofto assess which factors determine thegovernance structures.

The aim of this article is topresent a theoretical investigation of thefactors determining the governancestructures using the transaction costapproach. The coexistence of differentstructures in the same value chain,whose assets are not different in termsof specificity, is an important issue forTransaction Cost Economics, since itpredicts a convergence toward the mostefficient structures.

The research is pure andexplanatory, since it seeks scientific


Governance structure and transaction cost444

advances and intends to identify thedetermining or contributing factors tothe occurrence of the phenomena.Thus, the source of the research isdocumental, encompassing literature onthe relation between governancestructure and transaction costs.The participatory observer methodwas also used in the research and instudy cases on agro-industrial chainscarried out for the last five years(Pensa and Ipardes).

Besides this introductory section,the article encompasses four moresections. The second section poses theproblem to be discussed in the article.The third section analyzes Williamson’smodel. In the forth section,Williamson’s model is reanalyzed with aview to understanding the possibility ofcoexistence of governance structures inproduction chains with similar assets,under the perspective of the NewInstitutional Economics. This problemis approached through the analysis ofboth the markets of the firm andinterdependence among productionstrategies. The study of the Brazilianpoultry chain illustrates suchconsiderations. Finally, the fifth sectionpresents conclusions and raises newproblems for future discussion.

2_ Problem posing

Espino (1999, p. 293) defines governancestructure as an organization’s internalrules devised to guide its dailytransactions, i. e., the interactions amongindividuals within the organization andits relations with other organizations.He established that organizations areultimately institutional arrangementsand characterizes them, based on Dosi(apud Espino, 1999, p. 294), as

formas de organización de las

interacciones entre agentes; reglas

fundamentales del comportamiento,

que los agentes incorporan, hacia sus

competidores, clientes, proveedores,

empleados, autoridades gubernamentales,

etcétera; formas y grados de ejercicio

directo de poder discrecional ejercido por

actores ajenos al mercado, por ejemplo

autoridades reguladoras, jueces, etc.,que contribuyen a la formación de los

patrones de organización y

comportamiento en las empresas.1

Williamson (1996) associates theconcept of institutions with that ofgovernance for micro analyses of theindividual transaction. The institutionalenvironment (rules of the game) istaken as granted, and the economicplayers willfully align transactions withgovernance structures to optimize

Christian Luiz da Silva_Maria Sylvia M. Saes 445


1 The way the interactionamong agents is organized;fundamental behavior rules,which the agents incorporatetowards their competitors,clients, suppliers, employees,officials, etc.; ways and degreesof direct exercise ofdiscretionary power exertedby actors alien to the market,for instance, regulatoryauthorities, judges, etc., whichcontribute to the formation ofthe firms’ organizational andbehavioral patterns.

revenues. Thus, institutions aregovernance mechanisms and their study isdirectly related with the optimum decisionregarding lower transaction costs.

Arrow (apud Williamson,1996, p. 5) defines transaction costsas “costs of running the economicsystem”. Based on this concept,Williamson states that the choiceof governance mode is made througha comparison of the costs of onegovernance mode with those of others.In this sense,

the study of governance is concerned with

the identification, explanation, and

mitigation of all forms of contractual

hazards (Williamson, 1996, p. 5).

The contractual issue is at thecore of the debate on the costs ofrunning a transaction (Coase, 1972).Such issue contributes toward theprogress of the Theory of the Firm,inasmuch as it points out other relevantdeterminants of the firm’s productiveefficiency. For Williamson, the contractis a complex institutional arrangementinvolving the different aspects of aneconomic transaction (basic unit of aneconomic relation), such as planning,promises, competition and governance(Williamson, 1985, p. 30).

The existence of distinctdynamics within the internal logic ofthe transactions translates into acomplex puzzle of theoretical andempirical knowledge. These internaldivergences of the transaction areunderstood through the attributes thatlead the economic agents to negotiate.Based on the TCE, Zylbersztajn (1995,p. 137) infers that

the prevailing governance structures are

the optimizing result of the alignment of

characteristics of the transactions and of

the institutional environment. Thus

optimization is seen in the neoclassical

style, meaning search for efficiency.

Therefore, it is possible to make aDarwinian assumption that an efficientgovernance structure should prevail as awinning structure. And it is a fact thatthere is a process of expelling inefficientstructures – which may last until theresult is achieved. The path dependencemay allow for the persistence ofinefficient structures. The necessarytime for the most efficient structure towin would depend on a series of factors,among which is asymmetric orincomplete information or eveninstitutional rules – formal or informal– that prioritize certain structures.



Here, we can ask, “How doesECT define the choice of theorganizational structure?” According toWilliamson (1975) and to Klein,Crawford and Alchian (1978) differentgovernance structures reflect inherenttransaction attributes. Efficient,cost-minimizing structures result fromtheir alignment with the transactionattributes (frequency, uncertainty andasset specificity), considering the agent’sbehavioral presuppositions (bondingrationality and opportunism).

A degree of asset specificitywould be the main attribute of thetransaction used to explain a firm’sgovernance strategies. Specific assets arethose that are non-utilizable in anotheractivity or by another agent, except withloss of value. The more specific theasset the more the firm will internalizethe transaction via vertical integration.Klein, Crawford and Alchian (1978)argue that whenever the asset becomesmore specific, the cost of hiringgenerally increases more than that ofvertical integration. The basic idea isthat a firm appears in situations where itis not possible to draw up goodcontracts and where it is important toallocate power (Hart, 1997).

Therefore, the specificityof the assets is considered as one ofthe main elements that can explainthe transaction costs. The seconddimension to be considered in theanalysis of the transactions is thefrequency, i. e., the repetition of thesame kind of transaction, whoseimportance is seen in the dilution ofcosts for the adoption of complexmechanisms throughout severaltransactions, as well as in the formationof a reciprocal reputation amongagents. This concept is also used byKlein, Crawford and Alchian (1978)and Kreps (apud Azevedo, 1996, p. 26)who consider that the cost of anopportunistic action is determined bythe present value of the future flow ofresources involved in the bilateral relation.

The third dimension is uncertainty,which involves the understanding thatit is impossible to foresee future events,i. e., the contractual arrangement cannotex-ante establish price, delivery dates,quality and acceptance of the goodsnegotiated. Therefore, no contract iscomplete. Thus an opportunistic actionfrom one of the parties is possible: thecosts associated with such an action arethe transaction costs.



Most empirical works focusingon transaction costs try to confirm thethesis of the alignment of thegovernance structures – market,contract and vertical integration –resulting from the intensification of thetransaction costs (Joskow, 1993). Theyalso try to demonstrate that assetspecificity is one of the most importantdeterminants of the three transactionattributes. This means that whenever theinvestment in specific assets increases,the cost of performing a markettransaction increases more than that ofa transaction in more complexstructures, thus reaching verticalintegration (Willianson, 1985).

Ménard (2000, p. 248) relates thedefinition of the type of governancestructure to enforcement procedures.This relation highlights two definingfactors to explain the prevailingstructure: asset specificity anduncertainty level. The author states thatmany empirical works suggest that assetspecificity determines the governancestructure and related arrangements,whereas the uncertainty is said to bewhat most influences contracts andtheir relation to enforcementprocedures. That question ratifies theasset specificity as a determinant, but it

shows that another transactionattribute-uncertainty- can be adeterminant in the contractual relationestablished, i. e., in the full governancemode of the relation among the parties.

However, neither the traditionalnor Ménard’s approach can explain thecoexistence of different governancestructures if the same asset specificity isconsidered in an agro-industrial system.The challenge is, therefore, tounderstand this phenomenon within thescope of the Coasean proposal.

3_ Definition modelof the governance structure:Williamson’s View

Williamson’s analysis (1985) departsfrom the perspective of comparativestatic by positing a model that relatesthe degree of asset specificity to thegovernance mode cost. The authorconsiders that the decision on how toorganize production systems isconditioned by a degree variation in thespecificity of the asset involved.

Figure 1 shows a relationbetween asset specificity andgovernance mode cost. It can beverified that the governance structuresare distributed in three different ways,



two extreme ones, hierarchy and market,and an intermediary one, the hybridmode. The higher the asset specificityinvolved, the higher the cost of itsmarket monitoring. Thus thegovernance mode can be alteredtowards a hybrid mode, as seenat point (A ), at which monitoring costsby the market are higher than in thehybrid mode. In the mixed or hybrid

mode the existence of contractsenabling the system to be “almostverticalised” is verified. If themonitoring costs become so highas to make this governance modeinviable, the transaction then forcesthe system to be managed under thehierarchic mode, as seen at point (B),necessarily using internal organizationto coordinate it.



Figure 1_ Governance mode costs and asset specificity degree

m(k) = governance via market;x(k) = governance via contractual rules (hybrid);h(k) = govenance via hierarchy.

Source: Williamson (1975).

The hierarchy is characterized byinternal organization (verticalintegration). For Williamson (1985),while incorporating a transaction, theinternal organization increases the firm’spower to impose itself on the structureof the production system. The adoptionof the hierarchy occurs when the costsof this governance structure are inferiorto those obtained via the market.The governance structure characterizedby vertical integration is mainlydetermined by the characteristicsof the specific assets used in the chain.The higher the asset specificity, thelarger the prizes given by the adoptionof the hierarchy as a governance mode.The advantage of the latter vis-à-vismarket organization lies in its bettercapacity to adapt to environmentalchange conditions.

The type of contract used in thismode is relational, with more flexibletransactions and with the possibility of acontinuous negotiation, in whichadjustments are permanent and on-line

and, consequently, in which the originalcontract is no longer an exclusive basisfor negotiations (Macneil apud Jank,1996, p. 35). The adoption orintensification of the hierarchical moderequires increased bureaucratic costs

and decreased incentives from themarket to the agents (Zylbersztajn,1995, p. 141). If these costs are higherthan the benefits arising from the othermodes, such a situation enables theadoption of either market or hybridgovernance modes.

However, when considering thegovernance mode as an element thatexplains the Theory of Contracts,Williamson (1985) accepts that thisdefinition of the optimal structure isnot so biased in an economictransaction because contracts thereoftend to be incomplete. Brousseau andFares (2000, p. 410) state that

Agents therefore design incomplete

contracts that are not implemented and

are ex ante designed as a complete set of

(possibly contingent) behavioral rules

that will ex post solve all coordination

problems. Instead, they design

decision-making devices that ex post will

indicate the behavior required by

contractors to ensure the most efficient

coordination and the guarantee the

enforcement of mutual commitments.

Thus the decision makingprocess in a transaction will derive fromthe contractual parties, which can bevertically (hierarchically) integrated, andbased either on negotiation (hybrid) or



on a third party (market). Ex ante atransaction, there is a set of rules andthere are authorities established by thegovernance mechanisms. Brousseau andFares (2000, p. 410) verify that authorityand enforcement belong to the inherentnature of the governance structure, andthat its definition is associated with thecapacity of the agents that deal withsuch coercion mechanisms in thetransaction. Such arguments call for anew discussion of Williamson’s model,and a verification of its methodologicallimitations to define the governancestructure as a tendency to seekefficiency in the transaction.

4_ Rediscussing Williamson’s Model

Zylbersztain (1995, p. 83) points out animportant restriction to Williamson’smodel when he states that if, in a firstmoment, scale and scope2 economiesare negligible, there is a limitedpossibility that other decision elementsexist, regarding the integration of acertain production step. In this sense,there are variables only for the costs ofproduction and of organizing theinformation and the resources requiredin the process of making the product.There is no alternative for new

allocations of resources, since the firmis limited to a non-existence ofeconomies of scope, and since it isbased on the definition of alreadystrategically chosen products(beyond the definition of what andfor whom to produce; the definitionhere is only how to produce).

Thus, the total cost is the sum ofthe production cost and the governancecost, the latter referring toadministrative and bureaucratic costs.Initially, the governance cost has to beexamined as a variation between thebureaucratic costs associated with theinternalized production and thegovernance mode via market(Equation 1). Within these limitsexposed, this cost is only related to thespecificity of the assets. For instance, ifthe specificity is low, the organizationwill have high adaptability in the socialenvironment. That decreases the costsof managing resources and,consequently, makes the governancecost via market lower than the hierarchic

(�G > 0,) cost. As Zylbersztain pointsout (1995, p. 83), if the hierarchicgovernance cost (B) is higher than thatof the market (M) “this means that withlower degrees of asset specificity themarket is more efficient than the firms



2 A scope economy isconsidered as a cost reductionbased on production linediversification. Thisdiversification can occur withtotally different products orwith products within the samechain with an aggregation ofdifferentiated value.

in terms of transaction costs, since itavoids bureaucratic costs”. On the otherhand, when the adaptation to theenvironment becomes more difficult,uncertainty becomes more preeminentand greater adaptation of the firm toexternal changes is necessary. Here, thegovernance costs via market (M)become higher than the hierarchic costs(B), because the relative costs to controland adapt the organization toenvironmental changes become lowerthan those relative to the free market.There is a limitation regarding thechange of the type of governancestructure involving the balance betweenthe costs adapting to the environment

and to the firm (�G = 0). In this sense,the higher the need to adapt through theorganization, the higher the need forcontrols and bureaucracy and,

therefore, �G tends to zero. From thismoment on, the more uncertaintybecomes preeminent, and the moreadaptation is demanded by the firm,the more the option for hierarchicalgovernance is consolidated(bureaucratic and internal control).

�G = B(k ) – M(k ) (1)

where: �G = Governance cost variance;

B(k ) = cost of governancehierarquical as a function ofthe specificity of the asset;M(k ) = cost of governancethrough the market as a functionof the specificity of the asset.

Once the constraint to theeconomy of scale is eliminated, it isnecessary to take the production costsinto account. At a given moment, it canbe advantageous for the firm to havegovernance via market, but the firmwould not profit from scale economiesif its processes were hierarchic (orvice-versa). Thus, it is necessary toassess the total cost as the sum of thegains by the production cost (scale) andof the governance (bureaucratic) –Equation 2.

For Williamson (1985), bothcosts are associated with the type ofasset used and, therefore, the decisionregarding the best governance structurewill rely on the combination of scaleand bureaucracy in its evolutionaryprocess. The limit between thedefinition of structure will occur whenthe governance costs and the total costsare null. If such values are inferior tozero, then the prevailing governancestructure will be the hierarchic one, due



to the higher need for adaptability byinternal controls and by scale economies.

CT = [Ci(k ) – Cm(k )] + [B(k ) – M(k )] (2)

where: CT = total cost;Ci(k ) = hierarchical cost ofproduction as a function of thespecificity of assets;Cm(k ) = cost of productionthrough market as a function ofthe specificity of assets;B(k ) = hierarchical cost of go-vernance as a function of thespecificity of assets;M(k ) = governance costthrough market as a function ofthe specificity of assets.

The Williamson model is stronglycriticized for three reasons. The firsttwo come from Demsetz (1993) andBarzel (1997); they include the cost ofinformation as an important element todefine the governance structure. North(2005) points out that the persistence ofheterogeneous governance structuresmay be a result of factors such asinstitutional path dependency.

Demsetz’s criticism (1993) isbased on the analysis of profitmaximization or the efficiency in thereplacement of the firm by the marketwhich occurs if the cost of using the

market becomes relatively higher thatthe cost of the hierarchy. That meansthat the extension of the firm will bethat one defined by the equality amongthe marginal values of the transactioncosts and those of the hierarchy.According to the author, the cost ofinformation is what will define thegovernance structure adopted. Thus,to understand its existence it must berecognized that the hierarchy is aresource employed in a world whereknowledge is incomplete and obtainedat a high cost.

The author contends that internalproduction does not mean a clearelimination of the transaction cost.Likewise, the purchase of goods fromanother firm, instead of internalproduction, implicitly involves anotherfirm’s administration costs (of thehierarchy), so that hierarchical costs arenot eliminated when goods arepurchased through the market.The administration (hierarchy) will beworking in a more disperse manneramong many firms. Even if eachfirm is an individual entity,administration costs exist: those ofplanning and carrying out tasks. Besides,it is not correct to infer that productionwould become individualized if thetransaction cost were zero.



The independent individual orcooperative production through thefirm will depend upon on the extensionof the economies of scale (scope) andon the hierarchy. The degree ofdecentralization will not depend only onthe transaction cost, because this is notthe only cost the firm will take intoconsideration. There are many othercosts, including that of production.Thus, to say that firms produce theirown inputs when they are cheaper doesnot mean that the transaction costs arelower than those of administration(hierarchy). An increase in thetransaction cost does not leadto a replacement of the marketcoordination with the administration(hierarchy), but to a replacementof the hierarchical coordinationin small firms (higher quantity) withanother type of coordination in largercompanies (lower quantity).

For it, the emphasis given to thecost of transaction implicitly assumesthat all firms can produce goods withthe same facility. The market is seen as aperfect replacement in a firm’sproduction when the transaction cost inthe market is compared to that ofhierarchy within the firm. This analysisimplicitly presupposes that information

has no cost for the purpose ofproduction. That means that what afirm can produce another firm also can,so that the decision to buy or toproduce depends on the differences inthe transaction costs.3

Demtsez (1993, p. 165) posits that

each firm is a bundle of commitments to

technology, personnel, and methods, all

contained and constrained by a insulating

layer of information that is specific

to the firm, and this bundle cannot be

altered or imitated easily or quickly.

The components of this bundle that

are emphasized by transaction cost theory

are important, but not exclusively so.

The transaction cost plays animportant role determining how thefirm is formed, but its verticallimitations depend on the productivitythat will be reached according todifferent arrangements. Particularlyimportant in the determination of thebenefits of the cooperative productionare the considerations based onknowledge. Continuous association ofthe same persons facilitates theaccumulation of information by thefirm (gains of scale) and by the persons(specificity of the human capital). Thusthe limitations of the verticalintegration of a firm would be



3 It is worth noting thatWilliamson mentionsthe need to considerproduction costs in theanalysis, but he highlightsthat he wants to emphasizetransaction costs in his model.

determined by the economy ofconservation of the expenditures onknowledge. A single firm – verticallyintegrated– would find it difficult toacquire and keep the necessaryknowledge archives to control the costand the quality to make good managerialdecisions if their uses were multiple.

Another line of the analysisfocusing on information for theunderstanding of the firm’sconfiguration is found in evolutionarytheory. Winter (1993) holds that thefirm in this approach is seen as arepository of productive knowledge,which involves the idiosyncraticcharacteristics that distinguish it fromsuperficially similar firms in the sameline of business.

The evolutionary theory suggeststhat the concept of asset specificity isimportant to understand the working ofthe firm as a repository of knowledge.This theory emphasizes that the firmpossessing an established routine hasresources that can be used with greatprofit. Thus, the firm works as arepository of knowledge mainly due tothe time necessary to associate theinputs, particularly those regardinghuman services, with the firm. Thecosts and benefits arising from the

adjustment define a specific mode ofgovernance which is constantlyinfluenced by the pattern of transactionin force. Thus the process of changingthe way things are done in a firminvolves incremental adjustments in acomplex independent system.Naturally, the market supplies theinformation that guides the firm’sstrategy and global profitability.

It is thus necessary to understandthe factors favoring firms by opposition,examining others that present lowerperformance or those that merely copysuccess. The concept of asset specificityis fundamental to understand theworking of the firm as a repository ofknowledge and its growth. But it is alsonecessary to ally such analysis with awider concept, in which theenvironments of the transaction mustbe characterized so that they can give abasis for the analysis of the types ofroutines of the transactions that areviable in different environments.

The second criticism of the viewof Williamson’s approach originated inBarzel (1997). The author states that theWilliamsonian focus is not general, butrather, it is contained within a widertheoretical model whose information isthe general variable that explains the



existence of the transaction costs.For the author, transaction costs arecosts associated with the transfer,capture and protection (maintenance)of the rights. Given that a transactioninvolves several dimensions and that forthis reason it is complex, there are coststhat are hard to measure. Barzel affirmsthat the concept and measuring oftransaction costs is more complex thanthat proposed by Williamson and thedefinition of governing structure isdependent on other elements besidesthe specificity of assets.

Transaction costs will exist whenthere are information problems,regardless of the existence of specificassets. Thus, even if the degree of assetspecificity is very high, there would beno need for vertical integration if theinitial rules for contracting weretransparent and the distribution of thequasi rent, i. e., of the rights to theproperty of the income generated, werewell defined. However, if there were alarge variability in the income generatedand difficulty measuring it, one of theparties could capture that income,which would bring high costs formonitoring and protecting rights. Thismeans that when the residual rights tothe asset, which is shared by those

participating in the relation, are notconstant, then there is a mutual effort tocapture the biggest part of thisindefinite fraction of the income.Therefore, the maximization of the netvalue of an asset involves property andthe pattern of property. In this way, thepattern of property will be defined bythe variability in the assets’ value.Thus, integration acquires a relevantrole in the definition of the governancestructure when there is a situation ofhigh uncertainty of information andprohibitive costs to delineate rights.On the other hand, when the rightsare perfectly delineated and thereis no cost to obtain information aboutthe product, the relevant transactioncost will be zero.

According to this point of view,Williamson’s model only partly explainsthe real motivation to integrate. It is notdifficult to ensure the rights to an assetwhen the flow of services it generatescan be promptly verified, because it isrelatively simple to impose a chargecommensurate with the level of servicetransacted. Whenever the flow ofservice is known and constant, there areno costs to ensure the rights to theassets. If it varies, but is predictable, therights are also ensured. Naturally, the



variability can reduce the value of theassets, but it does not necessarily affectthe certainty of the possession of therights. However, when the flow of theincome of the transacted rights issubject to random fluctuations and bothparties can profit from that, then thedelineation of the rights is problematic.

Thus, if the degree of assetspecificity is the same, Barzel’s approachcan suggest an important argument forthe coexistence of different governancestructures in a production chain: thedifficulty of measuring information.This means that, in opposition to theWilliamsonian view, when the sameasset specificity is considered in aproduction chain, the coexistence ofgovernance structures would not beonly transitory. Also, it does not meanthat we would be at the indifferencepoint between a governance structureand another one, like at A or B inFigure 1. Rather, it means that therewould be a region of indifference betweenone or another situation because of thedifficulty measuring information amongthe different production chains, i. e.,despite the same degree of assetspecificity, the conditions of uncertaintyor of difficulty of measurement wouldlead to the coexistence of differentgovernance structures.

In his defense of empiricalstudies focusing on the issue of firmconfiguration based on the role ofspecific assets, Joskow (1993) posits thattheir approach was due to their capacityfor instrumentation. However, theauthor contends that there is no unifiedtheory. Several economic characteristicswill thus influence the decision ofwhether the firms will becomeintegrated or not.

The works of Muris, Scheffmanand Spiller (1992) follow this line ofthought. They have observed thatinvestments in specific assets in the softdrinks industry in the US wereimportant for the initial configurationof the firm’s governance structure. Thealteration in the governance structure,from the time the distribution channelwas employed to the mode of verticalintegration, was caused by changes inthe market configuration.

Thus, since there were nochanges in the specificity of the asset,the firms adopted the strategy of amore complex governance structurebecause they needed a higher level ofregional information about the demand.The efficiency in Williamson’s andBarzel’s views must be particularizedaccording to the type of demand thefirm meets. Thus it is possible to have



the same production system meetingdifferent demands, which makes theexistence of more than one type ofefficient structure possible.

The last criticism refers to theimportance North gives to pathdependence to explain the persistenceof governance structures. According tothe author, economic performance isdetermined, to a great extent, by thetype and quality of the institutions thatgive support to the markets. North(2000, p. 37) defines institutions as astructure that is imposed by humansupon themselves to facilitate interaction.Corroborating with North, Langolisstates, exemplifies and questions:

But what happened in the century

between the railroad and the Internet?

Why did high levels of verticalization

persist until the late twentieth century,

long after the passing of the original

entrepreneurial design problem that gave

rise to most of these firms? The answer

has to do with path dependency and the

nature of the selection environment.

(Langlois, 2005, p. 28).

This indicates that the decisionmay be the technical consistency andefficiency of the chain seekingoptimization of resources, but the wayhumans interact over time and theinstitutions that permeate and influence

them may be decisive in strategicdecisions, like the type of governancestructure adopted.

Stemming from the criticism, itcan be observed that the definition ofthe governance structure is morecomplex than if it is considered afunction of the specificity of assets.The authors discussed here emphasizethat information and the decisionmaking context may also be importantelements to understand the type ofgovernance structure in a chain. Thesetwo variables will be amplified tostrategies and the influence over thegovernance structure will be evaluated.

Therefore, it is possible to framea hypothesis referring to the coexistenceof governance structures. This meansthat the coexistence of distinctgovernance structures would becentered on the strategic issue of eachgroup of firms meeting different marketneeds. In order to discuss thishypothesis this study will evaluate: theimportance of the strategic axis for thedefinition of a governance structurestarting from the influence of the typeof market served (and the coexistenceof markets with the same productionstructure); and the interdependencebetween the production strategy andcommercialization.



4.1_ Markets Served

The decision concerning the type ofgovernance structure based onWilliamsom’s approach considers thedirect relation between asset specificityand total costs. However, a firm’seconomic efficiency must be alsodetermined by the optimization of theuse of its resources per market served.In some cases, the same asset canenable the firm to meet differentmarket segments. For instance, thepoultry market can meet the demandfor whole broiler or broiler cuts usingthe same production technology.

Such a possibility decreases theasset specificity, but not the firm’scapacity for adaptation and internalcontrol and its control of theenvironment. In this aspect, thisconsideration eliminates the secondrestriction to the Williamsonian model(present in Equations 1 and 2). It alsoemphasizes the need to evaluate theeconomy of scope to define the type ofgovernance structure. Therefore, therewill be governance costs distributedamong the manufactured products. Asfor the production costs, they can belower in virtue of the existing economyof scope. Equation 3 shows that thetotal cost will be distributed amongmanufactured products. If the total costis lower than the sum of the costs of

each individually manufactured productwithout the appropriate synergiesrelative to the economy of scope(Cta, b < Cta + CTb ), there can be a newconfiguration of governance.

CTA, B = [CiA(k ) – CmA (k )] ++ [CiB(k ) – CmB (k )] ++ BA, B(k ) – MA, B (k )

(3)

where: CTA, B

= total cost of productsA and B

CiA(k ) = cost of production

of product A hierarquicalas a function of the specificityof the asset.Cm

A(k ) = cost of production

of product A through themarket as a function of thespecificity of the asset.Ci

B(k ) = cost of production

of product B hierarquicalas a function of the specificityof the asset.Cm

B(k ) = cost of production

of product B through the marketas a function of the specificityof the asset.B

A, B(k ) = cost of hierarquical

governance as a function of thespecificity of the asset.M

A, B(k ) = cost of governance

through the market as a functionof the specificity of the asset.



As seen in equation 3, the total costwill be a function of the individualproduction costs and the governance costthat has synergy (bureaucracy optimizedwith the increment of new products), asobserved in Winter and Demtsez. Eachproduct will have its own basicgovernance cost, but part of this cost iscommon to more than one product,which allows for a reduction of the sameinsofar as it aggregates new products (thusconfiguring the economy of scope). Thus,the governance cost at a t1 moment is nota ratio between the governance cost at t0

because of the amount of productdiversification (two products would implyhalf the governance cost for each one).Part of the governance cost is duplicatedand thus the reduction of this cost is notvery significant, event though it exists.

With this reduction, the quantity ofassets to shift the market governance tothe hierarchic mode happens at a previouslevel of specificity (k1 < k0 ). In this sense,it is possible to infer a tendency to changethe governance structure based on theexistence of the economy of scope. Thelatter can result from a strategic definitionof the firm and from the level ofinformation it can obtain from themarkets being analyzed. On the otherhand, if the total cost of the scope(CT a, b) is higher than the sum of thecosts of each individual process, it is

necessary to decide which market toparticipate in (loss reduction by scope) orwhich governance to adopt. Thus, theevaluation of the relation between thechoice of the production scope and thetype of governance is not so evidentbecause it will depend exclusively on theexistence of economies of scope.This tends to happen mainly in processeswith significant economies of scope.To evaluate such economies, it is necessaryto reanalyze issues such as marketfunctioning, product type, competitors,demand characteristics and market sizeand to turn all these data into marketinformation. The higher the level ofinformation, the higher the capacityfor decision on the most efficientgovernance structure.

That relationship between scopeand governance can be illustratedwith the poultry market from thestate of Paraná, Brazil. Three largegroups direct their products(whole poultry and poultry cuts for thedomestic market; whole poultry andpoultry cuts for the international market;processed poultry for the domesticmarket). Based on Silva and Saes (2004)it is possible to see that companieswith the largest scope are the mostintegrated ones (hierarchic ones), whichcorroborates the previous statement(Equation 3 and Figure 2).



It is important to emphasize thatdespite the fact that the scale economyis a horizontal relationship (gainsstemming from the diversification ofproduction) it may be a source ofoptimization of governance costs andmay alter the vertical relationship(governance structure).

In serving distinct markets withthe same production technology,bureaucratic costs are optimized and thetotal for different products and marketsbecome less than the sum of allindividual parts (if the firm served eachmarket separately). This optimizationmay reduce the governance cost for



Figure 2_ Changes in total cost, governance cost and production cost based

on the economy of scope

Source: The authors.

each product produced below that of asingle product. Such a reduction ingovernance cost may make viable thechange in the governance structurefrom market to hierarchical, increasingthe firm’s control, reducing risk, withoutsignificant changes in costs.

As firms increase their scale ofsupply there is a tendency to reducemean bureaucratic costs, which, despitekeeping the same technology andspecificity of assets, makes changes inthe type of governance structure viable.

In fact, horizontal decisions, likethe increase of supply scale, may havevertical impacts, from the governancestructure perspective. For Williamson,this alternative was not consideredbecause it did not contemplate thepossibility to increase the potential ofscale economies, in other words,producing different products utilizingthe same technology. In making thisscale economy viable, a productive chainhas different commercial ties (servingdifferent markets with the sametechnological structure) and reduces itsmean bureaucratic costs. The larger thevariety of production andcommercialization utilizing the sameproduction technology, the smaller themean bureaucratic cost and the largerthe incentives for the relationships in

the chain to tend towards hierarquicaland away from market relationships,seeking to reduce risk at a lower cost(mean bureaucratic cost).

Another aspect referring to thestrategic definition of the type ofgovernance derives from the demandside and of the interdependencebetween production andcommercialization.

4.2_ Interdependence BetweenProduction andCommercialization Strategies

In addition to the economy of scoperelative to production costs, it ispossible to have an economy basedon the capacity to serve differentmarkets, thus reducing risks andmaximizing opportunities. In this sense,profitability would be distributedthrough the different productscommercialized, and, as compensation,a differentiated governance structurewould be required.

Using the poultry industryexample, Silva and Saes (2004), bymeans of an econometric model, haveproven that there is a correlationbetween the dynamics of the internaland the external market, even thoughthey are distinct, which stronglyinfluence the strategy of the firms. The



decision to migrate from one market toanother depends on the comparisonacross different structures between thecost of information (transaction) tocarry out that strategy and the revenuesreceived when sales are made in thisnew market. If the estimated cost islower than the projected gains, the firmwould incur in such costs to enter thenational or international market, or eventhe market of processed foods.

The average profit of firms canbe expressed through the followingrelations:

where: Pint = is the price in the domesticmarket, which is a function of theinternational price;Qint = is the quantity sold inthe domestic market;Pext = is the price in theexternal market, which is afunction of the currencyexchange rate;

Qext = is the quantity sold in theexternal market;Cfr = is the production cost;CG = is governance cost and;Cproc = is the cost of processedproduct;Pint and Pext = are market data.

Concerning governance,empirical research has shown that thefirms integrated by contract, a trendamong all exporting groups, guarantee aless variable price for producers thanfirms purchasing inputs on the spot

market (Silva and Saes, 2004). A formalcontract with the processing segmentand with the distribution channeldecreases the level of uncertainty. Theoffer of poultry in the internal market,in turn, depends on international pricesthat are functions of the exchange rate.Thus, considering a constant demand inthe internal market, the profit of the Lfirms depends on the poultry prices inthe international market.

Since there is an inter-relationbetween the national and internationalmarket, and considering the price in theinternational market as given, theBrazilian firms are also price takers andthe demand is inelastic at externalmarket price. However, if this price isinelastic in the international market, any



LCG

11

�� ( ( )Pint Qint – Cfr

Qint

) 1 (4)

LCG

22

�� ( )Pint Qint +Pext tcam Qext – Cfr

Qint + Qex

) ( ). ( 2

t(5)

LC

3�� (Pint Qint +Pext tcam Qext +Pproc.Qproc – Cfr) ( ). ( 3 proc CG� 3 )

Qint + Qext + Qproc(6)

alteration in that market willsignificantly affect the internal market.Non-exporting firms have theirstrategies subject to the behavior of theinternal market, and, to a certain extent,of the market of processed foods.Thus, this increased complexity anddifficulty to access information (pleaseread markets) would lead to differentgovernance structures in the chain.

Innovative firms (market leaders)and most imitative exporting firmsdirect their in natura produce to theexternal market; in the internal marketthey compete for the processed goods,which have another pattern ofcompetition and a more inelasticdemand when compared to the in natura

produces, and are less dependent on theinternational price dynamics.In addition, exporters are not interestedin competing in the Brazilian wholepoultry market. Their main reasonsinclude: high price volatility, strong and,at times, unfair competition, such in thecase of higher than permitted levels ofmoisture in the poultry. Thisinter-relation among national markets,international markets and differenttypes of products (whole poultry, meatpoultry and processed foods), allied tothe competitive characteristics of thewhole poultry market, enable the

continuity of slaughtering firms, in thismarket, with a smaller scale ofproduction and a less verticalgovernance structure.

Regarding this aspect, Williamson(1985, p. 125) comments on the influenceof the power of the market in thedefinition of the governance structure.To corroborate his statement, he presentsthe results of Porter and Livesay’s study,in which they observe that

the incidence of oligopoly and large size

was much less frequent among

manufacturers that did not integrate

forward than among those that did.

Another example was developedby Muris, Scheffman and Spiller (1992)for the soft drink industry, mentioned insection 2 herein. The governancestructures observed in both of the twolargest firms, Coca-Cola and Pepsi-Cola,in the North-American market haveundergone an important change in thelast thirty years. According to theauthors, the changes that resulted invertical integration with the distributingcompanies were motivated by strategicconsiderations, given the significantmarket changes, particularly regardingthe growth in the size of the companies’clients. The efficiency in thegeographically dispersed productiondecreased due to the economic cost



associated with the relativeconcentration of the buyers and theneed for a market strategy extrapolatingthe regional distribution of the bottlers.During the first years of the industry, acentralized control of these operationswas impossible due to the difficulty inmonitoring and communicating.

In that manner, theinterdependency between the form ofcommercialization and the structure ofproduction makes the governancerelationship in the production chaindependent not only on the specificity ofassets, but also on the way that productionand commercialization are linked.

The efficiency of the firm,throughout its production chain,is linked to the relationship between theproductive phase, discussed by Williams,and the way in which the production iscommercialized, which is notconsidered by that author.This peculiarity denotes that besidestechnology, the governance structurethroughout the chain can be definedfrom the firms’ production andcommercialization strategies.

In this situation, the economy ofscope assumes a determining status,because it develops alternatives forplacement of production, reducingmean bureaucratic costs. Horizontal

decisions (economy of scope –production mix and/or productionchannel, as exemplified in the poultrychain), in this situation, assume adetermining status in a verticalrelationship (definition of the morehierarchical governance structure).

Technology is, therefore, animportant decision variable in thegovernance structure, but not the onlyone, as Williamson pointed out.Information, institutional pathdependency, market and productionstrategies, are also relevant variablesto understand the definitions ofgovernance structures in a chain,allowing for the coexistence of differentstructures with the same productiontechnology or specificity of assets.

5_ Final considerationsand new works proposal

This article presented a theoreticaldiscussion of the factors determininggoverning structures based a transactioncost approach. Transaction CostEconomics points to a trend showingthe existence of only one governancestructure: the most efficient. However,as discussed herein, different governancestructures can be associated with



different market strategies. Structuresbasically differ when observed in termsof their production destination.

Instead of analyzing only theasset specificity to evaluate the trend toobtain a high governance cost and amore hierarchic structure, it is necessary,based on the argumentation developed,to bear in mind: the markets the firmsserve (size, level of informationnecessary, type of product, quantityof competitors and consumers);inter-relationship among the markets(dependence on the different marketsserved with the same productiontechnology); degrees of uncertainty.

The first issue is strategic for thefirm, since it defines the market the firmwishes to participate in. That decisionwill certainly be limited by its capacities,such as its control over the resources.Nevertheless, the firm will evaluate thecost (investment) and the benefit(capital return) based on thecharacteristics of the market (size,quantity transacted and quantity/powerof competitors and consumers). Thusthere can be firms with the sameproduction technology serving differentmarkets for strategic decisions. Theparticularities of each market can alloweach firm to continue surviving with

different strategies, which would alsoallow for the coexistence of differentgovernance structures.

The inter-relationship amongmarkets can be one of the conditioningsfor the firms to survive withoutadopting equal strategies. When theyparticipate in differentiated markets,however strongly inter-related they are,they will be competing in differentcompetition patterns. Thus, if stronglyinter-related markets are served by thesame production technology, firms willhave more possibilities for competitionand for strategies. In this case, thecoexistence of governance structures isfeasible, such in the case illustrated bythe poultry chain, in which although thedomestic and the international marketare strongly inter-related, each managesto survive with different governancestructures because there is a is strongrelation between the markets and thusalternatives for commercialization thatopen space for different groups offirms to compete in.

Therefore, besides the specificityof the assets, other reasons determinethe type of governance structure. Thiswork draws theoretically on thediscussions and examples from Joskow(1993) and Muris, Scheffman and Spiller



(1992), to conclude that, despite thesame degree of asset specificity amongthe firms, the coexistence of differentgovernance structures is possible andoccurs as a result of the firms’ strategiesconcerning target markets. As discussedin the fourth section herein, theefficiency in Williamson and Barzel’sviews must be particularized accordingto the type of demand the firm meets.Thus it is possible to have the sameproduction system meeting differentdemands, which makes the existence ofmore than one type of efficientstructure possible.

Williamson’s analysis departsfrom a perspective of comparative staticto propose a model relating the degreeof specificity of the assets to the costsof the governance modes. However, itcan be observed that besides the assets,the same chain can have differentstrategic directions, which makesdifferent governance structures viable.This issue trace its roots to the conceptof economic efficiency, which considersthat the relative efficiency betweenassets and transaction costs proposed byWilliamson is the productive one,whereas there is an allocative efficiencythat interferes in the governancestructure and in the transaction cost

based on the market strategy.This allocative efficiency is hereinunderstood as the gain obtainedthrough a better allocation of resources,arising, mainly, in situations ofeconomies of scope. Thus, the prevailingstructure would be a ratio of theproductive and the allocative efficiency,allowing for the coexistence of structureswith the same asset specificity.

In order to prove the conclusionsof this work, a comparative study ofdifferent market is suggested as aproposal of continuity. Thus it will bepossible to minimize the limitationsraised by Joskow (1993) in empiricalevidence, based on the possibility ofinterpretation and analysis of thedetermining factors of the definition ofgovernance structure, taking intoconsideration the theoretical basisherein discussed.





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References

Author’s e-mail:

[email protected]

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Artigo recebido em novembro de 2004;

aprovado em dezembro de 2006.

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