The Costs of Organization

Scott E. Masten James W. Meehan, Jr. Edward A. Snyder

Presented by Carla Fernández-Corrales, Fall 2013

Journal of Law, Economics, & Organization, Vol. 7, No. 1. (Spring, 1991), pp. 1-25.

University of Michigan Colby College University of Michigan (currently at Yale School of

Management)

Overview

• Problem for empirical research : Unobservability of transaction costs.• Indirect tests are unable to distinguish between

market and internal transaction costs.• The article focuses on the role of internal

organization costs. • Econometric methods are applied to analyze a large

naval construction project• The nature of data allowed them to isolate the

effects of transaction on the costs of organizing and to provide dollar estimates.

Hypothesis

• Criticism:• Latent costs: for example inflexibility• Unquantifiable costs: loses due to withholding of information

Institution chosen

Internal organization

Market exchange

Costs of each alternative

Reduced-Form Analysis

• Probability of observing

• Resulting estimates provide only ordinal measures of the costs• If X and Z have common elements, only the difference between

and can be determined.

X, Z: vectors of attributes , : vectors of coefficients e, u: normally distributed random variables

Direct tests

• Regression techniques yield dollar estimates of the costs of organization• Regression estimation can identify the

magnitude of the coefficients to perform test of hypotheses.

General hypotheses

Empirical setting: naval shipbuilding

• Final product large, discrete, and immobile during most of its fabrication• Assembly must proceed in order• Buffer inventories are impractical• High complexity• High human asset specificityy• Physical assets are less specific• Mainly involves low technology, labor intensive

activities.

Specific Hypotheses

Data

Data

Empirical results

Empirical results

Discussion

• Temporal specificity can be a major determinant of organization.• Integration occurs for relation specific human

capital and very complex components, but the incentive comes from the internal costs rather than market costs.• Relationship specific physical assets reduces the

costs of governance.• The firm is more likely to integrate engineering

intense activities and more likely to internalize labor intense activities.

Discussion

• The independent variables have their principal influence on costs of internal organization.• Effects of engineering.• Need to know the industry under study.• Implications of changes in regulations.• Idiosyncrasies of shipbuilding must be taken into

consideration.