WHY LAW, ECONOMICS, AND ORGANIZATION

doi:10.1146/annurev.lawsocsci.1.031805.111122c2005byAnnualReviews.AllrightsreservedCopyright󰀁

FirstpublishedonlineasaReviewinAdvanceonAugust19,2005

WHYLAW,ECONOMICS,ANDORGANIZATION?

OliverE.Williamson

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.WalterA.HaasSchoolofBusiness,UniversityofCalifornia,Berkeley,California94720;email:owilliam@haas.berkeley.edu

KeyWordsgovernance,transactioncosts,lawschoolteaching

■AbstractThisreviewshowsthatacombinedlaw,economics,andorganizationtheoryapproachleadstodifferentanddeeperunderstandingsofthepurposesservedbycomplexcontractandeconomicorganization.Thebusinessfirmforthesepurposesisdescribednotintechnologicalterms(asaproductionfunction)butinorganizationalterms(asanalternativemodeofgovernance).Firmandmarketarethusexaminedcomparativelywithrespecttotheircapacitiestoorganizetransactions,whichdifferintheircomplexity,soastoeconomizeontransactioncosts.Thepredictivetheoryofeconomicorganizationthatresultshasnumerousramificationsforpublicpolicytowardbusinessandforteachingandresearchinthelawschools.

INTRODUCTION

Whereaslawandeconomicsbeganastheapplicationofeconomicreasoningtoantitrustandregulation,ithassincebeenexpandedtobringeconomicanalysistobear(invaryingdegree)oneveryfacetofthelawschoolcurriculum.Occasionaldissentsnotwithstanding,lawandeconomicsiswidelyregardedasasuccessstory.Iconcurwiththisfavorableassessmentbutwouldobservethateconomicanal-ysiscomesinmorethanoneflavor.Asbetweenthetwomainbranches—thesci-enceofchoiceandthescienceofcontract—lawandeconomicsscholarshipmainlyworksoutofthescienceofchoicetradition.Allwellandgoodformanypurposesbutnot,Icontend,forall.Specifically,thosepartsofthelawandeconomicsen-terprisethatarecentrallyconcernedwithissuesofeconomicorganizationoughttobeinformed,additionallyorinstead,bythescienceofcontractperspective.1

Thisinvolves,amongotherthings,supplantingtheneoclassicaltheoryofthefirm-as-productionfunction(whichisatechnologicalconstruction)withthetheoryofthefirm-as-governancestructure(whichisanorganizationalconstruction).Acriticalconcession,whichmanylawandeconomicsscholarsareloathetomake,

Areasofthelawthataremostinneedofamoreveridicaltheoryofeconomicorganizationincludeantitrust,regulation,corporations,laborlaw,corporategovernance,agency,admin-istrativelaw,property,contract,securedtransactions,andtorts.Butthescienceofcontractbranchofeconomicshasramificationstothelawquitegenerally.1550-3585/05/1209-0369$20.00

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Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.isthattheorthodoxtheoryofthefirmwasneverdesignedwithreferenceto(and,hence,isoftenpoorlysuitedtointerpret)nonstandardandunfamiliarcontractualpracticesandorganizationalstructures.

Ibeginwithabriefdiscussionofthesciencesofchoiceandofcontractandofthedifferingneedsofeachforatheoryofthefirm.IthenturninthenextsectiontowhatIregardasthechieflessonsoforganizationtheoryforathe-oryofthefirm-as-governancestructure.Thecomparativecontractualapproachtoeconomicorganization,ofwhichthetheoryofthefirm-as-governancestructureisapart,isthensketchedinthesectiononComparativeContractualAnalysis.Applicationstopublicpolicyanalysisaresetoutinthenextsection,andthelessonsofthecomparativecontractualapproachtoeconomicorganizationfortheteachingofcontractlawaredevelopedinthefinalsection.Concludingremarksfollow.

CONCEPTUALFRAMEWORKSChoiceandContract

Althoughorthodoxeconomictheory,withitsemphasisonscarcityandefficientresourceallocation,iswidelyregardedasanall-purposetheory,itismoreprop-erlyregardedasthe“dominantparadigm”(Reder1999,p.43).Plainly,dominantparadigmscommandmorerespect.Often,however,theirusesaremuchmoreaptforsometypesofproblemsthantheyareforothers.

LionelRobbinscapturedtheemergingconsensusofwhateconomicswasallaboutinhisdescriptionofeconomicsas“thesciencewhichstudieshumanbe-haviorasarelationbetweenendsandscarcemeanswhichhavealternativeuses”(Robbins1932,p.16)—orasRederputsit,economicsdealswith“theallocationofscarceresourcesamongalternativeusesforthemaximizationofwantsatisfac-tions”(Reder1999,p.43).Thetheoryofconsumerbehaviorandthetheoryofthefirmarethetwokeybuildingblocksuponwhichthissciencerests:Theconsumerseekstomaximizeutilitysubjecttoabudgetconstraint,andthefirmisaproductionfunctionthattransformsinputsintooutputs,withefficiencyrealizedthroughthechoiceofoptimalfactorproportions.Allwellandgoodforthestudyofsupplyanddemand,pricesandoutput.Theeconomistworkingoutofsuchasetupdecid-edlydoesnot,however,addresshimselftoissuesoffirmandmarketorganizationexceptinnarrowlydelimitedways.2Thefirm,forallintentsandpurposes,isa“blackbox.”

JamesBuchananhasdeclaredthisscienceofchoiceperspectiveasa“wrongturn”(Buchanan1975,p.225),butIputitsomewhatdifferently.Economics

AsRonaldCoasehasputit,intheRobbinsconceptionofeconomics,theeconomist“doesnotinteresthimselfintheinternalarrangementswithinorganizationsbutonlyinwhathappensonthemarket”(Coase1992,p.714).

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Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.becameundulypreoccupiedwiththescienceofchoicetotheneglectofthescienceofcontract.Ratherthandealwithcontractandexchange,economicsbecamethescienceofconstrainedoptimization.

AsperceivedbyBuchanan,theprincipalneedsforascienceofcontractarefoundinthefieldofpublicfinanceandtaketheformofsocialordering:“Politicsisastructureofcomplexexchangeamongindividuals,astructurewithinwhichpersonsseektosecurecollectivelytheirownprivatelydefinedobjectivesthatcannotbeefficientlysecuredthroughsimplemarketexchanges”(Buchanan1987,p.296;emphasisadded).Bycontrast,Iseetheneedsforascienceofcontractprimarilywithreferencetothefieldofindustrialorganizationandinthecontextofprivateordering.

Comparedwiththepoliticsofcollectiveaction,privateorderingisaccomplishedthroughtheindividualeffortsoftheimmediatepartiestoanexchange.Outofawarenessofthelimitationsofspot-marketcontractingandtheimpossibilityofcomprehensivecontracting,theimmediatepartiestoanexchangecraftgovernancestructuresthatpermitthemtorealizemutualgains.

Theroleofthecourts,forsuchapurpose,isverydifferentfromthatprojectedunderthescienceofchoiceperspective.

Firms

“Anystandardeconomictheory,notjustneoclassical,startswiththeexistenceoffirms.Usually,thefirmisapointoratanyrateablackbox....Butfirmsarenotpoints.Theyhaveinternalstructure.Thisinternalstructuremustariseforsomereason”(Arrow1999,p.vii).Thecontrastbetweenthescienceofchoiceandthescienceofcontractinthisrespectisfundamental.AsHaroldDemsetzhasputit,“Itisamistaketoconfusethefirmofeconomictheorywithitsreal-worldnamesake.Thechiefmissionofneoclassicaleconomicsistounderstandhowthepricesystemcoordinatestheuseofresources,nottounderstandtheinnerworkingsofrealfirms”(Demsetz1983,p.377).Bycontrast,thescienceofcontractisexpresslyconcernedwiththeattributesoffirms,especiallyinrelationtotheattributesofalternativemodesofgovernance,asthesebearonthemanagementoftransactions.Asagainstatechnologicalviewofthefirm,thefirm(andothermodesofgovernance)aredescribedasgovernancestructures.JohnR.Commons’sprescientconceptionofeconomicsisbroadlycongruentwiththescienceofcontractperspective:“[T]heultimateunitofactivity...mustcontaininitselfthethreeprinciplesofconflict,mutuality,andorder.Thisunitisatransaction”(Commons1932,p.4).Notonlydoestransactioncosteconomics(TCE)concurthatthetransactionisthebasicunitofanalysis,butitviewsgovernanceasthemeansbywhichtoinfuseorder,therebymitigatingconflictandrealizingmutualgains.

Asdevelopedbelow,implementingtheprivateorderingbranchofthescienceofcontractisamuchmoremicroanalyticprojectthanisthescienceofchoiceapproachtoeconomics.Hithertoneglectedattributesofbothtransactionsandgovernancestructuresnowneedtobeuncoveredandtheirramificationsworked

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out.Intheprocess,awholeseriesofpublicpolicydifferencesbetweenthechoiceandcontractperspectivesemerge.

ORGANIZATIONTHEORY

Organizationtheoryisavastfieldtowhichsociology,psychology(cognitive,social,evolutionary),aspectsofpoliticalscience,economics,andculturalanthro-pologyallrelate.W.RichardScott’s(1987)influentialtextdistinguishesthreemainbranches:rational,natural,andopensystems—wheretherationalsystemsapproachplacesprimaryemphasisonformalstructure,thenaturalsystemsap-proachfeaturesinformalorganization,andtheopensystemsapproachexaminesshiftingcoalitionswithintheorganizationandinrelationtotheirenvironment.Allhavearoletoplayinunderstandingcomplexorganization.Ofthesethree,Iplaceprimaryemphasisonthecontributionsofrationalsystemstheory,althoughprovisionisalsomadeforthespontaneousforcesofinformalorganizationandtheintertemporaltransformationsthatrelatethereto.ChesterBarnard[1962(1938)],HerbertSimon(1947),andMarch&Simon(1958)areespeciallyprominenttotherationalsystemstradition.Ofthemanycontributionsthatoriginatewiththistradition,thefivethatIregardasmostrelevanttothescienceofcontractapproachtoeconomicorganizationare(a)humanactors,(b)adaptation,(c)intertempo-raltransformations,(d)choiceoftheunitofanalysis,and(e)discretestructuralfeatures.3

If,asIcontend,organizationtheoryisimportanttothestudyofeconomicorganizationinthesefiveandotherrespects,thepuzzleiswhyorganizationtheoryhasnotbeenmorefullyincorporatedwithineconomics.Thechiefreasons,Ithink,arethese:(a)organizationtheoryhaslessrelevancetothescienceofchoicethantothescienceofcontract,andmosteconomistshavebeencontenttoworkoutofthe“dominantparadigm”;(b)organizationtheoristsmainlydeliveranegativemessage(thescienceofchoiceiswrongheaded)ratherthanrelatetotheopportunitiesopenedupbytheincipientscienceofcontract;and(c)leadersofthelawandeconomicsmovement,suchasRichardPosner,whowerevotariesoforthodoxy,weredismissiveoforganizationtheory:“[O]rganizationtheory...[adds]nothingto...economicsthattheliteratureoninformationcostshadnotaddedmuchearlier”(Posner1993,p.84).

Bethatasitmay,mysenseisthatatheoryofeconomicorganizationthatas-pirestodealwithrealfirmsand,moregenerally,witheconomicorganizationinanuncontrivedwaycannotignoreordismissthecontributionsoforganizationtheorynamedabove—whicharenotthemainissueswithwhichthe“literatureoninfor-mationcosts”hasbeenconcerned(evennow,tosaynothingof“muchearlier”).

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.Otherimportantcontributionsinclude(f)weakformselection,(g)informalorganization,(h)cognitivespecialization,and(i)bureaucracy.

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HumanActors

Simonadvisedsocialscientiststhat“[n]othingismorefundamentalinsettingourresearchagendaandinformingourresearchmethodsthanourviewofthenatureofthehumanbeingswhosebehaviorwearestudying”(Simon1985,p.303).Thetwoattributesofhumanactorsthatareespeciallyrelevanttotheeconomicsofgovernancearecognitionandself-interestedness.

Simontookearlyexceptionwiththeideathathumanactorsaresupremelyrational,andheproposedinsteadthathumanactorsbedescribedasboundedlyrational,bywhichhemeantthattheyare“intendedlyrational,butonlylimitedlyso”(Simon1957a,p.xxiv).Humanactorsarethusneithernonrationalnorirrationalbutareattemptingeffectivelytocope.

TCEagreesthatscholars’viewofthehumanbeingswhosebehaviortheyarestudyinghasprofoundramificationsfortheresearchagenda.Italsoconcursthathumanactorsaresubjecttoboundedrationality.Ratherthandwellonthelessonsofboundedrationalityforthescienceofchoice(wheretheuseofmaximizingapparatuswascontested),however,TCEturnstothescienceofcontractandtakesthechieflessonofboundedrationalityforthestudyofeconomicorganizationtobethatallcomplexcontractsareunavoidablyincomplete.

Contractualincompletenessbyitself,however,doesnotaseriousproblemofcontractingmake.Governanceproblemsareposedwhenincompletecontracts(toincludeunforeseencontingencies)arecombinedwithopportunism.TheconflictstowhichCommonsreferrednowappear,especiallyduringcontractexecutionandatthecontractrenewalinterval.

NotethatTCEdoesnotdisputethatmostpeoplewilldowhattheysay(andsomewilldomore)withoutself-consciouslyaskingwhethertheeffortisjustifiedbyexpecteddiscountednetgains.Butwhileaccuratedescriptionsofwhatisgoingon“mostofthetime”areimportant,muchofwhatisinterestingabouthumanbehavioringeneralandcontractinparticularhasreferencenottoroutinesbuttoexceptions.Facedwithunanticipateddisturbancesforwhichanincompletecontractmakesinadequateorincorrectprovision(byreasonofgaps,errors,andomissions),suchdisturbanceswillpushthepartiestoanincompletecontractoffofthecontractcurve.Strategicconsiderationsnowcomeintoplayif,ratherthanfrailtyofmotive,opportunismistheoperativecondition.4Contractualbreakdownsbyreasonofdefectionfromthespiritofcooperationandrelianceontheletterofthecontractarenowinprospect.

Inefficienciesofallkindsneverthelessinviterelief.Outofawarenessofprospec-tivehazards,partiestoacontracthaveincentivestocraftexantesafeguardsina

Interestingly,opportunismmakesanappearanceinthenaturalsystemtreatmentofsociol-ogists.AsScottputsit,“thereisfrequentlyadisparitybetween...theprofessedorofficialgoalsthatareannouncedandtheactualoroperativegoalsthatcanbeobservedtogoverntheactivitiesofparticipants”(Scott1987,p.52).Whereasrationalsystemtheoristsemphasizethenormativestructureofexantedecisions,naturalsystemtheoristsstressthebehavioralstructureofexpostoutcomes(Scott1987,p.53).

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Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.cost-effectivedegree.Ratherthanpostulateeithermyopiaoromniscience,TCEassumesthathumanactorshavethecapacityfor“feasibleforesight,”whichisara-tionalspiritconstruction.GeorgeSchultzspeakstothepointasfollows:“mytrain-ingineconomicshashadamajorinfluenceonthewayIthinkaboutpublicpolicytasks,evenwhentheyhavenoparticularrelationshiptoeconomics.Ourdisciplinemakesonethinkahead,askaboutindirectconsequences,takenoteofvariablesthatmaynotbedirectlyunderconsideration”(Schultz1995,p.1).Buteconomistsdonothavealockonthis.AstheevolutionarybiologistRichardDawkins(1976)observes,the“capacitytosimulatethefutureinimagination...[saves]usfromtheworstconsequencesoftheblindreplicators”(p.200).Practitioners,consultants,andpublicpolicyanalystswhopossesstheskillsforandpracticetheartoffeasibleforesightwilllookahead,discernpotentialhazards,andfoldtheseintotheexantedesign.

Adaptation

Interestingly,boththeeconomistHayek(1945)andtheorganizationtheoristBarnard[1962(1938)]areinagreementthatadaptationisthecentralproblemofeconomicorganization.Theadaptationstowhichtheyhavereference,how-ever,differ.Hayekhadreferencetotheadaptationsofautonomouseconomicactorswhoadjustspontaneouslytochangesinthemarket(mainlyassignaledbychangesinrelativeprices).Bycontrast,Barnardappealedtointentionality.Hefeaturedcooperativeadaptationmadebyeconomicactorswiththeassistanceofhierarchywithinfirms.Althoughadaptationofeachtypeisimportantandcanbestudiedseparately,TCEisinterestedinmarketsandhierarchies(ratherthanmarketsalone,orhierarchiesalone).TCEthereforedealswithadaptationsofbothkinds(andmixturesthereof).Specifically,TCEholdsthatchoiceofcontractualmodeshouldbederivedbyrecognizingthattheadaptiveneedsoftransactions(inautonomousandcooperativerespects)varywiththeattributesoftransactionsandthattheadaptivecapacitiesofalternativemodesofgovernancealsodiffer.Theupshotisthatefficiencygainsarerealizedbyaligningtransac-tionswithgovernancestructuressoastoeffectaneconomizingoutcome.Push-ingthelogicofautonomousandcooperativeadaptationtocompletiontherebyleadstoapredictivetheoryofcomparativeeconomicorganization(Williamson1991).

IntertemporalTransformations

Thatinternalorganizationhasalifeofitsownhasbeenevidenttosociologistsoforganizationforalongtime.Thereismoretoit,moreover,thansimplybeingalertedtohithertoneglectedregularities.Oncedisclosed,theexanteorganizationaldesignramificationsoftheseregularitiesneedtobeworkedout.

RobertMichels’1911bookonPoliticalPartiesfocusedontheintertemporaltransformationsthatregularlyattendeddemocraticeffortsatpoliticalorganiza-tion.Themostimportantsuchintertemporaltransformationissummarizedbythe

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famousIronLawofOligarchy:“Itis[hierarchical]organizationwhichgivesbirthtothedominionoftheelectedovertheelectors,ofthemandatoriesoverthemanda-tors,ofthedelegatesoverthedelegators.Whosaysorganization,sayoligarchy”(Michels1962,p.365).Michelstracedthesourceoftheseoligarchicaltendenciesto“thenatureofthehumanindividual,...thenatureofthepoliticalstruggle,...andthenatureoforganization”(p.6).

Michels,moreover,hadaveryfarsightedviewofhisfindings:“Thesociologistshouldaim...atthedispassionateexpositionoftendenciesandcounter-operatingforces,ofreasonsandopposingreasons,atthedisplay,inaword,ofthewarpandthewoofofsociallife”(Michels1962,p.6).Unlesswearealerttotheintertemporalpropensitiesoforganization,wewillbeneedlesslyvictimizedbythem:“[N]othingbutasereneandfrankexaminationoftheoligarchicaldangersofdemocracywillenableustominimizethesedangers”(Michels1962,p.370).Thus,althoughtheoligarchicalpropensitiesofdemocraticorganizationmayhavebeenpoorlyunderstoodbyacademicsandsomepractitionersuntilMichelsclarifiedtheissue,thelurkinghazardsofoligarchyshouldnolongercomeasasurprise.Today’sorganizationaldesignerspresumablytaketheIronLawofOligarchyintoaccountintheinitialdesigncalculus.

Selznickcharacterized“Michels’theoryaboutdemocraticorganization...asaspecialcaseofthegeneralrecalcitranceofthehumantoolsofaction.Thetendencyforgoalstobesubvertedthroughthecreationofnewcentersofinterestandmotivationinheresinallorganizations”(Selznick1950,p.162;emphasisadded).Thestudyofunanticipatedconsequencesofallkinds—ofwhicholigarchyisbutoneexample—thusdescribesthelargerresearchagenda.

AkintothediscussionoffeasibleforesightinthesectiononHumanActors,above,TCErespondsinathree-partway.First,bealerttoallthesignificant,unanticipatedconsequencesandbureaucraticpropensitiesthatstudentsofinternalorganizationuncover.Second,takethelogictocompletion.Foreachunantici-patedeffect,askfromwhereitarises,whatarethemechanismsthroughwhichitoperates,whataretheeffectsoncontractandorganization,andwhataretheramificationsforexantedesign(therebymitigatingunwantedconsequencesandenhancingbeneficialeffects).Third,upontakingafarsightedviewofcontractandorganization,donotrelyentirelyonthereportsbyorganizationtheoristsofunanticipatedconsequences.Givencontractualincompleteness(byreasonofboundedrationality)andthepossibilityofdefectionfromagreements(byrea-sonofopportunism),practitionersofTCElookaheadtoascertainwhetherandwhenpredictablecontractualhazardswillaccrue.Ifandassuchhazardscanbeprojected,thegovernanceramificationsneedtobeworkedout.[Anillus-trationistheFundamentalTransformation,bywhichalargenumbersbiddingcompetitionis(sometimes)transformedintoasmallnumberssupplyrelationdur-ingcontractexecutionandatthecontractrenewalinterval(Williamson1985,pp.61–63).AsdevelopedinthesectiononApplicationstoPublicPolicy,below,contractualsafeguardsand(possibly)verticalintegrationarisetomitigatesuchhazards.]

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UnitofAnalysis

TCEadoptsthepurposiveperspectiveofJohnR.Commonsbynamingthetrans-actionastheunitofanalysis.Butthatismerelythefirststep.Namingaunitofanalysisneedstobefollowedbyprovidingoperationalcontent.Theproponentsofmanywould-beunitsofanalysisneverundertakethissecondsteporfounderuponreachingit.

Identifyingthecriticaldimensionswithrespecttowhichtransactionsdifferisfacilitatedbyaskingwhichattributes,amongthecountlesswaysinwhichtrans-actionsdiffer,haveconsequentialtransactioncosteffects.Sometransactionsaresimplewhileothersarecomplex.Whatarethedistinguishingfeatures?Olderstyleinstitutionaleconomicsneverasked,henceneveranswered,thisquestion.

Theobviousplacetobeginiswiththeidealtransactioninlawandeconomics—namely,contractsthattakeplacebetweenfacelesseconomicactors,whereconti-nuityisunimportantbecausetheidentityofthepartiesdoesnotmatter.Thenaskthequestion,“Whatattributesoftransactionsareresponsibleforthebreakdownofthiscontractualideal?”Relevantattributesfordescribingtransactionsbetweenpartieswhereidentitydoesmatterincludeassetspecificityinitsvariousforms(whichgivesrisetobilateraldependency),uncertainty(forwhichconsciouslyco-ordinatedadaptationstodisturbancesmaybeneeded),andfrequency(whichhasabearingonthefuturevalueofpreservingacontinuingrelationandontheincentivetoincurthecostofspecializedgovernance).

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.DiscreteStructural

Ifalternativemodesoforganizationdifferindiscretestructuralways,thenmarginalanalysiscanbesupplantedbydiscretestructuralanalysis,whichispurportedlyeasiertoimplement(Simon1978,pp.6–7).5Asacomparativecontractualmatter,however,therealimportofthepropositionthatmovingfromonegenericformoforganizationtoanotherisattendedbydiscontinuitiesisthatalternativemodesofgovernancehavedifferentstrengthsandweaknessesbyreasonofthesedisconti-nuities.Aswiththetransaction,moreover,thereisaneedtogobeyondthisfirststeptoascertainthecriticalattributeswithrespecttowhichgovernancestructuresdiffer.Thequestiontobeaskedandansweredhereisthis:Howdoalternativemodesofgovernancedifferincontractimplementationandenforcementrespects?Onedeviceforgettingatthisistoposethepuzzleofselectiveintervention:Canafirmreplicatethemarketmodeforallstaterealizationsforwhichmarketpro-curementworkswellandintervenealwaysbutonlywhenexpectednetgainscan

Becausemarginalanalysisisactuallyeasytoimplement,economistscanbethoughtofasanalyticalsatisficers:Theyuseworkableapparatusthat(often)is“goodenough.”Alsonotethattheuseofmarginalanalysisanddiscretestructuralanalysiscanbejoined,asinRiordan&Williamson(1985),wherediscretestructuraldifferencesgiverisetofirst-ordereffectsandmarginalanalysisintroducessecond-orderrefinements.

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beprojected.Iffeasible,thenlargefirmswillalwaysdoaswellasacollectionofsmallfirms(throughreplication)andwillsometimesdobetter(byselectiveinter-vention).AsIhavedevelopedelsewhere(Williamson1985,chapter6),sucheffortsarenotonlyimpossiblebut,ifattempted,areattendedbyaseriesofunwantedef-fects.Thisisbecauseeffortstopreservethehigh-poweredincentivesofmarketswithinhierarchiesgiverisetoassetdissipationlossesandstrategicdistortions.Theupshotisthatthemovefrommarkettohierarchyisattendedbyaweakeningofin-centiveintensityand,asaconsequence,byanincreaseinadministrativeoversightandcontrol.

Athirddiscretestructuraldifferencearisesincontractlawrespects.TheideathateachgenericmodeofgovernanceissupportedbyadistinctiveformofcontractlawcanbetracedtoKarlLlewellyn’s(1931)earlydistinctionbetweencontractasframeworkandcontractaslegalrules;toIanMacneil’s(1974)furtherdistinctionsamongclassical,neoclassical,andrelationalcontractlaws;tolatertreatmentsofprivateordering(Galanter1981,Klein&Leffler1981);andtocrediblecontracting(Williamson1983,Gilson1984).

Classicalcontractlawofalegalruleskindappliestotheidealtransactioninbothlawandeconomics,wherelargenumbersofinformedand“facelessbuyersandsellers...[meet]foraninstanttoexchangestandardizedgoodsatequilibriumprices”(Ben-Porath1980,p.4).Suchalegalrulesregimegiveswaytocontractasframeworkwhenlong-termcontractingwithdependencyrelationssetsin.Thepartiesherehaveaninterestinpromotingcontinuityinthefaceofunforeseendisturbances,andhencemovetoamorecooperativeandadaptablecontractingform.Suchneoclassicalcontractsarenot,however,indefinitelyelastic.Whenpushcomestoshove,theletterofthecontractbecomesthebasisfor“ultimateappeal”tothecourts(Llewellyn1931,p.737)—whereinthewrittencontractservestodelimitthreatpositions.

Whatthenisthecontractlawofinternalorganization?Asdevelopedelsewhere(Williamson1991),theimplicitlawofinternalorganizationisthatofforbearance.Thus,whereascourtsroutinelygrantstandingtointerfirmdisputesoverprices,damagesascribedtodelays,failuresofquality,andthelike,courtswillrefusetoheardisputesbetweenoneinternaldivisionandanotheroveridenticaltechnicalissues.Ifaccesstothecourtsisdenied,hierarchyisitsowncourtofultimateappeal,whereuponfirmshaveaccesstofiatthatinterfirmcontractingdoesnot.Takentogether,thelessonsoforganizationtheoryforthescienceofcontract(privateorderingbranch)arethese:

1.Allcomplexcontractsareunavoidablyincomplete(byreasonofboundedrationality),andhencecomprehensivecontingentclaimscontractingisin-feasibleandonce-and-for-allauctions(competitionforthemarket)areoftenfraughtwithhazards.

2.Farsightedplayerstoanincompletecontracthavetheincentivetolookahead,identifypotentialhazards,andattempttoprovideexantereliefforthesehazardsthroughthejudiciouschoiceofgovernance.

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3.Adaptationisthecentralproblemofeconomicorganization,andautonomousandcooperativetypesofadaptationneedtobedistinguishedand,asappro-priate,providedfor.

4.Becauseorganizationshavealifeoftheirown,allsignificantintertempo-ralregularitiesneedtobeuncoveredandtheramificationsforeconomicorganizationworkedout.5.Thekeyattributesofthetransaction(whichistakentobethebasicunitofanalysisforthescienceofcontract)needtobenamedandtheirramificationsworkedout.6.Becausealternativemodesofgovernancedifferindiscretestructuralways,thesyndromeofattributesthatdefineseachmodeneedstobenamedandthecomparativestrengthsandweaknessesofeachgenericformworkedout.Theupshotisthat,uponmovingfromthescienceofchoicetothescienceofcontractperspective,thecontributionsoforganizationtheoryforthestudyofeconomicorganizationcometolife.Theburgeoningstudyoftheeconomicsoforganizationthusholdsthatorganizationsmatter(intheabove-describedway,aswellasothers)andthatorganizationsaresusceptibletoanalysis(especiallywhenviewedthroughacomparativecontractuallensinwhicheconomizingontransactioncostsisfeatured).

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.COMPARATIVECONTRACTUALANALYSISDiscriminatingAlignment

ThediscriminatingalignmenthypothesisoutofwhichTCEworksholdsthattrans-actions,whichdifferintheirattributes,arealignedwithgovernancestructures,whichdifferintheircostsandcompetence,soastoeffecta(mainly)transactioncosteconomizingresult.Asindicatedabove,thisrequiresthattheattributesofbothtransactionsandgovernancestructuresbeidentifiedandtherelationsbetweenthemworkedout.

Goingbeyondthepropositionthatthetransactionisthebasicunitofanalysis,TCEtakesthenextstepandnamesassetspecificity(initsvariousforms),uncer-tainty,andfrequencyaskeyattributes.Ofthesethree,assetspecificityisthemostimportantanddistinctivetotheTCEenterprise.

Asdevelopedelsewhere,assetspecificityisameasureofthedegreetowhichtheassetsneededtoproduceagoodorservicecanberedeployedtoalternativeusesanduserswithoutlossofproductivevalue.Whereasidentityisunimportantforgenericgoodsandservices,theidentityoftheimmediatepartiestoanexchangearecriticalasassetspecificity(ofphysical,human,site,dedicated,brandname,ortemporalkinds)buildsup.Inthatevent,abilateraldependencyconditionsetsinandthepartiesaresubjecttoopportunisticdefectionfromthespiritofacontract

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Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.toinsistontheletterwherelargegainsareatstake.Maladaptationcostsattendedbycostlybargainingaretheresult.

Putdifferently,contractualhazardsarisewhenincompletecontractsthataresupportedbynontrivialinvestmentsinspecificassetsarebesetbydisturbances(uncertainty).Outofawarenessofthesehazards,partiestosuchcontractshaveincentivestotakehazard-mitigatingactions,suchasbydevisingsafeguardsthatservetoinfuseorderandtherebyreduceconflictandrealizemutualgains.

Asdiscussedaboveinconjunctionwithdiscretestructuralanalysis,alternativemodesofgovernancearedefinedasinternallyconsistentsyndromeswithrespecttothefollowingattributes:incentiveintensity,administrativecontrols,andcontractlawregimes.Becausedifferentmodesofgovernancecombinetheseattributesdifferently,alternativemodesdifferintheircapacitiestoimplementautonomousandcooperativeadaptations.Thedetailsaredevelopedelsewhere(Williamson1991).Bywayofsummary,thediscretestructuraldifferencesbywhichfirmandmarketaredistinguishedare

1.incentiveintensity:thehigh-poweredincentivesofmarketsgivewaytolow-poweredincentivesinfirms;2.administrativecontrols:comparedwithmarkets,firmsaresupportedbyamoreextensivearrayofadministrativerulesandprocedures,includingaccountingandauditing,aswellasthesupportsofinformalorganization;3.contractlaw:thecontractlawofmarketsislegalisticandreliesoncourtordering,whereas,asdescribedabove,thecontractlawofinternalorgani-zationisthatofforbearance.Becauseofthesedifferences,marketsenjoytheadvantageineffectingautonomousadaptations,whereastheadvantageaccruestofirmsineffectingcooperativeadap-tations.

TheSimpleContractualSchema

Uponadoptingacomparativecontractualapproachtoeconomicorganizationinwhich(a)thetransactionismadethebasicunitofanalysis,(b)alternativemodesoforganizationaredescribedasgovernancestructurestowhichdiscretestructuraldifferencesaccrue,and(c)economizingontransactioncostsistakentobethemaincase,averydifferentconceptofthefirmandofthepurposesservedbynonstandardandunfamiliarcontractualpracticesandorganizationalstructuresresults.Notethatthefirm,inthisschemeofthings,isnotastand-aloneconceptbutisexaminedinrelationtoalternativemodesofgovernance.Alwaysandeverywheretheactionresidesinthemicroanalyticsoftransactionsandgovernancestructures.

Thus,assumethatafirmcanmakeorbuyacomponentandassumefurtherthatthecomponentcanbesuppliedbyeitheroftwotechnologies.Oneisageneral-purposetechnologyandtheotheraspecial-purposetechnology.Thespecial-purposetechnologyrequiresgreaterinvestmentintransaction-specificdurableassetsandismoreefficientforservicingsteady-statedemands.Steady-state,

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Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.however,isananalyticalconvenience:Mostcontractsareimplementedundercon-ditionsofuncertaintyforwhichadaptationtodisturbancesisneeded.Becauseanincompletecontractbetweenbilaterallydependentparties(thatis,thoseforwhichcontinuityhasvalue)isoftensilentonormakesincorrectorinadequateprovisionforsomeoftheseadaptations,contractualconflictsprospectivelyarise.Thusal-thoughmutualgainswillalwaysberealizeduponcostlesslyrestoringapositiononthecontractcurve,eachpartymaypostureandmakeopportunisticrepresentationsoverthedivisionofgains.Costlydelaysandimperfectadaptationsresult.

Usinghasameasureofcontractualhazards,thetransactionsinFigure1thatusethegeneral-purposetechnologyareonesforwhichh=0.Autonomousadaptationinacompetitivemarketsufficesbecausethepartiesarefaceless.Ifinsteadtransac-tionsusethespecial-purposetechnology,anh>0conditionexists.Assetsherearespecialized,whenceproductivevalueswouldbesacrificedifh>0transactionsweretobeprematurelyterminated.Suchbilaterallydependentpartieshavein-centivestopromotecontinuityandsafeguardinvestments.Cooperativeadaptationthuscomestothefore.

Letsdenotethemagnitudeofanysuchsafeguards.Ans=0conditionisoneinwhichnosafeguardsareprovided;adecisiontoprovidesafeguardsisreflectedbyans>0result.

Safeguardscantakeeitheroftwoforms.Oneformistoprovideinterfirmcon-tractswithaddedsupport:Penaltiestodeterbreachareintroduced,addedinfor-mationdisclosureisprovided,andspecializeddisputesettlementmachinery(e.g.,arbitration)isdevised.Thissafeguardisthecredibleinterfirmcommitmentop-tion.Asecondformistotaketransactionsoutofmarketsandorganizethemunderunifiedownershipwherehierarchy(toincludefiat)isusedtoeffectcoordination.

Figure1Thesimplecontractualschema.

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Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.NodeAcorrespondstotheidealtransactioninlawandeconomics:Withanab-senceofdependency(h=0),pricesaresetcompetitivelyinthemarket(bysupplyanddemand),and,intheeventofcontractualbreakdown,thecourtsawarddam-ages.NodeBposesunrelievedcontractualhazardsinthatspecializedinvestmentsareexposed(h>0)forwhichnosafeguards(s=0)havebeenprovided.Suchhazardswillberecognizedbyfarsightedplayers,whowillpriceouttheimpliedrisks.NodesCandDarethoseforwhichadditionalcontractualsupporthasbeenprovided(s>0),eitherintheformofcontractualsafeguards(nodeC)orunifiedownership(nodeD).

IntheeventthatcostlybreakdownscontinueinthefaceofbestbilateraleffortstocraftsafeguardsatnodeC,thetransactionmaybetakenoutofthemarketandorganizedunderunifiedownership(verticalintegration)instead.Inasmuch,however,asaddedbureaucraticcostsaccrueupontakingatransactionoutofthemarketandorganizingitinternally,internalorganizationisusefullythoughtofastheorganizationformoflastresort:Trymarkets,tryhybrids,andhaverecoursetothefirmonlywhenallelsefails.NodeD,thefirm,thuscomesinonlyashigherdegreesofassetspecificityandaddeduncertaintyposegreaterneedsforcooperativeadaptation.

APPLICATIONSTOPUBLICPOLICY

NodeAexcepted,whichistheidealtransactioninlawandeconomicstowhichIreferredpreviously,theneoclassicalandtransactioncostapproachestofirmandmarketorganizationplainlydiffer.Thesedifferencesareduetothebroaderconcep-tionofeconomicorganizationoutofwhichTCEworks(wherealternativemodesoforganizationaredescribedasgovernancestructures,towhichthelessonsofor-ganizationtheoryapply),andthesedifferenceshaveramificationsforpublicpolicytowardbusiness.Neoclassicalandtransactioncostinterpretationsofnonstandardandunfamiliarcontractingpracticesandorganizationalstructuresarecomparedandcontrastedhere.Theoverarchingdifferenceisthis:Orthodoxeconomicsismoreimperialinthatitimposesapricetheoreticinterpretationonthephenomenainquestion,whereasTCEismorecuriousandasksthequestion“What’sgoingonhere?”TheTCEactionisinthedetailsoftransactionsontheonehandandgovernancestructuresontheother,whichiscloserinspirittoorganizationtheory.

VerticalIntegration/VerticalMarketRestraints

Orthodoxexplanationsforintegration(backward,forward,orlateral)ofthefirm-as-productionfunctionkindinvokeconsiderationsoftechnology,inefficientfactorproportionsthatresultfromdouble-marginalization(McKenzie1951),and/ordis-tortionsthatarisefromgovernment-imposedquotasorsalestaxes.

JoeBain’streatmentofthermaleconomies,recentlyrepeatedbyDanielSpulber(1999,p.270),isillustrativeoftechnologicalreasoning:

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[T]hecasesofcleareconomiesofintegrationgenerallyinvolveaphysicalortechnicalaspectoftheprocessesinasingleplant.Aclassiccaseisthatofintegratingiron-makingandsteel-makingtoeffectasavinginfullcostsbyeliminatingareheatingofironbeforeitisfedtoasteelfurnace.Whereintegrationdoesnothavethisphysicalortechnicalaspect—asitdoesnot,forexample,inintegratingtheproductionofassortedcomponentswiththeassemblyofthosecomponents—thecaseforcostsavingsfromintegrationismuchlessclear(Bain1968,p.381).

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.Asatechnologicalmatter,however,thethermaleconomiestowhichBainandSpulberreferactuallyrequireonlythatthetwostagesbelocatedincloseproximitytooneanother.Thatthetwostagesbeplacedunderunifiedownershipisnotimplied.If,therefore,economiessomehowaccruetotheunifiedownershipofthesetwostages(thatis,therelationbetweenthetwostagesisbettermediatedbyhierarchyratherthanbymarket),thismustbeduetoother,possiblytransactionalratherthantechnological,reasons.

TCEthuslooksbehindapparentexplanations(suchaspricediscoveryorthermaleconomies)toseeiftheywithstandcomparativeinstitutionalscrutiny.Italsoaskswhetheroutsideprocurementposesinterfirmcontractualhazardsforwhichcost-effectivereliefwillberealizedupontakingthetransactioninquestionintothefirm(addedbureaucraticcostsnotwithstanding).Specifically,theprogressivebuildupofcontractualcomplications,asdiscussedinconjunctionwiththesimplecontractualschemainFigure1,ismainlywhatexplainssuccessivemovesfromidealmarkettohybridtohierarchy.

Sowhataboutverticalmarketrestrictions?Howarethesetobeunderstood?Forstarters,verticalmarketrestrictionscanbeinterpretedasadecisiontoremainatnodeCratherthanmovetonodeD.Thetransactioninquestionisonetowhichhazardsaccrue(h>0)forwhichcost-effectivesafeguardsareneeded(s>0).IfmostofthehazardscanberelievedatnodeCwithoutincurringtheaddedbureaucraticcostburdens(weakeningofincentiveintensity,addedadministrativecosts)ofunifiedownership,thenhybridmodes,ofwhichfranchisingisanexample,willbeemployed(providedthatthecontractualrestrictionsthataccruetheretoarenottreatedasunlawful).

Verticalmarketrestrictionsoftenariseinthesupportofbrandnamecapital(Klein1980),wheretheconcernisthatsuchcapitalwillbedevaluedbysubgoalpursuitamongindependentorquasi-independentdistributors(oftenfranchisees),withtheresultthattheintegrityofthesystemisplacedatrisk.Dependingontheparticularsofthetransaction,customerandterritorialrestrictions,exclusivedealing,orotherfranchiserestrictionsmaybeimposed.Absentstrategicpurpose,forwhichpre-existingmonopolypowerisarequisite,thechoiceofinstrumentsforimposingverticalrestraintswillbediscernedbyexaminingwhereandhowthecontractualhazardsoriginate.

Pricetheoreticexplanationsfornonstandardmodesofcontractingincludetheefficiencybenefitsthatpurportedlyaccruetopricediscrimination,thebenefitsof

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Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.efficientriskbearinginthefaceofdifferentialriskaversion,andtheattenuationoffree-riderhazardsthroughtheuseofverticalmarketrestrictions.Theallocativeefficiencybenefitsthataccruetopricediscriminationinazerotransactioncostworld(whichcanbereadilydisplayedinpricetheoreticterms)aremuchmoreproblematic,however,ifthecostsofdiscoveringcustomerpreferencesandofpreventingarbitragearepositive.Invokingriskaversiontoexplaincontractingpracticesamongfirms,moreover,isoftensecondorderinrelationtomorebasicconcernswithcontractualhazards.Finally,unspecificfree-riderclaimsaretoooftenusedasashibboleth.Theaction,alwaysandeverywhere,residesinthedetails.6

The“NewEconomy”

Istherereallyaneweconomy?Yesandno.Ontheonehand,thereisnothingnewunderthesun:realtimeresponsiveness,innovation,outsourcing,andpredatorybehaviorarenotnovelissues.Eachofthesehasbeenmagnified,however,bythedeploymentofnewinformationtechnologies,byanincreasingappreciationforrelationalcontracting,andbytheracesforthecommercializationandcontrolofinformationageandbiotechnologydevelopments.Achangeinkindseemstodescribecompetitioninmanyhightechnologysectors.

Orthodoxmicrotheorybearsonsomeoftheseissues,butofteninlimitedways.TCEmakeslimitedyetproductivecontactinthefollowingrespects:(a)Expressprovisionforcooperativeadaptationiscongruentwiththeneedforrealtimere-sponsiveness;(b)innovationisexaminedinasystemscontext—inwhichfirmsize,incentives,andintertemporaltransformationsarefeatured(Williamson1975,pp.196–207);(c)craftingcrediblecommitmentstosupportoutsourcingandthebureaucraticadvantagesofoutsourcingoverinternalprocurementarebothTCEthemes;and(d)testsforpredationthatexoneratebehaviordirectedatlessefficientcompetitors(Posner1976,p.193)aretoostaticinthattheyfailtomakeprovisionforcontingentpredation—“nowit’sthere,nowitisn’t,dependingonwhetheranentranthasappearedorvanished”(Williamson1977,p.339),whichintroducesintertemporalconsiderations.

Tobesure,neweconomyissuesposestrategicandknowledgecreationchal-lengesthatgobeyondTCE(Shapiro&Varian1999).Also,conceptssuchas“dis-equilibriumcontracting”(Williamson1991)bogglethemind.ThatTCEismoreresponsivetomanyofthepressingneedsofpublicpolicyintheneweconomythanisreceivedpricetheoryisnoteworthybutscarcelygroundsforcomplacency.

AlthoughPosner(1979)contendsthat“theproperlensforviewingantitrustproblemsispricetheory”(p.932),AlanMeese(1997)observesthat,“[d]espitereferencesbyChicagoansto‘pricetheory,’Chicago’sapproachtoverticalrestraintshasneverrestedupon...pricetheory.Instead,theChicagoapproachtoverticalrestraintsisanapplicationof[NIE/TCEreasoning]”(p.203).AlsoseeJoskow(1991,pp.567–57).

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Regulation/Deregulation

FRANCHISEBIDDING7

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.Posner’ssanguineassessmentoftheefficacyoffranchise

biddingfornaturalmonopolybeginswiththeclaimthatto“expoundthedetailsofparticularregulationsandproposals...wouldserveonlytoobscurethebasicissues”(Posner1972,p.98).Intheimperialtradition,alloftherelevantactionisconcentratedintheexantebiddingcompetitionforthecontract.ThisisconsonantwithPosner’sdismissiveviewoforganizationtheory,towhichIreferredattheoutset,andillustratesthepitfallsofdoingpublicpolicyanalysisheedlessofprocesstransformations.Upongoingbeyondexantebiddingcompetitiontoincludeexpostcontractimplementation,theattributesofthegoodorservicetobefranchisedturnouttobecrucialtoaninformedassessment.Specifically,ifthegoodorserviceistobesuppliedunderconditionsofuncertaintyandifnontrivialinvestmentsinspecificassetsareinvolved,theefficacyoffranchisebiddingishighlyproblematic.Theupshotisthatfranchisebiddingfornaturalmonopolyisnotanall-purposebutratheraconditionalsolution.8

Effortstopromoteefficie-ncybycreatingmarketsforelectricpowerhavebeenimplementedinanumberofcountrieswithvaryingdegreesofsuccess.Californiaisarecentexamplewheretheeffortstorestructurehavebeenincompletelyworkedthrough.Again,theimperialview(thisisthelawhere)trumpstheprocessview(what’sgoingonhere?).Thisshowsupintworespects.First,“goodtheories”werenaivelyexpectedtobeim-plementedwithoutmakingprovisionfortherealitiesofthepoliticalandregulatoryprocess.Failingtomakeexanteprovisionfortheserealities,politicsandregu-lationareconvenientlymadetheexpostscapegoatsforbehavinginperverseorunanticipatedwaysthat,inlargemeasure,wereforeseeableandshouldhavebeenfactoredintothecalculus(Williamson1996,chapter8).Suchlapsesinrealpoli-tikaside,PaulJoskow(2000)observesthattoomuchdeferencewasgiventothe(assumed)efficacyofsmoothlyfunctioningmarketsandinsufficientattentionwasgiventopotentialinvestmentandcontractualhazardsandappropriategovernanceresponsesthereto.AsJoskowputsit:

RESTRUCTURINGELECTRICITYSUPPLYINCALIFORNIA

ThissubsectioniselaboratedinWilliamson(1996,pp.84–85).

Examplesinwhichfranchisebiddingforgoodsandservicessuppliedunderdecreasingcostconditionscanpossiblysupplantextantregulationorpublicownershipwithexpectednetgainsincludelocalserviceairlinesand,possibly,postaldelivery.Thewinningbidderforeachbaseplant(terminals,postoffice,warehouses,andsoon)canbeownedbythegovernment,andotherassets(planes,trucks,andthelike)willhaveanactivesecondhandmarket.Franchisebiddingisnottotallylackinginmerit,therefore;onthecontrary,itisaveryimaginativeproposal.TCEmaintains,however,thatallcontractingschemes—ofwhichfranchisebiddingfornaturalmonopolyisone—needtobeexaminedmicroanalyticallyandassessedinacomparativeinstitutionalmanner.

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Manypolicymakersandfellowtravellershavebeensurprisedbyhowdifficultithasbeentocreatewholesaleelectricitymarkets....HadpolicymakersviewedtherestructuringchallengeusingaTCEframework,thesepotentialproblemsaremorelikelytohavebeenidentifiedandmechanismsadoptedexantetofixthem(Joskow2000,p.51).

THEINSTITUTIONALENVIRONMENT

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.TheNewInstitutionalEconomicsoperates

attwointerrelatedlevels:theinstitutionalenvironment(orrulesofthegame)andtheinstitutionsofgovernance(orplayofthegame).ThestudyofprivatizingtelecommunicationsbyLevy&Spiller(1994,1996)examinestheinstitutionalen-vironment(rulesofthegame)infivecountriesthroughacomparativecontractuallensinwhichcontractualhazardsandcrediblecontracting,orthelackthereof,arefeatured.Thisbottom-upapproachrevealsthatthedecisiontoprivatizeandthenatureofprivatizationvarywiththeconditionandqualityofjudicialindepen-dence,thedivisionofpowersbetweentheexecutiveandlegislativebranches,thecompetenceoftheregulatorybureaucracy,andcontractualsafeguards.Whetherandhowtoprivatizetelecommunicationsshouldthereforebemadeconditionalonthesefeatures.

Similarconsiderationsariseinprivatizingsocialisteconomies.The“bigbang”approachpayslittleheedtodifferencesamongindustries,whereasthosewhoaremoreconcernedwithcultivatinginstitutionsandthemechanismsofgovernanceadvisethatamoregradualprogrambeadoptedinwhichthe“easycases”arepri-vatizedfirst.Becausenaturalmonopoliesposestrainsonderegulationandprivati-zationalike(Arrow2000,Williamson2000),thesearecandidatestobeprivatizedlate(ifatall)andthenwiththesupportofafall-backregulatoryapparatus.

CorporateGovernance/DebtandEquity9

Pricetheorywaslongsilentonthematterofcorporategovernance.Firmsweresimplyassumedtomaximizeprofits.Theideathatmanagersmightengageinsubgoalpursuitthatiscontrarytoprofitmaximizationwasinimicaltotheor-thodoxconstruction[althoughitcanbeandhasbeenaddressedinnearlyortho-doxtermsbyreformulatingtheobjectivefunction(Baumol1959,Williamson19)].

TCEinterpretstheboardofdirectorsmainlyasasecurityfeaturethatarisesinsupportofthecontractforequityfinance.Specifically,debtandequityareviewednotmerelyasalternativemodesoffinance,whichisthelawandeconomicsconstruction(Easterbrook&Fischel1986,Posner1986),butalsoasalternativemodesofgovernance.Thus,supposethatafirmisseekingcost-effectivefinanceforthefollowingseriesofprojects:general-purposemobileequipment;ageneral-purposeofficebuildinglocatedinapopulationcenter;ageneral-purposeplantlocatedinamanufacturingcenter;distributionfacilitieslocatedsomewhatmore

9

ThissubsectionisbasedonWilliamson(1996,pp.184–85).

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remotely;special-purposeequipment;marketandproductdevelopmentexpenses;andthelike.

Supposefurtherthatdebtisagovernancestructurethatworksalmostentirelyoutofrules.Specifically,assumethatdebtfinancingrequiresthedebtortoobservethefollowing:(a)Stipulatedinterestpaymentswillbemadeatregularintervals;(b)thebusinesswillcontinuouslymeetcertainliquiditytests;(c)sinkingfundswillbesetupandprincipalrepaidattheloan-expirationdate;and(d)intheeventofdefault,thedebt-holderswillexercisepreemptiveclaimsagainsttheas-setsinquestion.Ifeverythinggoeswell,interestandprincipalwillbepaidonschedule.Butdebtisunforgivingifthingsgopoorly.Failuretomakesched-uledpaymentsthusresultsinliquidation.Thevariousdebt-holderswillthenrealizedifferentialrecoveryinthedegreetowhichtheassetsinquestionareredeployable.

Becausethevalueofapre-emptiveclaimdeclinesasthedegreeofassetspeci-ficitydeepens,thetermsofdebtfinancingwillbeadjustedadversely.Confrontedwiththeprospectthatspecializedinvestmentswillbefinancedonadverseterms,thefirmmightrespondbysacrificingsomeofthespecializedinvestmentfeaturesinfavorofgreaterredeployability.Butthenalowercostofcapitalcomesatanaddedproductioncost.Mightitbepossibletorelievethetrade-offbyinventinganewgovernancestructuretowhichsuppliersoffinancewouldattachaddedcon-fidence?Inthedegreetowhichthisisfeasible,value-enhancinginvestmentsinspecificassetscouldtherebybepreserved.

Supposearguendothatafinancialinstrumentcalledequityisinvented,andassumethatequityhasthefollowinggovernanceproperties:(1)Itbearsaresidual-claimantstatustothefirminbothearningsandasset-liquidationrespects;(2)itcontractsforthedurationofthelifeofthefirm;and(3)aboardofdirectorsiscreatedandawardedtoequity,aboardofdirectorsthat(a)iselectedbytheproratavotesofthosewhoholdtradeableshares,(b)hasthepowertoreplacethemanagement,(c)decidesonmanagementcompensation,(d)hasaccesstointernalperformancemeasuresonatimelybasis,(e)canauthorizeauditsindepthforspecialfollow-uppurposes,(f)isapprisedofimportantinvestmentandoperatingproposalsbeforetheyareimplemented,and(g)inotherrespectsbearsadecision-reviewandmonitoringrelationtothefirm’smanagement(Fama&Jensen1983).Theboardofdirectorsthusevolvesasawaytoreducethecostofcapitalforprojectsthatinvolvelimitedredeployability.Notonlydotheaddedcontrolstowhichequityhasaccesshavebetterassuranceproperties,butequityismorefor-givingthandebt.Effortsarethereforemadetoworkthingsoutandpreservethevaluesofagoingconcernwhenmaladaptationoccurs.Thus,whereasthegover-nancestructureassociatedwithdebtisofaverymarket-likekind,thatassociatedwithequityismuchmoreintrusiveandisakintoadministration.Thecorrespon-dencetowhichIreferredearlierbetweenoutsideprocurement/debtandverticalintegration/equitythereforeobtains.Ineffect,debtisthemarketformoffinance,andequity(theadministrativeform)appearsascontractualhazardsbuildup.Eq-uityisthefinancialinstrumentoflastresort.

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.LAW,ECONOMICS,ANDORGANIZATION387

OtherVariationsonaTheme

TCEmaintainsthatanyissuethatarisesasorcanbeposedasacontractingproblemcanbeexaminedtoadvantageintransactioncosteconomizingterms.Accordingly,thereachoftransactioncostreasoningisvirtuallyendless.Ibrieflysketchtwoadditionalapplicationshere(withoutbotheringwithpricetheoreticexplanations).

PUBLICBUREAUS

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.AccordingtoDouglassNorth,“Politicalmarketsare...prone

toinefficiency”(North1990,p.365)and“hightransactioncostissuesgravitatetothepolity”(p.372).Thatisworsethanaparadox.Thatisperverse.Badenoughthatpoliticalmarketsareinefficient.Butsurelytheappropriatelessonisforhightransactioncostissuestofleefromratherthanbeattractedtothepolity?

Maybe,butthenagain,maybenot.Hightransactioncostissues,afterall,areonesthatareinherentlydifficulttoorganize.AssetoutinFigure1,suchtransactionsareonesforwhichnodeAgovernance(inthemarket)ispoorlysuitedcomparedwithnodeDgovernance(inthefirm).Ifstilladditionalcontractualhazardsbuildup,mightsomeofthesetransactionsbecandidatesforgovernanceinthepublicbureau?ThatispreciselytheargumentthatIadvanceelsewhere(Williamson1999).Specifically,themanydisabilitiesofthepublicbureaunotwithstanding—verylow-poweredincentives,verycostlyadministrativeprocedures,veryprotectiveemploymentrelations—therearesometransactions(ofwhichforeignaffairsisanexample)forwhichthepublicbureaucomesoffbestjudged,asitshouldbe,comparatively.Thereisaplaceforeachgenericformoforganization,yeteachneedstobekeptinitsplace.

Theorganizationoflaborreflectsmanypurposes,monop-sonypowerandpoliticalpurposesincluded.Whataboutefficiency?Again,theactionresidesinthedetails.Thoselabortransactionsthatposegreatercontractualhazards(h>0)willbenefitfromgovernanceeffortstomitigatethehazards(s>0),whereasitwillbelesscost-effectivetosupplythesesamesafeguardstogenericlabor(ofanodeAkind),whichisarecurrenttheme.Asdevelopedelsewhere(Williamsonetal.1975;Williamson1985,chapter10),theobservedorganizationoflabortracksanefficiencyrationale.

LABORORGANIZATION

CONTRACTANDECONOMICORGANIZATIONAlternativeApproaches

IfthecontractualapproachtoeconomicorganizationhasthereachthatIascribetoit,thenthesystematicapplicationofTCEtolegaleducationandtolegalandeconomicresearchoncontractingholdsoutconsiderablepromise.Thiswillentailgoingbeyondthe“sortofcontractlawthathasflourishedinAmericanlawschools:thelawembodiednjudicialdecisionsandstudiedbyanalyzingthesedecisions”(Rubin1995,p.109).WhatEdwardRubin(1995)recommendsinsteadisthatthe

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Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.lawschools(andstudentsofcontractmoregenerally)needa“theoryofcontract...thataddressesthecontractingprocessitself,ratherthanthejudicialadjudicationofthatprocess,”whereupona“nonjudicialdomainofcontractingbehavior”willbegivenprominence(p.108,emphasisadded).

Inprinciple,lawandeconomicscouldhavebeenappliedtothatpurpose.Thatproject,however,tooka“massivewrongturn”bytheargumentadvancedbyPosnerandothersthat“thecontractlawgoal[of]economicefficiency...[was]achievedthroughcommon-lawadjudication”(Rubin1995,p.113).Bydrawingattentionawayfromcontractsandthecontractingprocesstowardjudicialadjudication,“lawandeconomicsbecamejustanothertoolforanalyzingjudicialdecisions”(p.113).Rubinisneverthelessheartenedthatalthoughthe“lawschoolcurriculumcontinuestoberelativelyresistanttoatransactionaltheoryofcontract,...legalscholarshiphasgraduallybeguntoshiftitsfocusasaresultoftheeconomicandsociologicalanalysisoftransactions”(p.114).

Sowhatdoesacombinedlaw,economics,andorganizationsapproachtothestudyofcontract,broadlyconceived,entail?AsIseeit,theoverarchingmoveistobringthelensoftransactioncosteconomizingassiduouslytobear.Theexam-inationofincompletecontractinginitsentiretywillbefacilitatedbysupplantingtheacademicconceptofcontractaslegalrulesbythatofprivateorderingandbyinquiringintothemechanismsthroughwhichtransactioncosteconomizingisaccomplished.Interestingly,RonaldGilson(1984)mademanyofthesesameargumentsearlierinhisexaminationofcorporatefinancetransactions.

TheEconomizingPerspective

Theeconomizingperspectiveholdsthat,subjecttotheremediablenesscriterion,inefficiencyinvitesitsowndemise—whereinefficiencyisassessedinrelationtofeasiblealternatives(ratherthanahypotheticalideal)andprovisionismadeforimplementationcosts.Becausejointgainswillalwaysberealizedbymovingfromalesstoamoreefficientmode,providedthatimplementationcostsdonotdissipatethegains,farsightedbusinessmenandtheirlawyerswilleschewinferioroutcomes(suchasnodeBintheschema).IncontrasttoMachiavelli’smyopicadviceto“getthembeforetheygetus,”thefarsightedviewofcontractingisto“giveandreceivecrediblecommitments”(Williamson1983,1993b)—byprovidingbetterinformationandaddedsecurityfeaturesthatservetoinfuseconfidenceandrealizemutualgains.

Gilson’s(1984,p.255)descriptionofbusinesslawyersastransactioncosten-gineersisverymuchinthisspirit.Hethusurgesthattransactionsbeexaminednotinaone-sidedwaybut“fromtheperspectiveofbothclients”(p.245;emphasisinoriginal),whencemutualgainistheobject.Hefurthermoreadoptsatransactioncosteconomizingapproachtoprivateordering(Gilson1984,p.255),includingexpressreferencetocrediblecommitments(p.281).Also,heviewsdeparturesfromtheassumptionsofthe(ideal)capitalassetpricingmodel—namely,commontimehorizon,identicalexpectations,notransactioncosts,andcostlessinformation

LAW,ECONOMICS,ANDORGANIZATION3

(Gilson1984,p.252)—asgristfortheTCEmill:“[T]heunrealityofthese[ideal]...assumptionsisnotcausefordespair.Rather,itistheveryfailureoftheseassump-tionstodescribetherealworldthatIfindthepotentialforvaluecreationbylawyers”(Gilson1984,p.253;emphasisadded).Theinstitutionsofgovernancearisepreciselyonaccountofthesedisparities(Arrow1963).

PrivateOrdering

THECONCEPT

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.MarcGalanter(1981)takesexceptionwiththeusualacademic/

legalcentralistapproachtocontractinwhichdisputespurportedly“require‘access’toaforumexternaltotheoriginalsocialsettingofthedispute[whereby]remedieswillbeprovidedasprescribedinsomebodyofauthoritativelearninganddispensedbyexpertswhooperateundertheauspicesofthestate”(p.1).Thefactsdiscloseotherwise:Mostdisputes,includingmanythatundercurrentrulescouldbebroughttoacourt,areresolvedbyavoidance,self-help,andthelike(p.2).Thisisbecausein“manyinstancestheparticipantscandevisemoresatisfactorysolutionstotheirdisputesthancanprofessionalsconstrainedtoapplygeneralrulesonthebasisoflimitedknowledgeofthedispute”(p.4).Gilson(1984)concurs:Whenbusinesslawyersplaytheroleoftransactioncostengineerwell,“thecourts,andformallawgenerally,shrinkdramaticallyinimportance”(p.294).

KarlLlewellyn’s(1931)earlierdissentfromthelegal

rulesapproachtocontractintroducestheconceptofcontractasframework:

[T]hemajorimportanceoflegalcontractistoprovideaframeworkforwell-nigheverytypeofgrouporganizationandforwell-nigheverytypeofpass-ingorpermanentrelationbetweenindividualsandgroups...—aframeworkhighlyadjustable,aframeworkwhichalmostneveraccuratelyindicatesrealworkingrelations,butwhichaffordsaroughindicationaroundwhichsuchrelationsvary,anoccasionalguideincasesofdoubt,andanormofultimateappealwhentherelationsceaseinfacttowork(Llewellyn1931,pp.736–37).Thislastpointisimportantinthattheprospectofultimateappealtothecourtsservestodelimitthreatpositions.

Relatedideashavebeenadvancedbyothers,includingClydeSummers(1969)whodistinguishesbetween“blackletterlaw”(whichbearsalikenesstoblackboxeconomics)andamorecircumstantialapproachtocontract.Theformeremploysthecounterfactual“illusionthatcontractrulescanbestatedwithoutreferencetosurroundingcircumstancesandarethereforegenerallyapplicabletoallcontractualrelations”(p.566).

TheTCEargumentthateachgenericmodeofgovernanceissupportedbyadistinctiveformofcontractlawisbroadlyinthiscircumstantialspirit.Theideal(nodeA)transactioninbothlawandeconomicsisthatofspotmarketstowhichidentityisunimportantandlegalrulesapply(Macneil1974).ThislegalrulesapproachgiveswaytoLlewellyn’sconceptofcontract-as-frameworkastheimportanceofcontinuitybuildsupandincompletelong-termcontractingisadopted

CONTRACTLAWS(PLURAL)

390WILLIAMSON

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.(nodeC).Thatinturnundergoeschangewhentransactionsaretakenoutofthemarketandorganizedinternally(nodeD),wheretheimplicitlawofcontractnowbecomesthatofforbearance.Aspreviouslynoted,courtsroutinelygrantstandingtofirmsengagedininterfirmcontractingshouldtherebedisputesoverprices,thedamagestobeascribedtodelays,failuresofquality,andthelike,yetcourtswillrefusetoheardisputesbetweenoneinternaldivisionandanotheroveridenticaltechnicalissues.Accesstothecourtsbeingdenied,thepartiesmustresolvetheirdifferencesinternally(Rubin1995,p.117).Accordingly,hierarchyisitsowncourtofultimateappeal.Thatfirmsandmarketsdifferintheiraccesstofiatispartlyexplainedbythesecontractlawdifferences(Williamson1991).

Mechanisms

CORPORATEACQUISITIONTRANSACTIONS

TCEsubscribestothedictumthat“ex-planationsinthesocialsciencesshouldbeorganizedaround(partial)mechanismsratherthangeneraltheories”(Elster2000,p.75;emphasisinoriginal).ThatisevidentinthewaybywhichTCEexaminesthecanonicalmake-or-buydecisionandofcontractingmoregenerally.ItisalsoevidentinGilson’s(1984)examinationofeffortsbybusinesslawyerstoperfecttheacquisitionagreementinthefaceof“deviations”fromtheidealassumptionsofthecapitalassetpricingmodel:

Earnoutorcontingent-pricingtechniquesrespondtothefailureoftheho-mogeneousexpectationsassumption;controlsoveroperationoftheseller’sbusinessduringtheperiodinwhichthedeterminantsofthecontingentpricearemeasuredrespondtofailureofthecommon-time-horizonassumption;andthepanopolyofrepresentationsandwarranties,togetherwithprovisionsforindemnificationandotherverificationtechniques,respondtothefailureofthecostless-information(Gilson1984,p.293).

CONTRACTLAWDOCTRINE

Amicroanalyticexaminationofthemechanismsthat

ariseinconjunctionwithcontractlawdoctrineswouldalsobeilluminating.IanMacneil(1974)describesthelegalsystem’s“lessthantotalcommitmenttothekeepingofpromises”asfollows:

Contractremediesaregenerallyamongtheweakestofthosethelegalsys-temcandeliver.Butahostofdoctrinesandtechniquesliesinthewayofeventhoseremedies:impossibility,frustration,mistake,manipulativeinter-pretation,jurydiscretion,consideration,illegality,duress,undueinfluence,unconscionability,capacity,forfeitureandpenaltyrules,doctrinesofsubstan-tialperformance,severability,bankruptcylaws,statutesoffraud,tonameafew;almostanycontractdoctrinecananddoesservetomakethecommit-mentofthelegalsystemtopromisekeepinglessthancomplete(Macneil1974,p.730).

Therefusalbythecourtstoenforcestipulateddamagesclausesisespeciallypuzzling.Becausethepartiestoacontractcanbepresumedtoknowbestwhat

LAW,ECONOMICS,ANDORGANIZATION391

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.contractualtermsservetheirinterests,whyshouldthecourtsrefusetoenforcestipulateddamagesintheeventofbreach?

Onepossibilityisthatcontractisadeviousthing.Thus,althoughsuchaclausemayfrequentlybetheefficientwaytosettleabreach,itcouldalsoservestrategicpurposes,ofwhichinducedbreachisone.

TheissueofcontrivedcancellationhasbeenaddressedbyKennethClarkson,RogerMiller,andTimothyMurisintheirdiscussionofrefusalofthecourtstoenforcestipulateddamageclauseswherebreachhasbeendeliberatelyinduced(Clarksonetal.1978,pp.366–72).Inducedbreachcouldarisewhenapartyintentionallywithholdsrelevantinformationyetcomplieswiththeletterofthecontract.Oritmightinvolveperfunctoryfulfillmentofobligationswheremoreresourcefulcooperationisneeded(pp.371–72).Ineithercase,inducedbreachiscostlytodetectand/orprove(p.371).Transactioncostconsiderationsareplainlyoperative.

RamificationsforLegalEducation

Gilson(1984)advisesthatmyobservationthatthelegalcentralismapproachtocontractrelieves“lawyersandeconomists...oftheneedtoexaminethevarietyofwaysbywhichindividualpartiestoexchange‘contractoutoforawayfrom’thegovernancestructuresofthestatebydevisingprivateorderings”(Williamson1983,p.520)istoosweeping.Itshouldberestrictedtoacademiclawyersandeconomists(Gilson1984,p.295).Thatisbecause“businesslawyershavedoneanawfullygoodjobatsomethingthelawschoolsdidnotand,forthemostpart,stilldonotteach:helpingpeoplearrangetheirrelationshipsintheabsenceofgovernmentalintervention:facilitatingprivateordering”(Gilson1984,p.303;emphasisinoriginal).Butthen“whyhavelawschoolsdonesobadajobtrainingbusinesslawyers?”(p.303).Gilson’sansweristhat“Therehasbeennotheory...thatdealtwithprivateordering”(p.304)priortotheappearanceof“twoareasineconomics—financeandtransactioncosteconomics”(p.305).

Twentyyearslaterwefindthattheteachingofcontractlawhaschangedverylittle.Whatexplainsthiscontinuingneglect?

Oneexplanationisthatmainlinelawandeconomicshasremainedcomfortablyascendant.Therelationbetweenlawandeconomicsthuscontinuestobeoneinwhichtextbookeconomicorthodoxyisthefount.Thepredilectiontoworkoutofatheoryofthefirm-as-productionfunctionsetupisthusreaffirmedandthesubjectoforganizationremainsdisjunct.Reservationsabouttheefficiencyofcommonlawadjudicationnotwithstanding,contractlawteachingstayspredominantlyfocusedonlegalrulesandadjudication.

Asecondexplanationisthattheworldofprivateorderingisimpossiblycom-plex.Asgoodlawyersarequickstudies,betterthattheylearnaboutprivateorderingonthejobratherthanintheclassroom.

Thefirstoftheseargumentsisalameexcuseforcomplacency,whereasthesec-ondoverlooksthepossibilitythattheeconomicsoforganizationinvolves

392WILLIAMSON

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.variationsonafewkeythemes.Inthatevent,attentioncanbefocusedoncanonicalcases—ofwhichcredibleinterfirmcontractingisoneandverticalintegrationisanother.Thebuzzing,bloomingconfusionofprivateorderingistherebyreducedtomoremanageableproportions.Becausetheclassroomistheplacetolayouttheintuition,merits,andmechanismsofcrediblecontracting(nodeC)andtoex-aminethecomparativestrengthsandweaknessesofthefirm-as-governancestruc-ture(nodeD),torelegatethestudyofprivateorderingtoon-the-jobtrainingisanachronistic.

Even,moreover,ifthebasiclawschoolcurriculumisunmovedbytheseargu-ments,itisnoteworthythatanumberofleadinglawschoolshavebeguntoofferanelectivecourseoncomplexdeals,manyofthemmodeledafterthecourseofferedbyGilsonandVictorGoldbergatColumbiaLawSchoolon“Deals:TheEconomicStructureofTransactionsandContracting.”Ifthedemandfortransactioncosten-gineerscannotbemetbythelawschools,thebusinessschoolscouldendupeatingthatlunch(Rubin1995,p.114).

CONCLUSIONS

Thereisgrowingagreementthat“theobjectivesoffirms,thereasonfortheirexistenceandthemanneroftheirdecisiontaking...willrequiremodesofanalysisquitedifferentfromthosewhichhavedominatedinthiscentury”(Hahn1991,p.49).NotonlydoesTCEholdthatthewaytothinkaboutcontractandorganizationistobringthepurposiveandfarsightedlensofeconomizingtobear,10buttheexistenceandgovernanceoffirmsareboththekeyTCEissues.

Asdevelopedherein,organizationtheoryhasmassiveramificationsfortheTCEtheoryofthefirm.Salientcontributionsfromorganizationtheoryincludethede-scriptionofhumanactorsinmoreveridicalterms,theimportanceofintertemporalprocesstransformations,choiceoftheunitofanalysis,andthedescriptionofal-ternativemodesofgovernanceassyndromesofcomplementaryattributes.Theresultingtheoryofthefirmdiffersgreatlyfromtheneoclassical(Kreps1990,p.96).Because“[a]nystandardtheory,notjustneoclassical,startsfromtheexistenceoffirms”(Arrow1999,p.vii),thatisverybasic.

Tobesure,theproximatelessons(asadvancedbyorganizationtheorists)andtheultimatelessons(asviewedfromaneconomizingperspective)oftendiffer—andthatisconsequential.Butthemorebasicpointisthis:Someoneneededto

10

Farsightedcontractingismoreplausibleinintermediateproductmarketcontractsthaninfinalgoodsmarkets.Still,farsightedfirmsthataresellingtoconsumerswholacktherelevantexpertiseandforesightneverthelesscananddotakestepstoalleviatethehazards—throughbranding,warranties,guarantees,andthelike.Idonotmeantosuggest,however,thatthereisneveranoccasiontocraftadditionalrelief(possiblywiththeaidofpublicpolicy)againstresidualhazards.

LAW,ECONOMICS,ANDORGANIZATION393

Annu. Rev. Law. Soc. Sci. 2005.1:369-396. Downloaded from arjournals.annualreviews.orgby 221.234.46.142 on 10/12/09. For personal use only.stepupandoffertrenchantcritiquesandidentifyrelevantphenomena.Organi-zationtheoristswerepreparedtodothatwhenotherswerecomplacentorheldback.

Thetheoryofthefirm-as-governancestructurethatissketchedhereinisanongoingratherthanfinishedconstruction.11Itsevolvingstatusnotwithstanding,ithasalreadyservedtodeepenourunderstandingofmanycomplexcontractualandorganizationalphenomenaanditoperatesasacheckagainstoverusesandmisusesoforthodoxy.Inthatspirit,Isuggestthatmainstreamlawandeconomicsstandstobenefitbyincorporatingthelessonsandsomeofthemethodsoflaw,economics,andorganization—bothasthesebearonpublicpolicyandinrelationtothelawschoolcurriculum.12

ACKNOWLEDGMENTS

ThispaperwasoriginallypreparedfortheceremonyinauguratingthePrograminLawandEconomicsattheUniversityofChileinAugust2000.ThatprogramisajointeffortbetweentheFacultyofEconomicsandBusinessandtheFac-ultyofLawto“promoteanddevelopinterdisciplinarytheoreticalandappliedresearchinthearea.”ItwassubsequentlypresentedattheopeningsessionofthefourteenthannualconferenceoftheInternationalSocietyforNewInstitutionalEconomicsinTuebingen,Germany,attheLawandEconomicsSeminaratGeorgeMasonUniversity,theLaw,Economics,andOrganizationSeminarattheUniver-sityofSouthernCalifornia,andattheFirstAnnualSymposiumattheCenterforLegalDynamicsofAdvancedMarketSocietiesatKobeUniversity.Usefulques-tionsandcommentsatallfivesessionsaregratefullyacknowledged.AnearlierversionofthispaperwaspublishedintheKobeUniversityLawReview(2004)38:59–95.

11

Fullformalizationistheultimateobjective.TheGrossman-Hart-Mooremodel(Hart1995)qualifiesasafullyformalmodelbutislackinginplausibility(Kreps1999).ThetreatmentofprocurementbyBajari&Tadelis(2001),whichfocusesontheincentiveandexpostadaptationdifferencesbetweenfixedpriceandcostpluscontracting,ismuchcloserinspirittoTCE.12

OneofthecommentsthatIhavereceivedonthisreviewisthatthebasicmessagehasnotonlybeenheard,butthatithasregisteredandtakeneffect.Thatisgratifying,yetotherreadersremarkthatmuchofthisisunfamiliarterrainandneedstobemorefullyspelledout.Icomeoutsomewhereinbetween.Thus,althoughmanyofthefirm-as-governancestructureideashavetakenhold,privateorderingremainsunderdevelopedandorganizationtheoryisscantedbymainlinelawandeconomics—witnessthelead-ingtextbooks(Cooter&Ulen2000,Polinsky19,Posner1998).Publicpolicyinroadsnotwithstanding,thebasiccontractlawcourseremainsimmunetotheargumentsinthispaper.

394WILLIAMSON

TheAnnualReviewofLawandSocialScienceisonlineat

http://lawsocsci.annualreviews.org

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CONTENTS

COMINGOFAGE:LAWANDSOCIETYENTERSANEXCLUSIVECLUB,

LawrenceM.Friedman

THECOMPARATIVESTUDYOFCRIMINALPUNISHMENT,

JamesQ.Whitman

.yECONOMICTHEORIESOFSETTLEMENTBARGAINING,

lnoAndrewF.DaughetyandJenniferF.Reinganum

esu lLAWANDCORPORATEGOVERNANCE,NeilFligsteinandJenniferChoo

anosTRANSNATIONALHUMANRIGHTS:EXPLORINGTHEPERSISTENCEANDrepGLOBALIZATIONOFHUMANRIGHTS, HeinzKlugrFo EXPERTEVIDENCEAFTERDAUBERT,MichaelJ.Saks

.9/0andDavidL.Faigman

21/01PLEABARGAININGANDTHEECLIPSEOFTHEJURY,BruceP.Smith no THEDEATHPENALTYMEETSSOCIALSCIENCE:DETERRENCEAND241JURYBEHAVIORUNDERNEWSCRUTINY,RobertWeisberg

..4VOICE,CONTROL,ANDBELONGING:THEDOUBLE-EDGEDSWORDOF32.PROCEDURALFAIRNESS,1RobertJ.MacCoun

22 yLAW,RACE,ANDEDUCATIONINTHEUNITEDSTATES,SamuelR.Lucas

bandMarcelParet

LAWFACTS,ArthurL.Stinchcombe

REALJURIES,ShariSeidmanDiamondandMaryR.Rose

FEMINISM,FAIRNESS,ANDWELFARE:ANINVITATIONTOFEMINISTLAWANDECONOMICS,GillianK.Hadfield

CRIMINALDISENFRANCHISEMENT,ChristopherUggen,AngelaBehrens,

andJeffManza

AFTERLEGALCONSCIOUSNESS,SusanS.Silbey

WHYLAW,ECONOMICS,ANDORGANIZATION?OliverE.WilliamsonREVERSALOFFORTUNE:THERESURGENCEOFINDIVIDUALRISKASSESSMENTINCRIMINALJUSTICE,JonathanSimonINDEX

SubjectIndex

117356185105131151171203233255285307323369397423vii

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