Managing Business Transactions: Controlling the Cost of Coordinating, Communicating, and Decision Making.

• Author: Lee, Dwight R.

In recent years economists have made important strides toward explaining why firms are organized as they are and why the intra firm contracts that define the firm and the extra firm contracts that describe its behavior across markets are written as they are. Building on Coase's 1937 argument that firms exist because there are costs associated with all transactions, economists have been able to open up what was, in economic theory, the black box of the firm and subject it to economic analysis. The transactions cost theory of the firm has developed primarily as a descriptive theory explaining the existing structure and practices of firms. Though much remains to be done in better understanding firms as they are, the transactions cost theory of the firm has reached the point where it can be used as a managerial tool to prescribe ways for firms to improve the efficiency of their operations. This prescriptive step is the one that Rubin takes in his book, Managing Business Transactions.

In standard economic theory the firm is a simple entity that somehow performs the complicated task of efficiently converting inputs into the profit maximizing quantity of output. While this theory provides the business manager with efficiency requirements expressed in terms of equating a set of marginal conditions, the generality of these conditions renders them difficult to apply to particular problems. For example, the standard economic theory of the firm provides almost no guidance to the business manager grappling with the choice between purchasing an input or producing it. Rubin devotes his opening chapter to an explanation of why the "make or buy" decision is of fundamental importance to business managers, and to a discussion of several factors that are crucial to this decision. This discussion begins introducing concepts that lie at the foundation of the transactions cost theory of the firm; concepts such as asset specificity, opportunistic behavior, quasi rents, residual claimants, and asymmetric information.

Purchasing inputs from another firm would typically be the best choice except for opportunistic temptations such purchases often create for the supplying firm. Any arrangement that reduces those temptations allows more of the benefits from market purchases to be realized. Court imposed penalties on parties that breach the terms of a contract provides some protection against opportunistic behavior. But for a number of reasons, relying solely on court...