Transactional hazards, institutional change, and capabilities: Integrating the theories of the firm

• Author: Jorge Tarziján,Francisco Brahm
• Date: 01 February 2014
• DOI: http://doi.org/10.1002/smj.2094
• Published date: 01 February 2014

Strategic Management Journal

Strat. Mgmt. J.,35: 224– 245 (2014)

Published online EarlyView 10 April 2013 in Wiley Online Library (wileyonlinelibrary.com) DOI: 10.1002/smj.2094

Received 3 November 2010;Final revision received 27 November 2012

TRANSACTIONAL HAZARDS, INSTITUTIONAL

CHANGE, AND CAPABILITIES: INTEGRATING THE

THEORIES OF THE FIRM

FRANCISCO BRAHM and JORGE TARZIJ ´

AN*

School of Management, Pontificia Universidad Cat ´

olica de Chile, Santiago, Chile

Using a detailed dataset from the Chilean construction industry, we explorehow the predictions of

the transaction cost and capabilities theories interact to explain building contractors’ decisions

to ‘make or buy’ the specialty trade activities needed to complete a construction project. We

show that the contractor’s productive capabilities strongly mediate the relationship between

transaction hazards that originate from either temporal specificity or an exogenous change

in the subcontracting law and the vertical integration decision. The inclusion of differential

capabilities and its interaction with transactional hazards infuse contractors’ boundary choices

with systematic patterns of heterogeneity and contribute to the integration of these theoretical

perspectives. Our analysis corrects for the endogeneity of the capabilities variable and provides

a detailed assessment of the marginal effects in logit models. Copyright 2013 John Wiley &

Sons, Ltd.

INTRODUCTION

Researchers have sought to explain firm bound-

aries since the pioneering work of Coase (1937).

Scholars have theorized and empirically shown

(see Macher and Richman, 2008 for a review)

that transaction costs stemming from contracting

difficulties, particularly from inefficient ex-post

adaptation to high asset specificity (Williamson,

1979), from difficulties in measuring the qual-

ity of goods (Barzel, 1982) and from institu-

tional change enacted through variations in law

and regulation (Williamson, 2000), drive the

comparative assessment of market versus firm

governance.

In parallel, the development of the ‘capabili-

ties’ theory of firm boundaries, which maintains

Keywords: make or buy; transaction costs; capabilities;

institutional change; interaction effects

*Correspondence to: Jorge Tarzij´

an, School of Manage-

ment, Pontificia Universidad Cat´

olica de Chile, Avda. Vicu˜

na

Mackenna, Macul, Santiago, Chile. E-mail: jtarzija@uc.cl

Copyright 2013 John Wiley & Sons, Ltd.

that firms will vertically integrate the transactions

for which they have stronger productive capabil-

ities than their suppliers (Argyres, 1996; Jaco-

bides and Winter, 2005), suggests that the differ-

ential in capabilities across firms may complement

the generic prescription derived from the char-

acteristics of the transaction itself , such as its

specificity, its institutional setting, and its measur-

ability. As such, the inclusion of capability differ-

entials among firms has the potential to provide a

more nuanced and comprehensive account of firm

boundaries, permitting the analysis of the hetero-

geneity of firm boundaries and the evolving rela-

tionship between capabilities and transaction costs

(Argyres et al., 2012).

The current article contributes to the existing

empirical research that seeks to fulfill the poten-

tial for integrating the roles of transaction costs

and firm capabilities into assessments of firm

boundaries (Fabrizio, 2012; Mayer and Salomon,

2006). Following Williamson (1999), we empir-

ically explore how the predictions of these the-

ories interact to explain the choice of Chilean

Integrating Theories of Firm Boundaries 225

building contractors either to subcontract specialty

trade activities (e.g., molding, plumbing, or heat-

ing) or to perform these activities internally. We

show that all of the transactional hazards exam-

ined, including the hazards created by ‘temporal

specificity’ (Masten, Meehan, and Snyder, 1991)

and the hazards produced by an exogenous change

in the subcontracting law that increases transac-

tion costs, are associated with increased vertical

integration. More importantly, however, we illus-

trate how a contractor’s productive capabilities in

specialty trade activities strongly mediate the rela-

tionship between transaction hazards and integra-

tion, acting as a shift parameter. A contractor with

strong productive capabilities can better counter-

act the impact of the increased transaction hazards

detailed above.

To reach this conclusion, our analysis identifies

the capabilities’ marginal effects in logit models,

an aspect that is almost absent from previous

research studies that use these models (e.g., Mayer

and Salomon, 2006), and illustrates how the

marginal effects differ depending on the ex-ante

likelihood of integration of boundary choices.

We also make three additional contributions to

the firm boundaries literature. First, we provide

evidence of boundary choices for the construc-

tion industry, an industry that has been mostly

neglected in previously published studies that

address the boundaries of firms. Second, we pro-

vide additional evidence for a distinct type of

specificity; namely, ‘temporal specificity,’ which

has received relatively little empirical attention

since its introduction by Masten et al. (1991).1

Finally, we argue that capability heterogeneity

may also be linked to prior governance choices

in industries such as construction (Argyres and

Zenger, 2012).

This article is divided into six sections. Follow-

ing this introduction, the second section presents

this study’s empirical setting, and the third section

develops its theories and hypotheses. The fourth

section provides the database and variable mea-

surements used for this investigation, and the

fifth section presents its econometric model and

main results, as well as the discussion of these

results. Finally, the sixth section provides our

conclusions.

1Some of the notable exceptions are the empirical studies by

Nickerson and Silverman (2003a, 2003b), which document the

presence of temporal specificity in trucking.

EMPIRICAL SETTING

We analyze the different hypotheses of this study

within the context of the construction industry.

This industry is important (it accounts for 8– 10%

of the GDP in many countries; see Gordon,

1992) and represents an ideal setting for research

on governance because construction projects are

long-lived, nonstandardized, and require coop-

eration between specialized project constituents,

all of which lead to complex relations between

firms and contractual intensity and incompleteness

(Puddicombe, 2009; Winch, 2001). However, we

know of only three studies that have empirically

explored the vertical integration of this industry

Eccles (1981) and Gonzalez-Diaz, Arru˜

nada, and

Fern´

andez (1998, 2000). We seek to add to this

literature by studying the ‘make or buy’ decision

that building contractors must make for eight dis-

tinct specialty trade activities: (1) building and

installing the metallic structure, (2) building the

formwork, (3) installing the electrical services,

(4) installing the plumbing and water services,

(5) installing the heating and cooling systems, (6)

building and installing the windows, (7) painting,

and (8) building and installing the furnishings and

the appliances. These activities account for a large

proportion of the total number of activities in typi-

cal construction projects.2For each of these activ-

ities, the contractor must decide whether to rely

on external subcontractors or to execute the task

directly.

Our units of analysis are the specialty trade

activities within projects. A building contractor

may be in charge of different projects. Each project

generally has an independent manager, workers,

designers, and geographical location. The con-

tractor may make different governance decisions

regarding each of the activities to be performed

in the projects. In this setting, ‘to buy’ implies

using subcontractors (also known as ‘specialty

trades contractors’). These subcontractors are

typically specialized in a particular activity,

with little diversification of their abilities among

2For example, Riley et al. (2005) indicated that the construction

activities (3), (4), and (5) account for 40– 50% of the total

construction costs in industrial, educational and health projects

and for 20– 30% of the total costs in commercial and housing

complex projects. Activities (1) and (7) are typically expensive,

especially in housing and residential building projects. All in all,

the activities we specified capture approximately 50% or more

of project costs.

Copyright 2013 John Wiley & Sons, Ltd. Strat. Mgmt. J.,35: 224– 245 (2014)

DOI: 10.1002/smj