204 ACCOUNTING FOR MANAGERS
co-ordination occur within the organization’s hierarchy (i.e. within the corporate
structure), while others take place through exchanges outside the organization in
the wider market (i.e. between arm’s-length buyers and sellers).
The work of business historians such as Chandler (1962) reflects a transaction
cost approach in explanations of the growth of huge corporations such as General
Motors, in which hierarchies were developed as alternatives to market transactions.
It is important to note that transactions take place within organizations, not just
between them. For managers using accounting information, attention is focused
on the transaction costs associated with different resource-allocation decisions and
whether markets or hierarchies are more cost effective.
Transactions are more than exchanges of goods, services and money. They
incur costs over and above the price for the commodity bought or sold, such
as costs associated with negotiation, monitoring, administration, insurance etc.
They also involve time commitments and obligations, and are associated with
legal, moral and power conditions. Understanding these costs may reveal that
it is more economic to carry out an activity in-house than to accept a market
price that appears less costly but may incur ‘transaction’ costs that are hidden in
overhead costs.
Under transaction cost economics, attention focuses on the transaction costs
involved in allocating resources within the organization, and determining when
the costs associated with one mode of organizing transactions (e.g. markets)
would be reduced by shifting those transactions to an alternative arrangement
(e.g. the internal hierarchy of an organization). The high costs of market-related
transactions can be avoided by specifying the rules for co-operative behaviour
within the organization.
The markets and hierarchies perspective considers the vertical integration
of production and the decision about whether organizations should make or
buy. Both bounded rationality and opportunistic behaviour are assumed in this
perspective (see Chapter 6 for a discussion of this in relation to agency theory)
and transaction costs are affected by asset specificity, when an investment is made
for a specific rather than a general purpose. Transaction costs are also affected by
uncertainty and the frequency with which transactions take place.
Seal (1995) provided the example of a make versus buy decision for a component.
In management accounting, a unit cost comparison would take place. (Relevant
costs for make versus buy decisions were described in Chapter 9.) A transaction
cost approach would consider whether the production of the component required
investment in specialized equipment or training, a problem of asset specificity.
This approach raises the problem that an external contract may be difficult to
draw up and enforce because the small number of organizations bargaining may
be hindered by opportunistic behaviour. It may therefore be cheaper to produce
in-house due to contractual problems.
Williamson (1975) argued that the desire to minimize transaction costs resulting
from bounded rationality leads to transactions being kept within the organiza-
tion, favouring the organizational hierarchy over markets. Markets are favoured
where there are a large number of trading partners, which minimizes the risk of
opportunistic behaviour.