Transaction Cost Theory

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2.4. Transaction Cost Theory
Transaction Cost Theory (TCT) is another popular framework applied to explain economic exchanges (e.g. Anderson, 2008; John and Weitz, 1988). This section therefore deals with some aspects of it such as the transaction cost approach, application of TCT, determinants of transaction costs, governance problems associated with TCT, and a comparison of TCT with AT.
2.4.1. The Transaction Cost Approach
TCT emerged as part of the New Institutional Economics. Its basic premise is the consideration of the firm as a governance structure. TCT was initially approached by Coase (1937) and further developed by Williamson (1975b). Coase (1937) argued that firms and markets have different transaction costs and that they are alternative
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Bounded Rationality
Bounded rationality refers to constrained cognitive capabilities and limited rationality of decision makers. Decision makers may be unable to act rationally due to their limited ability to process information and to communicate (Simon, 1957). Issues arise according to TCT when the circumstances cannot be identified ex ante, i.e. due to environmental uncertainty, or when performance cannot be verified ex post, i.e. due to behavioral uncertainty (Rindfleisch and Heide, 1997).
Opportunism refers to self-interest seeking, which includes cheating, lying, and other forms of deceit (Williamson, 1985, p. 47). Opportunism becomes particularly problematic when specific assets are involved in the relationship between the two partners and those assets only have limited value outside that agreement (Rindfleisch and Heide,
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Application of TCT
TCT is most commonly applied for vertical integration decision, e.g. manufacturing firms contemplating integration into supply of materials etc., or into distribution and sales. Research has explored various fields of TCT. John and Weitz (1988), for example, explored TCT using direct versus indirect distribution channels in forward integration into distribution. Anderson (2008) and Weiss and Anderson (1992) also applied TCT when exploring selection of integrated versus independent sales forces by manufacturing firms.
One major problem that can be identified in franchising in the context of TCT is the potential of quasi-rent appropriation. A quasi-rent represents the difference between the value of an asset and its salvage value (Klein et al., 1990). Quasi-rent appropriation is especially risky when initial fees are high. Franchisees will consequently ask for higher rates of return that allow them to depreciate the value of their investment in order to balance out this type of inefficient risk-bearing. As a consequence, franchisees will also demand greater company ownership if initial investment is high (Brickley and Dark, 1987; Carney and Gedajlovic,
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