“Explaining the Swollen Middle: Why Most Transaction are a Mix of ‘Market’ and ‘Hierarchy’,” Organization Science 4(4): 529-547.

Hennart, Jean-Francois. (1993).

Extend Transaction Cost Theory to respond to critiques: TCE is only a theory of market failure—it does not

explain why firms succeed. TCE does not distinguish between transaction

cost and management costs TCE neglects the complexity of actual institutions Most transactions cannot be categorized as either

pure market or pure hierarchy. *No attempt is made to systematically incorporate the

criticisms, though some are addressed.

Motivation

(1)There is not a 1-to-1 correspondence between economic institutions (markets vs. firms) and methods of organizing (price system vs. hierarchy).

(2) The price system meters/rewards output; the hierarchy, behavior (input). Each method is equally effective in a world with zero costs to exchange.

(3) Price systems are vulnerable to cheating costs; hierarchies, shirking costs.

(4) Price systems minimize shirking; hierarchies minimize cheating.

(5) Institutions may find that using a mix of price incentives and behavioral constraints is optimal due to diminishing returns in measuring output and constraining behavior.

(6) Most institutions are hybrids; hence, the bulging middle.

6 Main Points

Organizing Costs

Information

Bargaining

Enforcement

Market(rewards outputs)

Hierarchy(rewards behavior)

Shirking Costs

Cheating Costs

How is the price system

used in employment relations?

Shirking…?

TheModel

Transaction Costs

Property Rights

Agency Theory

2 Organizing Costs from Measuring

People=Risk Neutral

Shirking &

Cheating

Cheating

Model cont.

Ceteris Paribus, should be used more when: Large and diversified firm Low managerial expertise (discern behavior &

quality) Limited knowledge and/or costly to supervise

activities

Using Price Incentives in the Firm

Can we use the framework developed by Mahoney 1992 (non-separability and low/high task programmability)? What else would (does) it need?

How does this paper relate to Chi 1994? (Especially with regards to cheating)

The paper discussed the rise and fall of piecework and/or profit centers. What do you see happening in the future and why? Outsourcing Global Economy New Incentive Schemes

Discussion