Equity, opportunism, and the design of contractual relations

Abstract

The primary focus of the New Institutional Economics has been on evaluating the choice among alternative economic institutions. As Oliver Williamson recently described it, implementing transaction-cost economics mainly involves a comparative institutional assessment of discrete institutional alternatives (Williamson [1985], pp. 41 -42, emphasis added). Thus, the New Institutionalism puts markets versus hierarchies, regulation versus franchise bidding, and long-term contracts versus simple exchange. The application of transaction-cost reasoning to these questions has provided numerous insights. In addition to its theoretical appeal, a considerable body of empirical work has emerged supporting the relationship between the decision to integrate and factors such as the degree of asset specificity and the complexity of the transaction. x Indeed, the success of this approach in analyzing the theory of the firm has been such that it must now be considered the predominant theory of vertical integration. But the systematic analysis of transactional frictions developed to examine questions of institutional choice has been less extensively applied to questions of institutional design. 2 How, for example, do transaction costs affect the internal organization of the firm or the details of contractual relationships? Do opportunism and bounded rationality play an similarly pivotal role in deter-