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How Can Integration Reduce Inefficiencies Due to Ex Post Adaptation?


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  • Mori, Yusuke
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    How can integrated firms immediately settle ex post adaptations to unanticipated disturbances? While this question is crucial to the understanding of transaction cost economics (TCE), TCE has not provided any formal answer. This paper develops a model that explores this question by employing three behavioral assumptions: reference-dependent preference, self-serving bias, and shading. We present two reasons why integration can avoid costly renegotiations and realize immediate adaptations; these stem from the fact that while nonintegrated parties have to engage in negotiations for the adaptations, integrated firms can implement these by fiat. First, punishments for rejection of an order under integration are severer than those for rejection of an offer under non-integration. Second, under integration, the utility improvement for a subordinate from rejecting an order is not sufficient to offset the loss from a severe punishment. Furthermore, we point out a trade-off between immediate agreement and the aggregate sense of loss.

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    Bibliographic Info

    Paper provided by Center for Japanese Business Studies (HJBS), Graduate School of Commerce and Management Hitotsubashi University in its series Working Paper Series with number 142.

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    Length: 34 p.
    Date of creation: Apr 2012
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    Handle: RePEc:hit:hjbswp:142

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    Keywords: Reference-dependent preference; self-serving bias; contracts as reference points; transaction cost; ex post adaptation;

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    1. Andrea Gallice, 2011. "Self-serving biased reference points," Carlo Alberto Notebooks 223, Collegio Carlo Alberto.
    2. Kirk Monteverde & David J. Teece, 1982. "Supplier Switching Costs and Vertical Integration in the Automobile Industry," Bell Journal of Economics, The RAND Corporation, vol. 13(1), pages 206-213, Spring.
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