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The Contractual Governance of Transactions Within Firms

Author

Listed:
  • Catherine Magelssen

    (Strategy and Entrepreneurship, London Business School, London NW1 4SA, United Kingdom)

  • Beverly Rich

    (Department of Entrepreneurship and Strategy, David Eccles School of Business, University of Utah, Salt Lake City, Utah 84112)

  • Kyle Mayer

    (Marshall School of Business, University of Southern California, Los Angeles, California 90089)

Abstract

A central theoretical premise is that firms internalize transactions that are not suited for formal contracting. Yet, there is growing evidence that firms rely on formal contracts to govern some of their transactions within the firm . This paper discusses why firms use formal contracts between units within the firm and develops propositions for when formal contracts arise. Internalization does not eliminate transactional problems, and informal agreements for transactions between units often suffer from problems in understanding what the other unit will do and whether it will do what it promises. We argue that many of the features that make formal contracts valuable tools for market exchange are beneficial within firms, even if court enforcement of the contract is not possible. We suggest that formal contracts between units serve as communication and commitment devices that address coordination and incentive problems within the firm by providing clarity and credibility on the rights allocated to the units in the transaction.

Suggested Citation

  • Catherine Magelssen & Beverly Rich & Kyle Mayer, 2022. "The Contractual Governance of Transactions Within Firms," Organization Science, INFORMS, vol. 33(6), pages 2226-2249, November.
    • Handle: RePEc:inm:ororsc:v:33:y:2022:i:6:p:2226-2249
    DOI: 10.1287/orsc.2021.1536
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