How Can Integration Reduce Inefficiencies Due to Ex Post Adaptation?
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.
|Date of creation:||Apr 2012|
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- Botond Kőszegi & Matthew Rabin, 2006.
"A Model of Reference-Dependent Preferences,"
The Quarterly Journal of Economics,
Oxford University Press, vol. 121(4), pages 1133-1165.
- Botond Koszegi & Matthew Rabin, 2004. "A Model of Reference-Dependent Preferences," Method and Hist of Econ Thought 0407001, EconWPA.
- Botond Koszegi & Matthew Rabin, 2005. "A Model of Reference-Dependent Preferences," Levine's Bibliography 784828000000000341, UCLA Department of Economics.
- Koszegi, Botond & Rabin, Matthew, 2004. "A Model of Reference-Dependent Preferences," Department of Economics, Working Paper Series qt0w82b6nm, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
- Oliver Hart & John Moore, 2008. "Contracts as Reference Points," The Quarterly Journal of Economics, Oxford University Press, vol. 123(1), pages 1-48.
- 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.
- Andrea Gallice, 2009. "Self-serving biased reference points," Department of Economic Policy, Finance and Development (DEPFID) University of Siena 0909, Department of Economic Policy, Finance and Development (DEPFID), University of Siena.
- Andrea Gallice, 2011. "Self-serving biased reference points," Carlo Alberto Notebooks 223, Collegio Carlo Alberto.
- Oliver Hart, 2009. "Hold-up, Asset Ownership, and Reference Points," The Quarterly Journal of Economics, Oxford University Press, vol. 124(1), pages 267-300. Full references (including those not matched with items on IDEAS)
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