The Importance of Transaction Cost Economics

"TCE’s main theme is that transactions -which differ in their attributes – are aligned with governance structures-which differ in their costs and competencies – in a discriminating, economizing way"- Roland F. Spekle (2001). It may be observed that some organizations use very extensive and formal planning to direct their efforts, whereas other organizations may not attach that much importance for planning. Similarly rules, procedures, and standards dominate the working of some firms while individual judgments provide the basis of working in other firms. Although these phenomena do not find any statutory explanation for such organisational behaviours, Management Control theory has come a long way in providing satisfactory explanations in this direction. On a similar footing, "TCE studies organization from a comparative point of view in which different institutional arrangements are considered alternative ways to organize economic activity" – Roland F. Spekle (2001). TCE tries to explain the rationale behind the behaviour of an organization in getting some transactions executed within the same organization while some other transactions are getting outsourced. The TCE’s reasoning to this specific attitude of the firms lies in the fact a specific institutional arrangement is chosen to govern a specific transaction because that arrangement offers some distinctive set of control devices. Another filed of economics which deals with the organisational behaviours is the Evolutionary theories which have a long tradition in the kinds of the literature of socio-economics and strategic management and have influenced recent studies of the evolution of management accounting systems. "A review of the literature of economic indicates that three main concepts are at the core of evolutionary thinking: institutionalization, capabilities and learning and change". – Alan F. Coad and John Cullen (2006). Thus Evolutionary Theories also center on the basic concepts of organizational changes due to these three factors. This paper envisages describing the basics of Transaction Cost Economics and Evolutionary Theories, the nature of their relationships and their relative contribution to Management Accounting.
Transaction Cost Economics is most associated with the work of Oliver Williamson. It must be emphasized that while Williamson’s work is very distinctive, it falls well within mainstream economic thinking. It is sometimes said that TCE attempts to explain why firms exist. That is why there are some transactions directed by managers in the context of a hierarchy, as opposed to taking place in an open market. It’s more accurate, though to say that TCE tries to explain the particular structure of a firm, most importantly, the extent to which it will integrate vertically. Williamson’s theory is based on the assumption that the primary aim of firms is profit maximising and that involves cost minimization. He also tried to make a distinction between transaction costs and production costs. Production costs are assumed to be those which are incurred to build and run an ‘ideal business setup’ and transaction costs are those incurred for departure from the ideal set up. As it is the fact that the existence of the ‘ideal set up’ requires a perfectly efficient market and the prerequisites of such a market are the factors like availability of full information to all the parties and perfect competition among other requirements.