Transaction Cost Theory

Paper Summary:

The transaction cost theory as proposed by Ronald Coase and Oliver Williamson, states that organizations experience enormous economic costs and corresponding economic advantages in each and every one of their captivities or transactions. The paper shows that for many years, the dominant neo-classical approach to the theory of the firm suggested that nothing significant would be gained from peering into the "black box" called the firm and that it was enough to know that a firm operated to maximize profits. In the core model of perfect competition, this was achieved subject to known technology and known prices. The paper shows that transaction cost theory takes into account the assertion that the firm exists because of its capacity to economize on the costs of market-oriented production. The firm itself emerges as the most superior economic device for the reduction of market costs. Consequently, the efficiency advantages of any organization or firm are regarded by Coase as greatest where long-term contracts are negotiated. The paper shows that long-term contracts -- including contracts and other arrangements that address staffing and employment issues -- will be preferred unless the costs of negotiation and enforcement of separate or short-term market contracts are low. The paper focuses on the health care industry, with transaction costs understood in the context of employee turnover.

From the Paper:

"At the same time, Kazemek and Shomaker (1990) also noted that hospital staff shortages caused by both turnover and national vacancy rates in critical patient care areas pose a considerable revenue threat. A substantial number of health care institutions have begun to reduce their workforce and to eliminate services. Murphy and Murphy (1996) claim that health care organizations which have implemented across-the-board workforce reductions as a transaction cost savings mechanism have actually tended to experience decreased service quality, increased employee turnover, and minimal savings in labor costs. This phenomena suggests that work process analysis might be useful prior to a downsizing effort."

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