“Explaining the Swollen Middle: Why Most
Transaction are a Mix of ‘Market’ and ‘Hierarchy’,”
Organization Science 4(4): 529-547.
Hennart, Jean-Francois. (1993).
Motivation

Extend Transaction Cost Theory to
respond to critiques:




TCE is only a theory of market failure—it does not explain
why firms succeed.
TCE does not distinguish between transaction cost and
management costs
TCE neglects the complexity of actual institutions
Most transactions cannot be categorized as either pure
market or pure hierarchy.

*No attempt is made to systematically incorporate the criticisms,
though some are addressed.
6 Main Points
There is not a 1-to-1 correspondence between economic
institutions (markets vs. firms) and methods of organizing
(price system vs. hierarchy).
(2) The price system meters/rewards output; the hierarchy,
behavior (input). Each method is equally effective in a world
with zero costs to exchange.
(3) Price systems are vulnerable to cheating costs; hierarchies,
shirking costs.
(4) Price systems minimize shirking; hierarchies minimize
cheating.
(5) Institutions may find that using a mix of price incentives and
behavioral constraints is optimal due to diminishing returns
in measuring output and constraining behavior.
(6) Most institutions are hybrids; hence, the bulging middle.
(1)
Cheating Costs
Market
(rewards outputs)
Hierarchy
(rewards behavior)
Shirking Costs
Organizing
Costs
How is the
price system
used in
employment
relations?
Bargaining
Information
Enforcement
Shirking…?
Shirking &
Cheating
The
Model
2 Organizing
Costs from
Measuring
Transaction
Costs
People=Risk
Neutral
Property
Rights
Agency
Theory
Cheating
Model cont.
Using Price Incentives in the Firm

Ceteris Paribus, should be used more when:



Large and diversified firm
Low managerial expertise (discern behavior & quality)
Limited knowledge and/or costly to supervise activities
Discussion


Can we use the framework developed by Mahoney
1992 (non-separability and low/high task
programmability)? What else would (does) it need?
How does this paper relate to Chi 1994?


(Especially with regards to cheating)
The paper discussed the rise and fall of piecework
and/or profit centers. What do you see happening in
the future and why?

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
Outsourcing
Global Economy
New Incentive Schemes