Asset Specificity and Vertical Integration: Williamson's Hypothesis Reconsidered
Description
A point repeatedly stressed by transaction cost economics is that the more specific the asset, the more likely is vertical integration to be optimal. In spite of the profusion of empirical papers supporting this prediction, recent surveys and casual observation suggest that higher levels of asset specificity need not always lead to vertical integration. The purpose of this paper is to uncover some of the factors driving firms to (sometimes) choose to remain separated, rather than integrate, in the presence of high specificity. Its main economic message is that in a world where outside options matter and investments are multidimensional, high levels of asset specificity can foster nonintegration: a low level of specificity provides the most misdirected incentives when transacting in a market (because the outside option of external trade becomes so tempting), thus making a stronger case for nonintegration when specificity is high. The paper thus provides a rationale for the pattern of new organizational forms that we are seeing, which are characterized by high degrees of uncertainty, frequency and asset specificity, and yet do not lead to integration — a pattern that has proved hard to explain with traditional transaction cost economics.