TRANSACTION COST THEORY

Transaction Cost Theory

Transaction Cost Theory

Introduction

According to this theory, Multinationals and other large Corporations tend to internalize the transaction cost, which is very high in the market. It is recommended to carry out these transactions within the company, instead of independent companies. The transaction cost theory wants to explain why certain transactions in particular institutional arrangements. It includes different organizational form of exchanges, which are handled more efficiently. It is believed that any action taken by Government is in connection with market. The cost is compared with the market than any decision is taken by the company.

This theory engages contrary to the common assumption of a perfect market and neoclassical theory and set costs and prices according to its requirement.

Discussion

The concept of transaction costs has become a cornerstone of modern economic theory. It was Ronald Coase, who first drew attention to these costs in 1937 article. The so-called Coase Theorem states that if there were no transaction costs, resource allocation would always be the most effective.

In economic theory, property rights means freedom of choice or ability to take a decision concerning a good or service. Transaction costs can be defined as "the costs of transferring property rights" or, more subtly, as "the costs of establishing and maintaining property rights." Property rights are never perfect and that our freedom to dispose of a thing is never complete. Whenever possible someone stealing something, the right of ownership over this thing will be imperfect because the owner must protect it from theft, losing some freedom at your disposal.

The model shows institutions and markets as a possible form of organization for the settlement of transactions. If the transaction costs of the market are higher than the internal transaction costs, than the foundation of an enterprise is more economical. If the internal transaction costs are higher than the external transaction costs, then foundation of an enterprise is costly.

Transactions are the basic units of analysis in transaction cost theory. Relations between two parties are formed to ensure that all transmissions are from property rights to goods and services in exchange (Miles, 2012, pp. 82-90).

As an economic theory, the efficiency of transactions is an important driver. This refers to the most economical use of scarce resources. These are not only for creating the replacement of a good or service consumed (volume of production costs), but also for the execution and organization of exchange (volume of transaction costs).

Transactions are then efficient if the players choose a form of organization, which offers lowest production or transportation cost.

According to transaction cost theory and property right theory, shareholders should have residual control rights over the firm, because they are the only residual claimants and they will pursue their interests to increase residual returns, which leads to efficient management. However, typical shareholders cannot control the firm. McWilliams and Siegel (2000, 606) pointed out that during 1980s ownership in public companies was widely dispersed. Numerous small shareholders own only a small stake of a large corporation, ...