By Benito Arruñada and Giorgio Zanarone*
Oliver Williamson is best known for his theory of the firm—particularly, for the idea that incomplete contracts, opportunism and mutual dependence between firms are the key drivers of vertical integration. However, Williamson always strived to ground his theory of the firm upon a more general economic and legal theory of contractual relationships. His central tenet is that complex transactions require “relational contracts,” that is, ongoing collaborations in which adaptation is achieved, and disputes are resolved, without recourse to court litigation.
Williamson’s view of relational contracts was most clearly articulated in “Transaction Cost Economics: The Governance of Contractual Relations” (JLE ’79) and “Comparative Economic Organization: The Analysis of Discrete Structural Alternatives” (ASQ ’91). There are three central ideas in these articles. First, collaborating firms write their contracts to establish procedures and rules that facilitate contractual completion and non-judicial dispute resolution. Second, while the law has developed over time its own flexible rules to interpret and complete relational contracts (e.g., the excuse doctrine), the risk of judicial misunderstanding and overreach may encourage opportunism and hence undermine relational contracting between firms. Third, judicial enforcement is often not available (and hence cannot do harm) within firms, where divisions must settle their own disputes privately and the only court of appeal is the upper management (“forbearance”).
These ideas gave rise to a distinctive and important research agenda for future work in law, economics, and organization. Williamson’s “procedural” view, whereby interfirm formal contracts establish private dispute resolution and contractual completion mechanisms alternative to the courts, expands the established view in economics, according to which court-enforceable formal contracts reduce the “relational capital” necessary to support a transaction (e.g., several works by Benjamin Klein and by George Baker, Bob Gibbons, and Kevin J. Murphy). Williamson’s intuition has inspired empirical research on interfirm contracts, including Claude Menard’s numerous contributions on hybrids, Scott Masten’s work on leasing with Edward Snyder (JLE ’93), Gillian Hadfield’s recent work on “scaffolding” with Ida Bozovic (WLR ’16), and our own papers on the allocation of decision rights in car distribution agreements (Arruñada, Garicano & Vazquez JLEO ’01; Zanarone JLE ’09, JLEO ’13).
Williamson’s concept of forbearance is also important to understand contractual relationships as it suggests that parties in a relational collaboration would benefit from altogether ruling out judicial intervention (“private ordering”). Understanding the differences between private ordering within and between firms is a fascinating topic for future research.
We foresee that Oliver Williamson’s ideas will continue having profound impact on the research on contractual relationships by stimulating further theoretical analyses and more quantitative empirical research based on field data. This research has the potential to illuminate managerial and policy decisions in key areas, from the governance of new technologies such as blockchain to the renewal of competition policy with respect to vertical restraints to making judiciaries more effective and better adapted to current business practices.
*Benito Arruñada is Professor of Management at Pompeu Fabra University. He served as President of SIOE (then called ISNIE) in 2005-06. Giorgio Zanarone is Associate Professor of Management at CUNEF, and Visiting Associate Professor at Washington University in St. Louis. He has been in the Board of SIOE (then called ISNIE) in 2011-13, and has served as Secretary of SIOE since 2014.