98-009
IMPLICIT CONTRACTS AND THE THEORY OF THE FIRM
George Baker, Robert Gibbons, and Kevin J. Murphy
We analyze the role of implicit contracts based on noncontractible
performance measures in determining whether transactions will occur in
firms, in "relational contracts" (implicit contracts in markets), or in
spot markets. We derive four results: (1) implicit contracts (whether
inside or outside firms) cannot exist if the spot market offers an inferior
but sufficiently palatable alternative; (2) vertical integration is an
efficient response to widely varying supply prices; (3) incentives are
"higher-powered" in relational contracts than in firms; and (4) transfer
pricing is part of the firm's performance-measurement and incentive system,
not a device for allocating resources. Our model suggests why "management"
(the development and implementation of unwritten rules and codes of
conduct) is essential in organizations.
O&M
41 pages
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