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Received 24 January 2000
Final revision received 25 March 2003
Key words: vertical integration; transaction cost theory; resource-based view; option theory
A large literature has successfully employed transaction cost economic theory to describe how exchange conditions affect the optimal form of organization. However, this approach has historically not accounted for the influence of firm-specific attributes on the governance decision. This paper develops a model based on insights from transaction cost economics, the resourcebased view, and real options theory to examine how transaction-level characteristics, firmspecific capabilities, and product-market scope influence the governance of production. Empirical evidence derived from analysis of 469 make-or-buy decisions involving 117 semiconductor firms indicates that decisions regarding the governance of production activities are strongly influenced by both transaction- and firm-level effects. Copyright ???2003 John Wiley &Sons, Ltd.
The determination of a firm's boundaries represents a question of both theoretical and practical importance. Indeed a broad and impressive body of scholarly work has addressed the problem, including research drawn from economic (e.g., Coase, 1937; Williamson, 1975) and organizational (e.g., Lawrence and Lorsch, 1967; Thompson, 1967; Galbraith, 1977) perspectives. This work has described how the information and coordination advantages associated with integration may provide scale and scope benefits (Chandler, 1962), reduce transaction costs (Coase, 1937; Williamson, 1975), align incentives (Grossman and Hart, 1986), exploit powerful relationships (Pfeffer and Salancik, 1978), and allow an organization to reduce its dependence on buyers and suppliers (Pfeffer and Salancik, 1978).
While a number of theoretical approaches have been put forth to analyze firms' vertical boundary decisions, existing research has largely followed the precepts put forth in transaction cost economics (TCE) and argued that the optimal form of organization is primarily a function of the characteristics underlying a given exchange. Under the assumption that economic actors are both boundedly rationale and potentially opportunistic, transaction cost theory explains how unfavorable exchange conditions can increase the cost of writing enforceable contracts and create ex post maladaptation and hold-up problems (Williamson, 1985). Moreover, TCE asserts that in these unfavorable situations hierarchical organization will be beneficial because it aligns the interests of exchange parties, provides for the reconciliation of differences via fiat, and permits a more effective, sequentially adaptive decision-making process (Williamson, 1975). This logic has been used to argue...