We begin by reviewing some transactions cost-based arguments for
integration. Coase (1937) suggested that transactions will be organized
in the firm when the cost of doing this is lower than the cost of
using the market. He added some content to this idea by proposing
that the costs of constant recontracting with an outside firm or manager
can be high relative to those of signing a long-term contract with
an employee in which the employee agrees to carry out the commands
of the employer. Klein et al. (1978) and Williamson (1979) added
further content by arguing that a contractual relationship between a
separately owned buyer and seller will be plagued by opportunistic
and inefficient behavior in situations in which there are large amounts
of surplus to be divided ex post and in which, because of the impossibility
of writing a complete, contingent contract, the ex ante contract
does not specify a clear division of this surplus. Such situations in turn
are likely to arise when either the buyer or seller must make investments
that have a smaller value in a use outside their own relationship
than within the relationship (i.e., there exist "asset specificities").