Contractual Commitments, Bargaining Power and Governance Inseparability : Incorporating History into Transaction Cost Theory

Transaction cost and modern property rights theories of the firm take the transaction as the fundamental unit for analyzing governance choices. This paper explores the limits of the theories when transactions cannot be analyzed and governed separately; that is, when they are subject to "governance inseparability". We argue that two sets of factors act individually, or in combination, to produce governance inseparability. First, prior contractual commitments with parties other than the immediate contractual partner can limit the feasible set of mechanisms for governing current transactions. Second, unanticipated changes in bargaining power can enable a party to place restrictions on the governance choices that a partner can make in future contracts with other parties. We use several examples to show how governance inseparability has constrained outsourcing, subsidiary formation, and the terms and conditions of franchise contracts. We draw implications for the affects of firm and environmental characteristics on governance choices, as well as the limits to, and impact of uncertainty on, firm scope