Monday, October 02, 2006

Nobel Series: Oliver Williamson, part 2

Williamson's work in transaction cost economics sheds light on the question of what determines the length of a contract. For instance, why is my contract with The Walker School a 1-year contract? Why do some companies give contracts of 3 to 5 years (informally through a trial period)? Why do temp agencies have people whose job is to work for contracts of as little as a day or a few hours?

Part of the reason comes down to the type of investments involved in the transactions. The basic conclusion is that the more "relationship-specific" the investments, the longer the length of the contract. As an example, job-training can be looked at as an investment from both the employer and the employee side. In situations where the employer has to spend a lot of time training employees in skills that are very specific to their company (like a technical job where the software is company-specific), we would expect to see longer contracts. Whereas, in a temp agency where the only training involved is in office skills that can be used in any job (therefore, not very relationship-specific), the contracts can be very short.

An interesting article in Financial Times by economist Tim Harford talks about this very issue. He discusses marriage as a unique long-term contract and how it relates to corporate examples of contract length and relationship-specific investments.

Any other examples of "long-term contracts" that you know of that might have to do with how specific the investments involved are? Reactions to the Harford article?


Anonymous said...

Loooking at our school one long-term investment would be the payment of school for our teachers. Walker invests money in this because like education is the most important investment. Our parents invest money in us so that one day we will be succesful and be happy. Maybe we'll even take care of them some day.

Anonymous said...

One long term relationship I can think of is leasing a car. Buyers who lease a car often lease for between 3-5 years and pay interest. The interest is the long term relationship specific factor. If they buyer were to engage in a short term contract then they would not have to pay interest and could keep the car as long as they want. I think the Harford article shows why temps are only needed for short periods vs. an employee of higher status. temps perform jobs that often can be filled by another person quickly and easily and the tasks are not crucial to the company. An employee has a specific skill that only he/she may know how to do and is not easily replaced. That is why employees have longer contracts.
-Austin Lintault

Anonymous said...

Other long term investments are real estate (mortagages) and 401K/Retirement plans becuase you put money in and don't pay taxes on the initial money you put in (tax deferred). If you take the money out later, however, then you have to pay taxes and penalties. These particular plans help to accumulate wealth over time. But all long term plans aren't as beneficial and nice. For example, in job contracts where you commit multiple years, you could be bound to a job you hate. But a signed contract can keep you tied down. However...overall, I think that these long term investments are economically smart.

Anonymous said...

Another long term contract, similar to that of a marriage, would be the position of the Pope, or any preacher, priest, etc...for that matter. He holds this title until the day he dies. He invests all of his time into doing the best he can of guiding people of the catholic faith from the day he is appointed Pope. The catholic people are investing their faith and need for moral guidance in the Pope so he must be well qualified for such a large task. Therefore his job title is very relationship-specific.
-Lauren Henderson