These two chapters on credible commitments maintain and develop the viewpoint that private ordering is widely used to govern complex contractual relations. It thus takes issue with the legal centralism tradition. Rather than employ a legal rules approach to contract, the concept of contract as framework is emphasized instead. Disputes are not therefore routinely litigated; contract and the courts are used for ultimate appeal (Llewellyn, 1931). Such ultimate appeal affords protection against egregious abuses, of which “might is right” is an elementary example. But ultimate recourse does not imply a capacity to make frequent and nuanced adjustments in continuing relations so as to restore the parties to a trading position on the shifting contract curve.
Rather than maintain the presumption that the courts “work well,” therefore, the approach taken here acknowledges that court ordering often experiences severe limitations. Since the severity of those limitations varies with the circumstances, a discriminating approach to the study of contract will necessarily acknowledge differing governance capacities and needs. The study of contract is thus appropriately extended beyond legal rules to include a comparative assessment of transactions in relation to alternative governance structures. Of special interest is the use of bilateral governance structures to implement nonstandard contracts where the adaptation and continuity needs of the parties are especially great.
This chapter and the one preceding establish the following:
- Hostages. Contrary to the prevailing view that hostages are a quaint concept with little or no practical importance to contemporary contracting, the use of hostages to support exchange is widespread and economically important. But hostage creation is only part of the story. Expropriation hazards and prospective maladaptation conditions also have to be considered. Complex governance structures, of which reciprocal trading is one, arise in response to such conditions.
- Asset specificity. The organization of economic activity is massively influenced by the degree to which the transactions under examination are supported by assets that are specific to the parties. These chapters reaffirm the basic proposition that governance structures must be matched to the underlying attributes of transactions in a discriminating way if the efficiency purposes of economic organization are to be realized and establish that, as between two buyers, one of whom posts a hostage in support of specific asset investments by suppliers while the other does not, suppliers- will better terms to the former, ceteris paribus.
- Contracting in its entirety. Not every transaction poses defection hazards, and it may not be possible to safeguard all that do. Where the potential hazards that beset contracts are evident to the parties from the outset, however, studies of contract and of contracting institutions arguably start “at the beginning.” This has ramifications for assessing the importance of the prisoners’ dilemma and for understanding the administration of justice.
- Prisoners’ dilemma. The benefits of cooperation notwithstanding, the achievement of cooperation is widely thought to be frustrated by the relentless logic of the prisoners’ dilemma. To be sure, it has always been evident that defection can be deterred if payoffs are appropriately altered. But that stratagem is held to be infeasible or is otherwise dismissed, on which account the dilemma persists or appeal is made to “exogenous norms of cooperative behavior [that are] adhered to by the actors” (Hirschman, 1982, p. 1470). I submit that the feasibility of crafting superior ex ante incentive structures warrants more attention. A leading reason for its neglect is that the study of the institutions of contract has occupied such a low place on the research agenda. Subtle incentive features incorporated in nonstandard contracting practices have gone undetected as a consequence of this nonchalance—hence the practical significance of the prisoners’ dilemma to the study of exchange has been vastly exaggerated.
- Justice. The notion that hostages are deVnanded as a condition for supplying product on favorable terms has the appearance of an arbitrary exercise of power: The stronger party “demands” aWtage from the weaker, who accedes because it has no other choice. In fact\a comparative institutional assessment of contractual alternatives discloses that efficiency purposes are often served by hostages and that it is in the mutual interest of the parties to achieve that result. Not only can producers be induced to invest in the most efficient technology, but buyers can be induced to take delivery whenever demand realizations exceed marginal cost. More generally, contracts ought to be examined in their entirety, with special attention to their governance features. Principles of justice or competition that look at the relation between the parties at the execution stage without examining the ex ante bargaining relation are at best incomplete and are frequently mistaken. Parties to a contract should not expect to have their cake (low price) and eat it too (no hostage).
Source: Williamson Oliver E. (1998), The Economic Institutions of Capitalism, Free Press; Illustrated edition.