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Subject Area: Political Theory

Corporations & Transaction Costs - Leonard P. Liggio, Literature of Liberty, Autumn 1982, vol. 5, No. 3 [1982]

Edition used:

Literature of Liberty: A Review of Contemporary Liberal Thought was published first by the Cato Institute (1978-1979) and later by the Institute for Humane Studies (1980-1982) under the editorial direction of Leonard P. Liggio.

Part of: Literature of Liberty: A Review of Contemporary Liberal Thought, 20 vols. 19781-982

About Liberty Fund:

Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.


Corporations & Transaction Costs

Oliver E. Williamson

  • University of Pennsylvania

“The Modern Corporation: Origins, Evolution, Attributes.” Journal of Economic Literature 19 (December 1981): 1537–1568.

There is virtual unanimity over the proposition that the modern corporation is a complex institution which has played a crucial role in the development of modern Western economies. However, there is much less agreement on what its attributes are and on how and why it has evolved to take on its current form. Prof. Williamson argues that the modern corporation is to be understood mainly as the product of a series of organizational innovations that have had the purpose and effect of economizing on transaction costs.

After discussing the development of the basic corporate form in the nineteenth century, Williamson goes on to analyze what he considers the most significant organizational innovation of the twentieth century: the gradual shift from the centralized, functionally departmentalized or unitary (U-form) structure to the multidivisional (or M-form) configuration.

As corporation activities grew more numerous and complex at the beginning of our century, the inherent weaknesses of the centrally governed, departmentalized company became apparent. Administrative problems such as coordination, appraisal, and policy formulation increased to such an extent that senior executives found themselves unable to handle their entrepreneurial responsibilities efficiently. U-form structure had created a communications over-load in which the welter of details to be attended to hampered concentration on global goals.

Responding to this administrative glut, Pierre S. DuPont and Alfred P. Sloan devised the M-form organization for the DuPont Company during the 1920s. This new structural mode involved the creation of semiautonomous operating divisions (mainly profit centers) organized along product, brand, or geographic lines. The operating affairs of each were thus managed separately.

DuPont and Sloan saw, however, that more than a change in decomposition rules was needed for the M-form to be fully effective. They thus created a general office consisting of a number of powerful general executives and large advisory and financial staffs to monitor divisional performance and engage in strategic planning. In this way, the M-form removed executives responsible for the destiny of the entire enterprise from routine operational activities, and so gave them the time, information, and even psychological commitment for longterm planning and appraisal. Although the structure was imitated very slowly at first, adoption by U.S. firms proceded rapidly from 1945 to 1960. Wide acceptance of this form by European companies has occurred from the 1960s to the present.

The American advance in adopting the M-form innovation enabled the U.S. to pioneer in the development of two extremely potent corporate forms: the conglomerate and the multinational. Both structures have been severely criticized since their inception. Nonetheless, in Prof. Williamson's view, the significant transaction cost economizing effected by both warrants more sympathetic assessments.

Specifically, conglomerates in their diversity have shown themselves to be superbly equipped for allocating resources to valued uses. The activities of the multinational, on the other hand, have been selective in a most positive way—being concentrated in the more technologically progressive industries where higher rates of research and development are reported and where technology transfer poses greater difficulties. Multinationals can smoothly transmit new technical knowledge from one national branch to another. This obviates the often thorny dilemma of a foreign company which buys information, the exact value of which will not be known until after the sale has been consummated. Thus, patterns of direct foreign investment by multinationals cannot simply be explained as the pursuit of monopoly, as is so often charged. On the contrary, these investment patterns are, on the whole, consistent with effective transaction-cost reasoning.