THE ROLE OF ASSET SPECIFICITY IN THE VERTICAL INTEGRATION DECISION

According to the logic of transaction cost economics, several factors determine the most efficient form of economic organization. These factors include uncertainty and frequency of transactions involving the transfer of goods or services, although the most important factor is asset specificity. These characteristics of transactions engender high transaction costs, but they also parallel the conditions under which the sunk cost effect is most likely to be observed. The potential influence of sunk cost considerations in the choice of corporate governance structure is illustrated with respect to vertical integration, and was tested in a laboratory study in which subjects were asked to play the role of a firm's chief strategist. The results support the view that asset specificity drives vertical integration, but for reasons that may have little to do with transaction cost economizing.