Collateralized Social Relations: The Social in Economic Calculation

American Journal of Economics and Sociology, The, April, 2001 by Nicole Woolsey Biggart, Richard P. Castanias

For example, one important concern of agency theory is structuring relations between managers of a firm and the firm's owners (Alchian and Demsetz 1972; Jensen and Mechling 1976). As agents of investors, managers are obligated to maximize the interests of the owners or principals. In fact, managers may make decisions that optimize their own interests, such as granting themselves generous pension benefits. Agency theorists describe ways in which relationships between agents and principals can be structured to monitor the agents or structure the agents' self-interests, for example through compensation incentives, so that they are aligned with the interests of investors, a process known as "bonding." Both monitoring and bonding are "agency costs" due to the imperfect fit between the interests of principals and agents.

Williamson's transaction cost economics builds on Coase's (1937) insight that firms and markets are alternative ways of organizing economic activity. Markets organize exchange impersonally and firms organize economic activity authoritatively, that is, through social relations. The choice of organization or "governance" depends upon which is the least costly means for transacting exchange. According to Williamson (1975, p. 8; emphasis in original), "the costs of writing and executing complex contracts across a market vary with the characteristics of the human decision makers who are involved with the transaction on the one hand, and the objective properties of the market on the other." The human factors that Williamson considers most important in affecting the choice of governance structure are bounded rationality, the inability to completely understand all alternatives, and the possibility that actors will act opportunistically. Williamson has elaborated this perspective to examine such issues as alternative work organizations and inter-firm relations, always focusing on the most efficient (i.e., least costly) way to organize relations between economic actors given a set of behavioral assumptions

George Akerlof's work has developed the observation that most exchanges do not conform to the mainstream assumptions of large numbers of buyers and sellers, homogeneous products, and perfect information. Akerlof's analyses make the more realistic assumption that exchanges are often complicated by the fact that one party to an exchange relation has more information than another (information asymmetry) and further observes that individuals may act opportunistically. His famous article, "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism" (1970) examines the situation in which the selling party has information about the quality of the product that is not apparent to the buyer. He uses the used-car market to discuss how the possibility of misrepresentations (opportunistic behavior) on the part of owners makes buyers wary, discounting the price of all used cars, lemons and non-lemons alike, because buyers cannot easily discern between the two. Sellers of good used cars, knowing they are unlikel y to get full value, rationally hold their good cars off the market. Lemons are therefore overrepresented in the used-car market. Akerlof applies the "Lemons Principle" to labor and credit markets, among others, to show how information asymmetries can threaten the viability of markets. He argues that some social institutions that promote product reputation, such as brand names and franchises, can mitigate the Lemons Principle.