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Why and in what direction do organizations change?¹ Early responses to these questions generally fell into two camps. Adaptationist scholars proposed theories based on the assumption that organizations have wide latitude to change their structure, strategy, and scope. In the adaptationist view, organizations are able to change in the direction dictated by their environment or by the choices of organizational decision makers, whether in the pursuit of rational action (e.g., Lawrence & Lorsch, 1967; Williamson, 1985) or blind action (Weick, 1979). In its extreme form, the adaptationist view implied that firms can and do adapt nearly frictionlessly, suggesting that if there is a performance penalty associated with inappropriate organization, misaligned firms will change so as to reduce or eliminate this misalignment. Alternatively, selection-based theories, notably structural inertia theory within organizational ecology, contended that inertial forces tend to stymie attempts at organizational change (Hannan & Freeman, 1984). In its extreme form, the selectionist view implied that firms can rarely change successfully; instead, if there is a performance penalty associated with misalignment, misaligned firms will be “selected out” of the population.

A widespread consensus in strategy literature argues that firms acquire positions of advantage and competitive capability by assembling or “organizing” sets of uniquely complementary resources, activities, or assets. In this regard, value is created not only in identifying unique and valuable combinations of existing resources, but also in seeing unique and valuable ways to modify or cospecialize these assets. With the envisioned strategic bundle defined, the manager must then determine how to form, organize, and create this bundle. In particular, the manager must decide which assets, activities, and resources must be “owned” and which can be accessed contractually. We argue that although integration does have certain advantages over market transactions, it does not necessarily lead to the expansion of the scale and scope of the firm, because firms would also fail, particularly as they become larger in size. While established theories articulate this organizational failure puzzle in terms of incentive explanations and measurement difficulties, recent advancement in organizational economics and business strategy sees this as a result of influence activities, and social comparison and social attachment processes. These elements can serve as new building blocks for a more comprehensive theory of the nature and the boundary of the firm. Three future research trajectories – both theoretical and empirical in this realm – are suggested.

To assess the impact of TCE on the field of strategy, we first quantified the distribution of TCE-related research articles across all disciplines and fields. Specifically, we identified every article that appeared in a journal included in the Institute for Scientific Information's (ISI's) Web of Knowledge between 1975 and 2008 and that included among its keywords some variation of “transaction costs.” We then removed those articles for which this term clearly did not refer to transaction costs of the Coasean kind (primarily articles in finance and computing, for which “transaction cost” has a different meaning). Finally, we categorized each journal according to its discipline or field. Granted, this requires some judgment, but we attempted to be objective in our categorizations.¹ As Table 1 shows, articles that are self-described as part of the TCE research stream have appeared more frequently in strategy journals than in the journals of any other discipline or field. We interpret this as evidence of TCE's impact on strategy, and of the importance of the strategy field to TCE.

Entrepreneurs in a competitive economy face three fundamental problems. They need to search for and discover a business opportunity (Kirzner, 1973), evaluate it (Knight, 1921), and then seize the opportunity to reap entrepreneurial profits (Schumpeter, 1911) (Langlois, 2007). The problem that we address is how the ability to exploit business opportunities is influenced by entrepreneurial search and the economic organization of entrepreneurship (Arrow, 1962; Lippman & Rumelt, 2003b; Aghion et al., 2005; Foss, Foss, & Klein, 2007). In many cases, the discovery for a new business opportunity needs to be motivated by expected gains, since the search and evaluation of business opportunities is a costly, resource-consuming process (Denrell, Fang, & Winter, 2003; Nickerson & Zenger, 2004; Foss & Klein, 2005; Teece, 2007; Foss & Foss, 2008).¹ We show the critical role of expectations for understanding of the economic organization of entrepreneurship, and argue that transaction cost economics, with its insistence on bounded rationality, but farsighted contracting offers useful insights and presents rich opportunities for further theoretical and empirical research (cf. also Furubotn, 2002).

An important question facing business scholars is whether and how organizations may best adapt their investments, resource profiles, and strategies to the demands of their particular environments. While a broad literature describes organizational design principles that may assist in this regard, more recent work builds on Kauffman's (1993) NK model of biological evolution to explore how selection mechanisms and adaptive principles promote firms' exploitation and exploration efforts. This research stream has made contributions regarding the importance and efficacy of various internal adaptive factors in particular environmental settings. For instance, Levinthal (1997) shows that, despite extensive adaptation efforts, the influence of imprinting persists in complex environments with many local peaks. Rivkin (2000) demonstrates that NK complexity degrades the efficacy of search, compelling imitators to rely on search heuristics rather than adaptation via local learning. Rivkin and Siggelkow (2003) explore the tradeoffs between exploration and stability, and describe how particular organizational attributes, such as vertical hierarchy and group- or firm-level incentive systems, influence the flow of information throughout the organization. These as well as other contributions have added precision to the conceptualization of environments and sharpened understanding of organization by describing precisely how interdependencies across investment choices and/or resource profiles affect adaptation efforts.

The goal of interfirm contract research is to examine how formal contracts impact transaction success, firm relationships, and ultimately individual and collaborative firm performance when two or more firms interact. Most contract literature uses an economic lens to examine contracts: the property rights perspective, agency theory, and TCE. Property rights-based contract research (Coase, 1960; Demsetz, 1967; Alchian & Demsetz, 1973; Cheung, 1969) examines how efficient property rights assignment mitigates ex ante hazards. Similarly, agency theory-based contract research (e.g., Ross, 1973; Jensen & Meckling, 1976; Harris & Raviv, 1979) investigates how incentive alignment between the principal and agent leads to the mitigation of ex ante hazards. In contrast, TCE-based research (Williamson, 1975, 1985) examines contractual safeguards to mitigate both ex ante and ex post hazards (e.g., Joskow, 1985, 1987, 1990; Crocker & Reynolds, 1993). Because the three economic perspectives dominate, most research addresses how contracts are used to mitigate ex ante or ex post hazards. Therefore, many topics still need to be investigated to enhance our understanding of interfirm contracting.

According to TCE, different forms of economic organization – markets, hierarchies, hybrid forms of various kinds, etc. – are characterized by different “syndromes of attributes,” or coherent sets of features (Williamson, 1991). Because each form of organization implements a distinctive set of governance features, each is efficient for a different type of transaction, implying trade-offs among the forms. The two key categories of features are the allocation of decision-making authority among and within firms and the intensity of the incentives facing firms and members of them. By concentrating decision-making authority, hierarchies have the benefit of facilitating “cooperative adaptation”; that is, coordinated change among two or more parties. Adaptation to new economic circumstances is, after all, the main function of an economic system (Hayek, 1945). Hierarchies are said to facilitate cooperative adaptation better than markets because unlike for markets, courts will not intervene in internal disputes and fiat is available as a last resort. This leaves more scope for the management hierarchy to use its authority to promote cooperative adaptation to unanticipated circumstances (Williamson, 1975, 1991). On the other hand, hierarchies feature weaker incentive intensity, that is, weaker links between individual or unit performance and individual or unit reward. This is because market-like levels of incentive intensity would inhibit cooperative adaptation by stimulating “autonomous adaptation” instead. Autonomous adaptation refers to adaptation by individual firms or organizational members that occurs without regard to its effects on other parties. Williamson (1985) also argues that market-like incentives lack credibility within hierarchies due to the ultimate availability of fiat. Thus, for TCE, the most fundamental trade-off between various forms of internal organization is between cooperative adaptation and incentive intensity.

This chapter provides a retrospective analysis of Oxley (1997), placing the article in context, highlighting its main contributions, describing its impact on the strategy literature, and critiquing the research from the viewpoint of today. Recent advances in the analysis of alliance governance are surveyed, and opportunities for future research are suggested.