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The transaction cost economics (TCE) theory of trading favors

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Abstract

Trading favors is a pervasive business practice, especially in emerging economies. To date, a range of theories has been utilized to explore trading favors, but most extant studies focus especially on negative aspects of favors (e.g., corruption and bribery). We adopt transaction cost economics (TCE) to analyze systematically trading favors as an economizing practice serving efficiency purposes. From the TCE perspective, trading favors is a component of the relational contracting portion of transaction governance, and contributes to economizing on bounded rationality and bounded reliability. We hypothesize that trading favors will be more prevalent in (1) macro-contexts characterized by a vacuum of formal institutions as well as by excessive formal rules; (2) cultural contexts where in-group membership is highly valued; (3) high bounded rationality/low bounded reliability contexts where frequent opportunities exist for indirect reciprocity; and (4) cases whereby no asset-specific investment(s) in innovation need to be made by the supplier of the favor. Enforcement mechanisms such as in-group sanctions, access to formal contracting as a complement to favors, possibility of image scoring and incentive compatibility can function as critical components of the trading favors practice. We suggest a classification of favor trading practices based on their link to formal contracting and rate of recurrence, and describe a range of likely impacts.

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Notes

  1. Good faith reprioritization captures instances whereby economic actors make ex ante commitments in good faith (with benevolent intent), but the importance of those commitments diminishes over time (preferences are reordered). Time discounting bias (placing a lower value on future events than more proximate events) can also cause economic actors to reprioritize, and postpone efforts to make good on commitments to the point that such commitments can no longer be fulfilled. Scaling back on overcommitment results from the tendency of managers to make excessive commitments ex ante, that then need to be scaled back ex post.

  2. Linguistically, protetzia is in fact a borrowing from the Russian “протекция,” literally meaning “protection.” Both the word and the practice were likely influenced by extensive Russian emigration to Israel.

  3. Our viewpoint is different from Husted’s (1994), who looked solely at corruption (associated with an extreme type of trading favors with substantial negative spill-overs) as a distinct class of transactions, involving a private exchange between two parties, and associated with abuse of a public or collective responsibility.

  4. Zhou and Peng’s study focused specifically (and more narrowly) on bribery. To the extent that bribery can be interpreted as a specific (albeit potentially damaging) form of favors, their study does provide partial evidence that favors are more prevalent in underdeveloped institutional contexts.

  5. It should be noted that in real world situations a complete vacuum of formal rules is unlikely, as even newly emerging economies usually possess burdensome regulations in some policy areas. However, these economies simultaneously suffer from the lack of efficient, local intermediary firms. The institutional voids referred to in Hypothesis 1 pertain to the vacuum of helpful/business-friendly regulations and institutions that facilitate transactions and ensure their transparency, the information disclosure associated with them, and their legality.

  6. Here, we assume that business groups do not engage in questionable practices such as profit tunneling discussed in a previous example, and we use business group governance only as a generic illustration of how institutional voids can be filled.

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Authors and Affiliations

  1. Haskayne School of Business, University of Calgary, Calgary, Alberta, T2N 1N4, Canada

    Alain Verbeke & Liena Kano

  2. Slovay Business School, University of Brussels, Brussels, Belgium

    Alain Verbeke

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  1. Alain Verbeke
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  2. Liena Kano
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Correspondence to Alain Verbeke.

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Verbeke, A., Kano, L. The transaction cost economics (TCE) theory of trading favors. Asia Pac J Manag 30, 409–431 (2013). https://doi.org/10.1007/s10490-012-9324-6

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