The Transaction-Cost Approach

This chapter develops a transaction-cost model of the internalization decision of multinational firms. A key organizational decision of firms is the extent of control that firms choose to exert over the production of the different parts and components in their value chain. In many circumstances, ownership of the input producer's physical assets is the key method to enhance such control. For this reason, this decision is often dubbed “internalization.” The transaction-cost theory has arguably been the leading paradigm in the analysis of the internalization decision in international environments. In line with this theory, it is typically perceived that vertical (or lateral) integration is an effective way for firms to deal with situations of contractual incompleteness in international transactions, in which it may be hard to provide incentives to subcontracted producers.