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J) Some Empirical Evidence
On the whole, the results of the empirical literature are consistent with these
theoretical predictions. In the case of vertical integration, Monteverde and Teece (1982a)
found automobile components that required greater design engineering (human asset
specificity) were more likely to be vertically integrated (or less likely to be outsourced).15
Moreover, according to the Masten et al. (1991) study of subcontracting practices in naval
construction, the probability of vertical integration increased with the temporal specificity of
particular construction activities. This is because any delay in these key critical path
activities would disrupt the overall completion time of the project. If such a product was
outsourced instead of vertically integrated, subcontractors could threaten a delay (holdup) in
exchange for price concessions (increasing transaction costs). Reputation is another
important enforcement mechanism that can be used to alleviate this problem, especially in
the case of repeated relationships.16 We’ll observe in Section 3 that “past performance” is
used as a criteria for subsequent contract awards, revealing that reputation is indeed a
mechanism used to encourage specific investments and avoid holdups in practice.
There is evidence that longer term contracts are used as a mechanism to mitigate
the risk of holdup between coal mines and electric utilities that involve greater levels of asset
specificity. Joskow (1987) examines transactions between coal mines (sellers) and electric
utilities (buyers). The study reveals two interesting cases. In the West—where there are few
coal mines, more limited transportation, and different grades of coal—there is a higher
degree of asset specificity associated with transactions, and greater threat of ex-post
opportunism. As predicted by TCE, Joskow reports transactions in the West tend to be
governed by longer-term contracts, and that spot markets are virtually non-existent.17
In sharp contrast, in the Eastern United States—where there are many electric
utilities and coal mines, abundant and competitive transportation, and coal is largely
homogeneous—there is a lower degree of asset specificity associated with transactions,
and consequently a smaller threat of ex-post opportunism. As predicted by TCE, Joskow
reports transactions largely occur in spot markets governed by short-term contracts.
With respect to other mechanisms that can help promote and protect physical asset
specificity—such as Government Owned, Contractor Operated (GOCO) specific assets—
Monteverde and Teece (1982b) found automobile manufacturers were more likely to own
15 A specific example comes from the decision of prime system developer Texas Instruments to make their own
critical component of the Javelin anti-tank missile system: the matrix focal plane array. This item became the
pacing item in the entire program—leading to a holdup situation—and eventually had to be outsourced to another
vendor.
16 For example, Acheson (1985) found that in fish markets, given a price for a catch, buyers (sellers) could act
opportunistically by sorting individual high-quality (low-quality) fish. Monitoring could be used to avoid this, but
increases transaction costs and lowers the surplus enjoyed by both parties. Instead, informal reputation-based
agreements served to avoid these extra costs.
17 Moreover, Joskow (1985) reports that when electricity plants locate themselves near coal mines to avoid high
transportation costs (site specificity), they must be tailored to the grade of coal (physical asset specificity). As
TCE predicts, the measures of vertical integration and explicit long-term contracts are common. In fact, these socalled
“mine-mouth plants” were six times more likely to own the associated mine than other electricity
generators. Those contracts are typically twenty to fifty years in duration, with provisions that prohibit price
renegotiation for extended periods, specify in detail quantities to be supplied over the period, specify the quality
of coal, index costs and the prices of substitutes, and defined procedures for arbitration in the event of disputes.
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