Theory of Property Rights Applied to Contractual Safeguards in a Transition Economy

Program Director - Professor Stephen Nicholas

Project Partner
Centre for Property Rights, Shandong University, China

The aim of this project is to explore theoretically how the property rights literature informs the operations of contractual arrangements for safeguarding economic exchange.

International business (IB) research studies the economic organisation of mutually beneficial cross national border exchange of resources. At the heart of economic exchange is how firms (wholly-owned and equity joint ventures), non-equity alliances (including licensing and franchising) and markets protect and transfer property rights in firm-specific assets, including both codified and tacit know-how (Cheung, 1970; Demsetz, 1964; Eggertsson, 1990). The central place of property rights in IB research shares common theoretical ground with the new institutional economics (NIE), which is part of a much broader thrust in the social sciences to understand the complexities of organisations – the firm, the household and government – and to inject greater realism into the modelling of economic behaviour and activity for economic organisations and whole societies (Greif, 1989, 1993; Greif et al., 1994; Eggertsson, 1990; Landa, 1994; Libecap, 1996; North, 1990a).

NIE focuses on how societies promote co-operative exchange by economic organisations through formal and informal rules that create and protect property rights. First, the state plays a unique role in setting the property rights regime. The failure of states to comprehensively define and protect property rights gives rise to the problems of free-riding and exploitation (Olson, 1965; Libecap, 1989). When there are underdeveloped state-based property right rule structures, such as in transition economies, there are two broad, non-exclusive solutions to protecting firm-specific assets. Informal institutions or norms may effectively substitute for formal state-based constraints. Private ordering within close-knit groups often spontaneously generates rules that promote co-operative outcomes among group members (Ellickson, 1994; Landa, 1994). Non-legal sanctions within business communities or commercial networks are frequently complex and multidimensional, and include the desire to maintain reputation, profitable relationships and standing among peers (Macauley, 1963; Charny, 1990; Beale and Dugdale, 1975; Arrighetti et al., 1997). Second, economic organisations divert resources into the protection of property rights, discouraging violation of rights by other parties (Libecap, 1989).

The interplay between the institutional structure and the choice of economic organisation shapes the safeguards, including credible commitments, which allow firms to appropriate rents on their distinctive resources and capabilities (Jensen and Meckling, 1976; Johnson, 1970; Teece et al 1997). Surprisingly, the role of safeguards, including credible commitments, is both under-theorised and poorly understood in practice. NIE (North, 1990, 1993) and transaction cost economics (Williamson, 1985, 1993) take different approaches to the study of safeguards and credible commitments. While North (1993) views the enforcement of property rights within the context of formal and informal institutions (rules of the game) as central to contractual safeguards, Williamson (1993) focuses on the implementation of relation-specific investments by organizations (players) as the key to contractual safeguards.

Combining new institutional and transaction cost economics, the theory paper develops a framework that analyses how the property rights regimes and relation-specific investment impact on the full range of contractual safeguards (from credible commitments to dispute resolution approaches) for managing alliances.