Governance choice: Integration of capability differential with transaction costs

Abstract

While TCE provides a widely tested explanation for boundary choice, organizational capability based logic derived from resource based view of the firm was promoted as an alternative explanation for understanding governance decisions. In this paper, we study cloud adoption decisions for 206 IT enabled tasks in 45 organizations, to examine the factors that influence governance choice. We analyze this boundary choice decision by integrating transaction costs with the classical organizational capability view. We view capabilities as a bundle of both production and governance capabilities and define capability differential as the capabilities of the firm relative to the capabilities of the market. Borrowing from the literature on managerial cognition, we posit that capabilities of the market are heterogeneous across different firms and they differ based on the managers’ knowledge of the market. This study finds support for direct effects of asset specificity and capability differential on governance choice and also brings forth the quadratic moderation of capability differential on the relationship between asset specificity and governance choice. We find that when this capability differential is more pronounced, i.e. when the firm’s capabilities are much higher relative to the market’s or when the firm’s capabilities are much lower to the market’s, influence of asset specificity on governance choice is weaker and the decision making is based primarily on capability differential. But, when the firm’s capabilities are similar to that of the market’s, asset specificity becomes an important determinant of governance choice.