Contractual governance in trucking: a comment.

Mixon, Franklin G., Jr. ; Upadhyaya, Kamal P.

In an innovative and cogent article, Smith (1993) analyzes the structure of post-deregulation contracting in the trucking industry, utilizing the transactions-cost framework developed by Williamson (1979) and by Klein, Crawford, and Alchian (1978). In examining the relationship between trucking firms and final product suppliers, Smith employs Williamson's characterization of transactions based upon the level of uncertainty, the frequency of recurrence, and the level of specific investment associated with such transactions. Williamson's arguments do add much to the theoretical developments of Coase (1937), Alchian and Demsetz (1972), and Klein et al. (1978) by discussing the market (uncertainty and ex-post small numbers) and human characteristics (bounded rationality and opportunism) that affect many contractual arrangements (both vertical and horizontal) within industries.

Smith makes several valid points in his analysis. First, the degree of transaction-specific investment is a prime determinant of contractual governance structures. However, physical capital is not transaction-specific in the trucking industry (Smith, p. 58). The lack of specific capital does not rule out the possibility of the presence of specific investment, where Williamson emphasizes the importance of specific investment in human capital. As a source of specific investment, Smith points out that by allowing motor carriers to enter into "reduced-rate" agreements with individual shippers, the costs of negotiating the contracts is positive and creates an investment in negotiations that is transaction-specific (Smith, p. 58).

Smith's second major point is that uncertainty will increase the benefits of unified governance (vertical integration) or bilateral governance when some degree of specific investment is present (long-term contracting). Without such specific investment, Williamson's analysis points out that short-term contractual governance will be an option under uncertainty. Two sources of uncertainty among shippers and trucking firms is fuel prices and the possibility of bankruptcy of carrier firms (Smith, p. 58).

Third, Smith correctly points out that ex-post small numbers may lead to "opportunism" with contractual governance. Opportunism can be expected to arise in situations where recurrent transactions and mixed investment can create quasi-rents which facilitate the use of long-term, relational contracting (Smith, p. 60). Smith's analysis of the relationship between shippers and carriers lacks a cross-section of data, and he supports his observations with illustrative examples of these relationships.

The purpose of this comment is to provide support for Smith's analysis from current research. Using the ideas of Williamson (1971 and 1979), modified by the additions of other researchers such as Ekelund and Higgins (1982), our research suggests that vertical relationships within the motor carrier industry since the Motor Carrier Act of 1980 exhibit the theoretical construct developed by Smith (see Upadhyaya and Mixon, 1993; Mixon and Upadhyaya, 1993). Using a cross-section of carrier companies collected from trucks which were inspected by the Tennessee Public Service Commission, we are able to proxy many of the ideas developed by Smith. The firms we examine are similar in that they are all for-profit companies with I.C.C. authority to engage in interstate transportation for non-exempt cargo between 1982-1986 (n = 60). Our research examines the relationship between trucking companies and truck producing companies that lease and/or sell trucks and equipment to motor carriers. The relationships developed by Williamson and detailed by Smith are all valid. The decision to lease/contract or purchase capital equipment by motor carriers is subject to the degree of uncertainty of the demand for carriers' services, because it is derived from the demand for final goods and services.

The dependent variable in our analysis is the percent of total annual expenses in leasing transport equipment (versus ownership) in 1986, and we use various techniques to control for the problem caused by firm size in statistical analysis. Our measure of demand or market uncertainty is the absolute value of earnings deviations for each company between 1982 and 1986 (at 1986 prices). Because the demand for carriers' services is a function of the demand for final products, there is much uncertainty in motor carrier markets and will be captured by large variations in earnings over time. In all of our models, earnings deviation is positive and significant at the 99 percent level of confidence, which supports the ideas developed by Smith. Short-term leasing, in the absence of ex-post small numbers, is beneficial in the face of demand uncertainties. Our model did not consider the possibility of carrier bankruptcy, which would also favor short-term contracting over bilateral or unified governance in the leasing decision. Because our analysis examines an alternate vertical structure, our theoretical explanation of the role played by the possibility of firm bankruptcy offers a different conclusion regarding contractual governance, although the principles developed by Williamson and Smith are still adhered to.

Our results generally support the developments of Smith in his earlier study. Other avenues developed in our analysis examine the role of maintenance costs as specific human capital investment, which leads to greater leasing expenditures in this vertical arrangement between motor carriers and equipment suppliers. Here, trucking firms opt for full service leases (either short-term or bilateral) over unified governance. While we originally thought that our use of Williamson's theoretical constructs to explain vertical relationships in the motor carrier industry to be new and unique, our results specifically support the work of Smith regarding contractual governance in this industry. Hopefully, future researchers will recognize the useful contributions made by Smith as a theoretical background involving empirical analysis.

References

Alchian, A. and H. Demsetz. "Production, Information Costs, and Economic Organization." Journal of Law and Economics, 62 (1972), 777-795.

Coase, R. H. "The Nature of the Firm." Economica, 4 (1937), 386-405.

Ekelund, R. B. and R. S. Higgins. "Capital Fixity, Innovations and Long-Term Contracting: An Intertemporal Economic Theory of Regulation." American Economic Review, 72 (1982), 32-46.

Klein, B., R. Crawford, and A. Alchian. "Vertical Integration, Appropriate Rents, and the Competitive Contracting Process." Journal of Law and Economics, 21 (1978), 297-326.

Mixon, F. G., Jr. and K. P. Upadhyaya. "Economic Regulation, Firm Size, and Vertical Integration in the Motor Carrier Industry." Unpublished Manuscript, (1993).

Smith, B. R., II. "Contractual Governance in Trucking: Maislin v. Primary Steel and the Undercharge Crisis." The American Economist, 37 (1993), 56-63.

Upadhyaya, K. P. and F. G. Mixon, Jr. "The Transactions Cost Theory of Vertical Integration: Leasing in the Motor Carrier Industry." International Journal of Transport Economics, 20(1993), 295-304.

Williamson, O. E. "Transactions Cost Economics: the Governance of Contractual Relations." Journal of Law and Economics, 22 (1979), 233-261.

Williamson, O. E. "The Vertical Integration of Production: Market Failure Considerations." American Economic Review, 61 (1971), 112-123.