Transaction costs and risk preferences: Modeling governance in offshore drilling

This research examines oil companies' decision to vertically integrate into the drilling function within a transaction cost economics framework. Risk preference is also investigated as an explanation for organizational choice. Econometric models are specified and estimated for organizational choice and for the underlying cost functions of competing organizational forms. Estimation of the cost functions permits isolation of the effects of transaction attributes to each form of organization, shedding light on the relative impacts of hazards of exchange and internal costs. Results provide support for both the transaction cost and risk preference hypotheses as determinants of organizational form. The cost functions also enable estimation of the incentive gains of outsourcing and the avoided transaction costs due to organizing activities internally.