ACCA AFM Syllabus A. Role Of The Senior Financial Adviser - Transaction Cost Theory - Notes ^{4 / 6}

General

Transaction costs occur when dealing with another party.

If items are made within the company itself, therefore, there are no transaction costs

• Analysing these costs can be difficult because of:

  • Bounded rationality - our limited capacity to understand business situations

  • Opportunism - actions taken in an individual’s best interests

• Company will try to keep as many transaction as possible in-house in order to:

  • reduce uncertainties about dealing with suppliers

  • avoid high purchase prices

  • manage quality

Are the transaction costs (of dealing with others and not doing the thing yourself) worth it?

The 3 factors to take into account as to whether the transaction costs are worthwhile are:

1. Uncertainty

   Do we trust the other party enough?

   • The more certain we are, the lower the transaction / agency cost

2. Frequency

   how often will this be needed

   • The less often, the lower the transaction/agency cost

3. Asset specificity

   How unique is the item

   • The more unique the item, the more worthwhile the transaction / agency cost is

This can be applied to directors who may take decisions in their own interests also:

1. Uncertainty - Will they get away with it?

2. Frequency - how often will they try it?

3. Asset specificity - How much is to gain?