Institutions, Capabilities, and Contracts: Make or Buy in the Electric Utility Industry

This paper integrates transaction cost economics with the resource-based view of the firm and new institutional economics to examine how firms' capabilities and institutional environments influence governance decisions. We demonstrate that the impact of firm capabilities on governance choice varies with the level of transaction costs, which is itself a function of the institutional environment. Based on panel data for 240 investor-owned utility companies in 1990–2007, we find that firms with strong institutional safeguards, prior contracting experience, and inferior firm production capabilities will buy more electricity, and make less, to meet increases in demand. We also find that institutional safeguards substitute for prior contracting experience and increase the influence of production capabilities on governance decisions. These findings suggest that firm heterogeneity is a significant factor in governance decisions and that firms' capabilities and institutional environments merit additional consideration in the study of firm governance.