According to the logic of transaction cost economics, several factors
determine the most efficient form of economic organization. These fact
ors include uncertainty and frequency of transactions involving the tr
ansfer of goods or services, although the most important factor is ass
et specificity. These characteristics of transactions engender high tr
ansaction costs, but they also parallel the conditions under which the
sunk cost effect is most likely to be observed. The potential influen
ce of sunk cost considerations in the choice of corporate governance s
tructure is illustrated with respect to vertical integration, and was
tested in a laboratory study in which subjects were asked to play the
role of a firm's chief strategist. The results support the view that a
sset specificity drives vertical integration, but for reasons that may
have little to do with transaction cost economizing.