Jack Skeels, Working paper - February 2026
Abstract
Transaction Cost Economics (TCE) explains firm boundaries and governance structures as mechanisms for minimizing coordination costs under uncertainty, opportunism, and bounded rationality. In knowledge-intensive organizations, however, the dominant coordination cost is not physical transaction expense but the cost of reconciling distributed judgment under complexity. This note proposes a judgment-centered extension of TCE, arguing that coordination costs in knowledge work are best understood as the cost of aligning, legitimizing, and propagating judgment across interdependent actors. Furthermore, as technological change accelerates action capacity (e.g., through automation and AI), governance structures must adapt to preserve the balance between judgment and action. Failure to do so produces managerial expansion, decision latency, and throughput degradation. Structures that localize and preserve judgment continuity reduce internal transaction costs under these conditions.
1. Transaction Cost Economics and Knowledge Work
Coase (1937) and Williamson (1975, 1985) argue that firms exist because market transactions incur costs under conditions of uncertainty and bounded rationality. Firms substitute hierarchical governance for market exchange when internal coordination is more efficient than contracting across boundaries.
In classical TCE, transaction costs include search, negotiation, monitoring, and enforcement. These costs are particularly sensitive to uncertainty, asset specificity, and opportunism.
In knowledge-intensive organizations, however, much of what is coordinated is not the exchange of tangible goods but the interpretation, prioritization, and authorization of action. The core coordination problem shifts from asset transfer to meaning reconciliation. Under these conditions, transaction cost is less about logistics and more about judgment.
2. Coordination Cost as Judgment Reconciliation Cost
We propose the following reformulation:
In knowledge work, coordination cost is primarily the cost of reconciling distributed judgments under bounded rationality and uncertainty.
Judgment here includes interpretation, problem framing, risk assessment, quality evaluation, and legitimacy formation. Decisions are discrete events that crystallize judgment, but the larger system is continuous and distributed.
Under complexity (organizational complexity that is usually super-linear with size), coordination requires:
- Aligning interpretations of ambiguous information
- Reconciling differing risk tolerances
- Establishing shared understanding
- Determining legitimate authority to act
Each of these represents cognitive and temporal expenditure. As interdependence increases, so does the cost of judgment reconciliation.
This reframing remains fully consistent with TCE’s emphasis on bounded rationality: actors cannot process all relevant information, and governance structures economize on this limitation.
3. Structural Fragmentation and Judgment Decay
When work is fragmented across roles, projects, or hierarchical layers, the cost of reconciling judgment increases through two mechanisms:
- Judgment decay – Context and shared understanding erode across handoffs and interruptions, requiring repeated reconstitution.
- Judgment interdependence geometry – As the number of actors increases, the potential reconciliation paths grow combinatorially.
These dynamics generate increasing internal transaction costs. Managerial expansion often emerges as a compensatory response: additional layers attempt to restore alignment. However, these layers also increase second-order reconciliation costs, potentially producing super-linear growth in coordination overhead.
Thus, managerial growth can be interpreted as a structural response to rising judgment reconciliation cost under complexity.
4. Technological Acceleration and Transaction Cost Rebalancing
Traditional TCE implicitly assumes a relatively stable relationship between action cost and coordination cost. In many industries, execution historically constrained activity velocity, providing natural buffers that allowed judgment systems to cohere.
When technological advances reduce action cost dramatically—through automation, digitalization, or generative AI—the balance shifts:
- Activity velocity increases.
- Judgment bandwidth remains bounded.
- The time available for (judgment) reconciliation decreases.
Under these conditions, transaction cost increasingly concentrates in judgment authorization and alignment rather than execution. Observable symptoms include decision latency, rework, coordination bottlenecks, and managerial overhead.
This does not invalidate TCE; rather, it demonstrates that governance structures must adapt when the relative weight of action cost versus coordination cost changes.
5. Structural Adaptation and Judgment Continuity
Governance forms that reduce internal transaction costs under high complexity and high activity velocity share several features:
- Localization of judgment authority close to action
- Reduction of judgment distance and handoffs
- Preservation of contextual continuity
- Explicit alignment between risk ownership and decision authority
Such structures economize on bounded rationality by minimizing repeated judgment reconstruction and limiting combinatorial reconciliation paths.
In TCE terms, they represent governance adaptations that reduce internal transaction costs by reducing the cognitive burden of coordination.
Conclusion
Transaction Cost Economics remains a powerful framework for understanding firm boundaries and governance. In knowledge-intensive contexts, however, coordination cost is best conceptualized as judgment reconciliation cost. Structural fragmentation increases this cost through decay and geometric interdependence. Technological acceleration shifts the cost frontier further toward judgment constraints.
Organizations that redesign structure to preserve judgment continuity and localize authority can reduce internal transaction costs under complexity. Those that do not may experience managerial growth, latency, and declining throughput despite technological advances.
This judgment-centered extension of TCE provides a framework for analyzing organizational performance in environments characterized by complexity and accelerated action.
