Using a detailed dataset from the Chilean construction industry, we explore how the predictions of the transaction cost and capabilities theories interact to explain building contractors' decisions to ‘make or buy’ the specialty trade activities needed to complete a construction project. We show that the contractor's productive capabilities strongly mediate the relationship between transaction hazards that originate from either temporal specificity or an exogenous change in the subcontracting law and the vertical integration decision. The inclusion of differential capabilities and its interaction with transactional hazards infuse contractors' boundary choices with systematic patterns of heterogeneity and contribute to the integration of these theoretical perspectives. Our analysis corrects for the endogeneity of the capabilities variable and provides a detailed assessment of the marginal effects in logit models. Copyright © 2013 John Wiley & Sons, Ltd.

Research summary: Two central issues in strategic management are the determination of a firm's internal delegation and its vertical boundaries. Despite the importance of these issues, there is scant analysis concerning their interaction. Using a comprehensive database of the construction industry, we show that vertical integration positively influences the centralization decision and that the main mechanism driving this relationship is an improvement in the hierarchically coordinated adaptation of firm activities when complexity and uncertainty are high. We also observe that centralization is negatively related to the extent of relational contracts between principals and agents, and positively related to an exogenous increase in the cost of employee layoffs. Our results suggest that managers cannot consider firm boundaries and internal organization to be independent decisions. Managerial summary: We ask whether a firm's decision about vertically integrating or outsourcing its activities affects the choice of centralizing or delegating its internal decision-makingprocess. Our statistical analysis shows that firms with more vertical integration tend to centralize the decision-making process and that firms that outsource more tend to decentralize more. Why? Vertical integration enables the use of centralized authority to coordinate activities that interact intensively. Accordingly, we found that the positive influence of vertical integration on centralization is especially significant in more complex and uncertain environments, when the need for coordination is higher. Thus, our results suggest that managers should choose vertical integration considering its effect on internal decision-making processes, particularly when coordination is important.

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Organizations devoted to the production of goods and services, such as guilds, partnerships and modern corporations, have dominated the economic landscape in our species' history. We develop an explanation for their evolution drawing from cultural evolution theory. A basic tenet of this theory is that social learning, under certain conditions, allows for the diffusion of innovations in society, and therefore, the accumulation of culture. Our model shows that these organizations provide such conditions by possessing two characteristics, both prevalent in real world organizations: exclusivity of membership and more effective social learning within their boundaries. The model and its extensions parsimoniously explains the cooperative nature of the social learning advantage, organizational specialization, organizational rigidity and the locus of innovation. We find supportive evidence for our predictions using a sample of pre-modern societies drawn from the Ethnographic Atlas. Understanding the nature of these organizations informs the debate about their role in society.