A knowledge-based theory for legal departments, and its link to transaction cost economics

“According to the knowledge-based theory of the firm, the raison d’être of firms is to generate, combine, recombine, and exploit knowledge.” This quote comes from the Acad. Mgt. J., Dec. 2001 at 1212. Further, “whether a firm performs activities in-house or through market contracts depends on whether doing so makes the generation and exploitation of knowledge more efficient.” If legal departments fundamentally traffic in knowledge, then the decision to make that knowledge in-house or buy it from law firms would fall squarely in the sights of a knowledge-based theory for legal departments. So would the development of bench strength, knowledge management, process codification, and training of clients, to name a few implications when we focus on a law department’s knowledge creation and application.

Moreover, management scholars have integrated that theoretical framework with a second theory of the firm (or department): transaction cost economics (See my post of Nov. 19, 2009: Coasian analysis with 6 references.).

According to transaction cost economics, whether a legal department makes or buys legal services depends on (1) the specificity of the input or of any assets that underpin it [much legal knowledge bought from law firms can be obtained from multiple firms], (2) the frequency of interaction between the firm and supplier [aside from litigation, resort to outside counsel is a sometime thing for many law departments], (3) the amount of uncertainty about the input and its related activities [services from law firms can be uncertain as to quality, timeliness and cost], and (4) how opportunistic the supplier is [law firms, being profit-maximizers tinged with professional mores, are opportunistic].

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