Asset Specificity - Definition

Definition

Asset specificity is usually defined as the extent to which the investments made to support a particular transaction have a higher value to that transaction than they would have if they were redeployed for any other purpose (McGuinness 1994). Williamson (1975, 1985, 1986) argued that transaction-specific assets are non-redeployable physical and human investments that are specialized and unique to a task. For example the production of a certain component may require investment in specialized equipment, the distribution of a certain product may necessitate unique physical facilities, or the delivery of a certain service may be predicated on the existence of an uncommon set of professional know-how and skills.

Basically, asset specificity refers to the extent to which a party is "tied in" in a two-way or multiple-way business relationship. For example, learning to speak English, one of the most widely-understood languages of the world, is a highly asset-unspecific investment, since your investment will be likely to have equal returns (being able to communicate with others) across a variety of different settings. On the other hand, learning to speak Navajo, a rare Athabaskan language spoken in the southwest United States, could be highly asset-specific (human asset-specific, specifically), since your investment return (being able to communicate with others) is high with the few Navajo-speaking people, but almost zero otherwise.

Originally asset specificity is proposed mainly in a buyer-seller situation, where the buyer is the party that does not hold the specific assets and the seller is the party that holds the specific assets. For example, in Williamson's (1983) model, the hold-up is unilateral: the buyer holds up the seller. However later researchers have realized that asset specificity could be bilateral, or even multi-lateral. For example Joskow (1988) and Klein (1988) noted that even in a traditional buyer-seller situation, the hold up is bilateral because the buyer (the party that does not hold the specific assets) has exit cost associated with time and searching investment if he decides to switch party.