Part 1 - AL-Tax

Chapter 7to account for the nature of the firm and the difference between risk insuranceand uncertainty safeguards, because it is this that determines the nature of profit.If no direct price comparison is possible, it is this distinction which determineswhether the arm’s length analysis can be based on margin analysis, budget-actualanalysis, or value chain analysis, with allocation of residual profit pies at thenonroutine functions along the value chain.Transaction cost economics as developed by Williamson (1985, 1996, 1998) distinguishesbetween risk and uncertainty in order to measure the degree of entrepreneurship.Risk can be governed by insurance contracts. Such insurance costs can becalculated in terms of insurance premiums and/or other measures. The insurance ofrisk can be group-internal, such as in the course of a sophisticated group risk managementmodel or external in the form of an insurance policy with a third party.Whether it is internal or external is of secondary importance regarding the degree ofentrepreneurship of a given functional unit. However, it is of particular relevanceregarding the arm’s length nature of prices or margins: If a risk is insured internally,the price might be lower compared to a situation where the risk is insured throughan external insurer. The reason lies in the principal-agent structure and the informationabout the true nature of the risk. Likewise, if the risk exposure is not insuredbut borne by the (related) party A, which transfers its good or service to relatedparty B, the price could be smaller than in a comparable situation where the risk iscovered by a third-party insurance contract. Alternatively, risk borne without a damagingoccurrence produces higher profit margins compared to a situation where riskhurts through damage.On the other hand, uncertainty is not governed by means of internal or externalinsurance. Rather, it is coordinated by means of governance structures differentfrom insurance. Examples are certain mechanisms to search for information on thecreditability and/or liability of suppliers, subcontractors, or customers in order toavoid interruptions in the transactional exchange of products and services. Suchmechanisms rarely show the nature of ‘insurance’ rather than ‘governance’. Also,the internal uncertainty of a firm (e.g. the hazard of quality misalignment) might begoverned by certain mechanisms such as quality assurance systems or evenemployee motivation programs. These measures are also costly and, in the languageof transaction cost economics, to a large extent represent transaction costs.Note that such costs are not insurance costs on risk. Alternatively, uncertainty canbe turned into risk if the rate of frequency is sufficiently large.The difference between risk and uncertainty lies in quantification and calculation.Risk can be quantified and calculated, uncertainty cannot. Risk can be insured,uncertainty usually not. Risk is thought to be susceptible to assessment by using a157