Contract Theory

An Empirical Investigation of Interorganizational Opportunism and Contracting Mechanisms

by Fabrice Lumineau

Lumineau F. & Quélin B. V. 2012. “An Empirical Investigation of Interorganizational Opportunism and Contracting Mechanisms.” Strategic Organization, 10(1): 55-84.

This study investigates contracting mechanisms in situations of opportunistic disputes between organizations. We... more This study investigates contracting mechanisms in situations of opportunistic disputes between organizations. We specifically explore the relationships between the formal versus informal nature of opportunism and the formal versus informal nature of contractual governance. We use a unique data set of 102 buyer-supplier disputes to explore in depth different types of opportunism—that is, strong form versus weak form opportunism—and different types of contracting mechanisms—that is, the controlling and coordinating functions of formal contracts and the cooperative and competitive sides of relational contracts. Our detailed empirical analysis suggests distinct relationships between the different contracting mechanisms, the different types of opportunism, and the level of legal fees necessary to deal with the dispute. These findings enable us to derive implications for research on the role of contractual mechanisms in dealing with interorganizational opportunism.

An Organizational Learning Perspective on the Contracting Process

by Fabrice Lumineau

Lumineau F., Fréchet M., & Puthod D. 2011. “An Organizational Learning Perspective on Contract Design.” Strategic Organization, 9(1): 8-32.

The contracting process is a crucial step in alliance development and its success. However, the existing literature... more The contracting process is a crucial step in alliance development and its success. However, the existing literature reveals surprisingly little investigation into how organizational learning relates to the process of contract making. We therefore conducted an in-depth longitudinal study of the alliance contracting process in the animated film industry. First, our findings suggest that during the contracting process, firms can learn about the way to deal with the contracting process, about themselves and their partner, and about the transaction features. Second, the case analysis indicates a combination of experiential, vicarious, and inferential learning mechanisms. Combining these insights into the objects and the mechanisms of learning during the contracting process, we discuss how contracting and learning processes are related and analyze the role of the contracting process in supporting organizational learning. The findings show that the drafting of contractual clauses fosters learning and, in turn, this learning triggers new contractual negotiations. Hence we suggest that the alignment between transaction features and the choice of contractual governance results from learning during the contracting process. We then propose avenues for future research.

Shadow of the Contract: How Contract Structure Shapes Interfirm Dispute Resolution

by Fabrice Lumineau

Lumineau F. & Malhotra D. 2011. “Shadow of the Contract: How Contract Structure Shapes Inter-Firm Dispute Resolution.” Strategic Management Journal, 32(5): 532-555.

This paper investigates how contract structure influences inter-firm dispute resolution processes and outcomes by... more This paper investigates how contract structure influences inter-firm dispute resolution processes and outcomes by examining a unique dataset consisting of over 150,000 pages of documents relating to 102 business disputes. We find that the level of contract detail affects the type of dispute resolution approach that is adopted when conflict arises, and that different approaches are associated with different costs for resolving the dispute. We also find that the effect of contract choice on dispute resolution approach is moderated by the degree of coordination required in the relationship, and that the effect of dispute approach on costs is moderated by the degree of power asymmetry between the parties. Thus, even after controlling for various attributes of the exchange relationship and the dispute, the choice of contracting structure has important strategic implications.

Trust and Collaboration in the Aftermath of Conflict: The Effects of Contract Structure

by Fabrice Lumineau

Malhotra D. & Lumineau F. 2011. “Trust and Collaboration in the Aftermath of Conflict: The Effects of Contract Structure.” Academy of Management Journal, 54(5): 981-998.

Leveraging a longitudinal dataset concerning 102 inter-firm disputes, we evaluate the effects of contract structure on... more Leveraging a longitudinal dataset concerning 102 inter-firm disputes, we evaluate the effects of contract structure on trust and on the likelihood of continued collaboration. We theoretically refine and empirically extend prior research by (a) distinguishing between control and coordination functions of contracts, (b) separating goodwill-based and competence-based trust, and (c) evaluating the effects of contract structure on relational outcomes in the context of disputes. We find that control provisions increase competence-based trust, but reduce goodwill-based trust, resulting in a net decrease in the likelihood of continued collaboration. Coordination provisions increase competence-based trust, leading to an increased likelihood of continued collaboration.

When the Powerful Drag Their Feet

by Francesco Passarelli

Co-authored with Paul Schure and David Scoones

We examine the timing of group decisions that are taken by weighted voting. Decision-making is in two stages. In the... more We examine the timing of group decisions that are taken by weighted voting. Decision-making is in two stages. In the second stage, players vote on a policy restriction. In the first stage, players vote to determine the timing of the second-stage decision: “early”, before players’ types are revealed, or “late”. Players differ in both size and voting power. We show that players with greater power tend to prefer a late vote, whereas less powerful players tend to want to vote early. In contrast, large players tend to prefer an early vote and small players a late vote. We present evidence from the literatures on corporate
governance, international relations, European Union governance, and oil extraction. We examine an extension in which players choose the qualified majority threshold besides the timing of the second-stage vote.

The Separation/Specification Dilemma in Contracting: The Local Government Experience in Victoria

by Janine O'Flynn

Contracting Efficiency and New Firm Survival in Markets Enabled by Information Technology

by Anjana Susarla

Co-authored with Anitesh Barua, published in Information Systems Research

Application service providers (ASP), who host and maintain information technology (IT) applications across the... more Application service providers (ASP), who host and maintain information technology (IT) applications across the Internet, emerged as an innovation in the way IT services are delivered to client firms. In spite of many potential benefits of this model, ASPs experienced business failure and high rates of exit. Drawing on agency theory, we argue that the efficiency of contracting arrangements between ASPs and client organizations is an important determinant of ASP survival. We test this prediction using a unique data set combining multiple sources that allows us to track an ASP from the year of founding through the beginning of 2006. Contractual misalignment, or adopting contracts mismatched with the underlying agency costs, significantly lowers the probability of survival of service providers in the ASP marketplace. The impact of misalignment is particularly severe when coupled with adjustment costs that impede the transition to aligned contracts. To account for potential heterogeneity in ASPs' knowledge of contracting, we test for endogenous self-selection of ASPs in the relationship between contractual misalignment and survival. Our results are robust to a variety of model specifications as well as alternate explanations of survival from multiple theoretical domains.

Contractual Provisions to Mitigate Holdup: Evidence from Information Technology Outsourcing

by Anjana Susarla

Co-authored with Ram Subramanyam and Prasanna Karhade, published in Information Systems Research

The complexity and scope of outsourced information technology (IT) demands relationship-specific investments from... more The complexity and scope of outsourced information technology (IT) demands relationship-specific investments from vendors, which, when combined with contract incompleteness, may result in underinvestment and inefficient bargaining, referred to as the holdup problem. Using a unique data set of over 100 IT outsourcing contracts, we examine whether contract extensiveness, i.e., the extent to which firms and vendors can foresee contingencies when designing contracts for outsourced IT services, can alleviate holdup. While extensively detailed contracts are likely to include a greater breadth of activities outsourced to a vendor, task complexity makes it difficult to draft extensive contracts. Furthermore, extensive contracts may still be incomplete with respect to enforcement. We then examine the role of nonprice contractual provisions, contract duration, and extendibility terms, which give firms an option to extend the contract to limit the likelihood of holdup. We also validate the ex post efficiency of contract design choices by examining renewals of contracting agreements.

Multitask Agency, Modular Architecture, and Task Disaggregation in SaaS

by Anjana Susarla

Co-authored with Andrew B Whinston and Anitesh Barua, published in Journal of Management Information Systems

We examine contract choices in the provision of "software-as-a-service" (SaaS), which is a business... more We examine contract choices in the provision of "software-as-a-service" (SaaS), which is a business innovation that transforms information technology (IT) resources into a continuously provided service. We draw upon agency theory and modularity theory to propose that one of the central challenges in service disaggregation is that of knowledge interdependencies across client and provider organizations. The resulting lack of verifiability of certain tasks results in a multitask agency problem. Our key research questions involve (1) the suitability of high- versus low-powered incentives in SaaS contracts when the outsourced tasks involve business analytics that are difficult to verify, and (2) how such contract choices are affected by the modularity of interfaces between the client and the provider. Analysis of data collected from 154 providers of SaaS offering a range of IT services supports our contention that when contracting for business analytics characterized by knowledge interdependencies across clients and providers, incentives should be "low powered." Modularity in the interfaces of the service provider increases the desirability of high-powered incentives in such situations. Our results are robust after accounting for endogeneity issues arising from unobserved matching between service providers and the nature of IT services outsourced by clients. With the increasing importance of information systems in services, this paper suggests that arm's-length relationships and high-powered incentives may be ineffective in incentivizing providers to perform on complex business analytic tasks, unless accompanied by the modularization of interfaces.

Social Networks and Contract Enforcement in IT Outsourcing

by Anjana Susarla

Co-authored with Kiron Ravindran and Vijay Gurbaxani

Prior research on Information Technology Outsourcing has characterized the dominant governance modes as either... more Prior research on Information Technology Outsourcing has characterized the dominant governance modes as either ‘Formal’ or ‘Relational,’ which rely on stringent assumptions of either perfect foresight or about the extent to which one party can punish unilateral deviations by the other. We propose a third alternative for inter-firm contract governance. The social network capital offers a measure of reputation that can indicate to future trading partners the reduced likelihood of opportunistic behavior. The network of trading partners enables a community enforcement of contracting terms by providing safeguards that may not be offered by traditional measures. Based on a large dataset of public ITO announcements we examine the role that structural embeddedness can play in predicting contract duration. We find preliminary evidence suggesting that network position does matter in predicting contract structure over and above the traditional economic variables.

Contract costing in outsourcing enterprises: Exploring the benefits of discrete-event simulation

by James Byrne

Paul Liston, James Byrne, P.J. Byrne and Cathal Heavey (2007) International Journal of Production Economics Volume 110, Issues 1-2, October 2007, Pages 97-114

Outsourcing is a business strategy that has received much attention. An increase in outsourcing has a direct influence... more Outsourcing is a business strategy that has received much attention. An increase in outsourcing has a direct influence on the complexity of supply chain networks and on the number of contracts required to manage a supply chain. Outsourcing contracts may be entered into relatively quickly without a full understanding of the true cost implications. The research described here aims to develop tools based on discrete-event simulation to aid outsourcing companies when costing contracts. Currently available software for this type of application is reviewed. A field study is presented from the electronics sector, describing companies’ needs with respect to contract costing and how simulation could be used in the contract costing process. Simulation approaches are described for different contract costing scenarios. The paper concludes with a case study of a preliminary simulation model that has been developed to test the concept with a specific outsourcing scenario.

Willoughby's Apology

by Charles Durning Carroll

published in Persuasions On-Line, December 2009.

This paper (an excerpt from my dissertation) discusses the role of apology in Jane Austen's novel Sense and... more This paper (an excerpt from my dissertation) discusses the role of apology in Jane Austen's novel Sense and Sensibility. My primary thesis is that the ritual of the apology is a means to invoke the language of equality and social justice  carried in the social contract. I use the example of John Willoughby (and compare his apology to that of Edward Ferrars) to bring out the ways in which Jane Austen rewrites the social contract of Regency England.

Fundamental Issues for Reform of the Law of Contractual Interpretation

by Martin Hogg

(2011) Edinburgh Law Review 406-22

This article considers the issue of reform of the principles of interpretation of contract, particularly in the light... more This article considers the issue of reform of the principles of interpretation of contract, particularly in the light of the recent Scottish Law Commission Discussion Paper on Contractual Interpretation (SLC DP No. 147)

A Theory of Firm Scope Based on Limited Liability

by Di Pei

Draft only. The author is still working on the appendix.

This paper provides a new explanation for firm boundaries via limited financial liability. I set up a model with... more This paper provides a new explanation for firm boundaries via limited financial liability. I set up a model with multi-project firms and multiple agents while each agent could exert effort to lower the probability of loss of his project. The key assumption is that both the principal and the agents are protected by limited liability, which creates negative externalities between agents within the same firm. We call this ‘contagious shirking’. We will show that when the firm’s fundamentals (effort cost function) are private information to the principal, he could signal the information to the agents via firm scope. In a separating equilibrium, firms with good fundamentals choose a large firm scope in order to provide the agents more incentives to exert effort; firms with bad fundamentals choose small firm scope to avoid the costs brought up by extended financial liability and contagious shirking.

Context and Contract

by Carlo Penco

Perspectives On Contract Theory from a Mixed Legal System

by Martin Hogg

(2009) Oxford Journal of Legal Studies Vol 29, No. 3, pp 1 -31

In this article it is argued that Scottish contract theory retains distinctive features which are not shared with the... more In this article it is argued that Scottish contract theory retains distinctive features which are not shared with the Common Law. The origins of this theory lie in the ‘mixed' nature of its contract law, a mixture established principally through the writings of Stair. That mix is not merely the traditional mix of Roman and Common Law typical of mixed legal systems, but a mix also of natural law ideas with a respect for the rational and free choices of the parties. Respect for free will is seen not just in certain contractual rules such as the absence of a requirement of consideration, but in the existence of a separate obligation of unilateral promise. It is argued that the nature of Scottish contract theory lends itself more easily to defence of the will theory, and that there has been an absence of enthusiasm for the adoption of competing theories of contract in Scotland. It is suggested by way of conclusion that some of the benefits provided by the Scottish structure could be of use to future development of the Common Law, albeit that the Common Law has typically shown itself averse to legal borrowings from its nearest neighbour.