Structuring partnerships to facilitate long-term, productive
relationships is a central concern of researchers in strategy,
marketing, law, and economics (Dyer, 1997; Heide and John, 1990;
Macneil, 1978; Williamson, 1985, 1991). According to a number of
researchers, "the most challenging aspect of developing and
maintaining long-term exchange relationships" (Cracker and Masten,
1991: 70) is how to develop efficient (i.e., least costly) contracts to
effectively govern exchange (Macneil, 1978; Williamson, 1985, 1991).
Formal contracts enable parties in an exchange to coordinate their
actions and limit potential opportunistic behaviors (Dahlstrom and
Nygaard, 1999; Goldberg and Erickson, 1987). Yet the initial drafting
and subsequent maintenance of these contracts can be costly. Depending
on the type of contract used, these "transaction costs' can
include both the ex ante costs of initially establishing the contract,
and the ex post costs of periodically renegotiating and adjusting
existing contracts (Cracker a nd Masten, 1991; Williamson, 1985). A
critical question to be answered then is "How do transactors manage
the process of contract selection and maintenance?" Indeed, while
the factors influencing the type of contract chosen and the ensuing
costs associated with this choice are seen as critically important to
the long-term viability of an exchange, very few empirical studies have
examined actual contracting practices and their performance
implications.
This article seeks to address this shortcoming in the literature by
investigating the process of contract selection and the performance
implications related to how those contracts are managed. By doing so, we
seek to provide valuable insights into the contracting process that may
allow firms to realize the potential gains from their exchange
relationship (Williamson, 1996). In addition to the aforementioned
contribution, we also seek to directly investigate the costs of
contracting. While theoretical predictions provide valuable insights
into the nature of contracting, empirical investigation is necessary to
evaluate the normative implications of those theories (Dyer, 1997;
Williamson, 1996). However, most previous studies have failed to conduct
this empirical examination of the cost of transacting.
This study seeks to address this gap in the literature. By doing
so, we respond to calls for research that directly measures transaction
costs (Rindfleisch and Heide, 1997). It should also be noted that while
various types of transaction costs such as negotiating and monitoring
costs are incurred during exchanges, we focus solely on the negotiating
costs that are incurred to revise incomplete contracts (Williamson,
1985). While the negotiation costs of revising contracts can include a
wide variety of costs including travel and computer expenses Dobler et
al. (1990) argue that the majority of negotiation costs are
labor-related. Thus, we use an approach similar to the one suggested by
Anderson and Weitz (1992) and empirically measure the labor costs
associated with the renegotiation of incomplete contracts between
original equipment manufacturers (OEMs) and their component suppliers.
Thus, we have two main objectives in this paper. First, we develop
and empirically test a model of the determinants of contract choice.
This model draws on economic and legal theories suggesting that the
appropriate type of contract may depend on certain transactional and
relational attributes (Crocker and Reynolds, 1993; Williamson, 1985).
Second, we examine how exchange partners can effectively manage the
costs of adjusting and maintaining incomplete contracts after they have
been established. Literature in marketing, social contracting and
relational exchange theory suggests that certain behavioral
characteristics (i.e., relational norms) may play an important role in
contract management (Artz and Brush, 2000; Lusch and Brown, 1996;
Macneil, 1980).
In the next section, we discuss the concept of contract
completeness. The following section develops hypotheses concerning
contract choice and ex post negotiating costs. The methods section
describes our data collection, measures, and data analysis and is
followed by the results section. The discussion section presents
research and managerial implications, suggestion for future research,
and limitations of the study.
CONTRACTING
A review of the theoretical and managerial literature in economics,
sociology, strategy, and marketing, combined with in-depth field
interviews with purchasing personnel responsible for developing
contracts, revealed several distinct contract types used in
interorganizational exchanges. These contracts can be differentiated
based on their degree of completeness.
Contract completeness is the degree to which the obligations of the
exchange (e.g., price, quality, delivery, other terms and conditions)
are outlined upfront. A totally complete contract is one in which all
duties of all parties are completely prescribed for the duration of the
contract (Crocker and Masten, 1991). Conversely, a totally incomplete
contract places no a priori restrictions on the terms under which
subsequent trade may occur (Crocker and Reynolds, 1993). In practice,
contracts rarely exhibit the characteristics of purely complete or
incomplete contracts. Even in relatively complete contracts, some terms
and specifications are left to future determination. Likewise, even very
incomplete contracts must specify some terms and conditions upfront to
make exchange feasible. Thus, intermediate degrees of contractual
completeness are the norm and contract completeness is a relative term.
In relatively complete contracts, the majority of each party's
responsibilities and performance expectations are explicitly specified
in the document (Lusch and Brown, 1996; Macaulay, 1963). This reduces
the potential for opportunistic behavior by transactors after an
agreement is reached because terms of the contract are not renegotiable
(Dahlstrom and Nygaard, 1999). Since relatively complete contracts
attempt to clearly define nearly all terms of the exchange for the life
of the contract, specific terms are less likely to be violated (Dyer,
1997). However, while relatively complete contracts may provide
protection, it is often difficult to identify all possible contingencies
and negotiate mutually acceptable responses. Thus, relatively complete
contracts often result in considerable ex ante negotiating costs.
In contrast, relatively incomplete contracts do not attempt to
spell out the complete set of terms and conditions for the entire
contract term at the time the contract is established. Rather, they seek
to define a general process for periodic mutual adjustments of contract
items such as price and/or quantity (Goetz and Scott, 1981). Since
incomplete contracts do not attempt to stipulate a response to all
possible contingencies, they are considerably simpler and less costly to
draft than complete agreements (Crocker and Reynolds, 1993). Moreover,
incomplete contracts are intended to provide the partners with
flexibility to adapt to changing conditions. However, exchange partners
using incomplete contracts face greater potential opportunism, or what
Williamson defines as "self-interest seeking with guile"
(1979: 234), after the initial agreement is reached. In addition, they
may require costly ex post bargaining as the parties attempt to
periodically negotiate adjustments to the contract (Crocker and Masten,
19 91).
Given the differences between relatively complete and relatively
incomplete contracts, transactors face a trade-off between greater
safety and predictability (and higher ex ante negotiating costs) offered
by more complete agreements, and greater flexibility (and higher risk of
opportunism and ex post negotiating costs) offered by less complete
contracts (Tirole, 1986). What then are the factors that determine which
type of contract is ultimately chosen? We explore this question in the
following section.
THEORY AND HYPOTHESES
Contract Choice
A primary contribution of transaction cost economics (TOE) is its
insights into the conditions that determine the appropriate structure to
govern exchange (Williamson, 1996).
Thus, TCE provides valuable guidance in identifying factors that
may influence the type of contract chosen for an exchange. Here, we
examine the role of three such factors: environmental uncertainty,
transaction-specific assets, and the potential for opportunism.
The first of these, environmental uncertainty, is defined as the
inability to predict changes in factors surrounding an exchange (Walker
and Weber, 1987). Creating relatively complete contracts may be fairly
straightforward in simple environments. The task becomes more daunting
as the parties become less confident about future conditions or the
variables of concern are less quantifiable (Sutcliffe and Zaheer, 1998).
As Goetz and Scott state, contracts "... tend to be less complete
where the parties are incapable of reducing important terms of the
arrangement to well-defined obligations" (1981: 1094).
In the OEM-supplier relationships examined here, both parties
likely develop different goals and expectations for the exchange, and
hence for the terms of the contract (Artz and Brush, 2000). For example,
if a supplier cannot accurately forecast the price of its inputs, it
will be reluctant to enter into a contract in which the sales price for
its product is fixed for an extended period (i.e., a complete contract).
Rather, that supplier will seek to protect itself from fluctuations in
its input costs by insisting on a contract in which the sales price of
its product can be periodically adjusted during the contract (i.e., an
incomplete contract) (Sutcliffe and Zaheer, 1998; Heide and John, 1990).
Similarly, volume uncertainty makes it difficult for an OEM to predict
demand for its end products and may be hesitant to commit to purchasing
a specified quantity of a supplier's component (Walker and Weber,
1987). However, without the OEM's commitment, the supplier will be
hesitant to invest in production capacity f or fear it will be stuck
with costly excess capacity if OEM sales do not materialize (Helper,
1991).
Environmental uncertainty makes it more difficult for exchange
partners to negotiate complete contracts (Rindfleisch and Heide, 1997).
Instead, transactors will be more likely to rely on relatively
incomplete contracts that ". . . do not attempt to explore and
stipulate responses to every possible event" (Crocker and Masten,
1991: 73). Such agreements are less costly to initially negotiate and
provide more flexibility to make adjustments as the future becomes more
apparent (Crocker and Reynolds, 1993). Conversely, where economic
conditions are relatively simple and static, exchange partners will tend
to choose more precise but rigid agreements. Thus, we propose the
following hypothesis:
Hypothesis 1: Environmental uncertainty is positively related to
the use of incomplete contracts by exchange partners.
The second factor influencing contract choice is
transaction-specific assets. The distinguishing feature of these assets
is that they have little use or value outside a particular relationship
(Williamson, 1996). As a party increases its investment in
transaction-specific assets, it becomes increasingly dependent on the
other to realize the value of its investment. Thus, the investing party
is increasingly vulnerable to opportunistic behavior by its exchange
partner (Weiss and Kurland, 1997). To protect itself, a firm often
attempts to establish contracts that will safeguard its investment.
While scholars generally agree that a strong relationship exists
between transaction-specific assets and the choice of contract type,
there is disagreement about the direction of this relationship. For
example, Williamson (1979) suggests that transaction-specific assets
lead to greater use of incomplete contracts. He argues that asset
specificity increases the level of appropriable quasi rent to be
divided, and that this motivates long-term affiliations between
transactors. However, long-term agreements increase the likelihood that
conditions surrounding the exchange will change and it becomes
increasingly important that the parties be able to adjust their
contractual relationship to prevent any partner from being
"locked-in" to a contract that is unprofitable for them. Thus,
as Williamson states "What is needed, evidently, is some way for
declaring admissible dimensions for adjustment so that flexibility is
provided under terms in which both parties have confidence" (1979:
251). Such adjustments can best be made through the periodic
renegotiations included in incomplete contracts (Crocker and Masten,
1991).
On the other hand, other scholars argue that the larger the
specific investment, the greater the likelihood that transactors will
use complete contracts. While asset specificity does increase the amount
of quasi rent to be divided, this increases the amount of effort that
transactors are willing to spend to negotiate a favorable distribution
of those rents and makes periodic contract renegotiations unattractive
(Goldberg and Erickson, 1987). Specifically, in their examination of
exchange relationships between petroleum coke refiners and aluminum
producers (in which large transaction-specific assets are present),
Goldberg and Erickson state:
"reopening a contract would mean that the parties would haggle
over how to share the pie. The more parties are isolated from
alternative trading partners, the larger the size of the pie. The larger
the pie, the more resources the parties would devote to pursuing it.
That is, the higher reliance interest in the aluminum contract would
result in higher renegotiation costs, making frequent renegotiation less
attractive" (1987: 391).
Thus, transaction-specific assets may make it less attractive to
periodically reopen contracts for renegotiation, leading negotiators to
favor complete contracts.
As the above discussion illustrates, there are opposing theoretical
arguments about the effects of asset specificity on contract choice.
Here, we test for the relationship suggested by Williamson (1991) in the
following hypothesis.
Hypothesis 2: Investments in transaction-specific assets are
positively related to the use of incomplete contracts by exchange
partners.
Crocker and Reynolds (1993) suggest that the probability of future
opportunism depends, in part, on the likelihood that a transactor's
behavior will lead to a successful outcome. One factor determining
success is the ease with which the opportunistic party can be replaced
in the exchange. If alternative suppliers are unavailable or difficult
to find, a buyer's threat of switching to another supplier is not
credible (Heide and John, 1988) and suppliers are more inclined to act
opportunistically. If, on the other hand, a buyer can easily replace an
opportunistic supplier, then the supplier's attempt at opportunism
would likely meet with little success (Joskow, 1987). Thus, the
availability of alternative trading partners likely reduces the
potential for opportunism and increases the likelihood of using less
complete contracts. Stated more formally, we propose:
Hypothesis 3: Greater availability of alternative suppliers is
positively related to the use of incomplete contracts by exchange
partners.
Ex Post Negotiating Costs
A second aim of this research is to investigate the performance
implications associated with differences in how a relationship is
managed. Incomplete contracts define the process by which contract terms
can be adjusted over time. While this may mitigate some of the potential
for opportunism by defining the general terms of the exchange (e.g.,
renegotiations of price and quantity at specified intervals), enough
residual opportunism continues to exist so that considerable scope may
remain for exercising more subtle, though still costly, bargaining
strategies" (Crocker and Masten, 1991:77). Theoretically, the
extent to which transactors using incomplete contracts are able to
mitigate opportunism and reduce ex post negotiating costs depends not
only on the contract itself, but also on the effectiveness of the
process by which periodic contract adjustments are negotiated (Zaheer
and Venkatraman, 1995).
To provide insight into the factors that allow the management of ex
post negotiation costs associated with incomplete contracts, we turn to
the literature in social contracting and relational exchange theory
(Macneil, 1980). In contrast with the economic perspective of TCE,
relational exchange theory focuses on the sociological characteristics
of exchange relationships. Behavioral characteristics, or
"relational norms," are argued to be critical determinants of
how efficiently periodic contract renegotiations are carried out (Dore,
1983; Macneil, 1978, 1980). Relational norms evolve over time as
exchange partners become increasingly familiar with each other and
establish behavioral rules for such processes as conflict resolution,
monitoring and joint problem solving (Ring and Van de Ven, 1992).
Because each exchange dyad evolves in a unique manner, different
relational norms emerge (Dwyer et al., 1987). The key question then, for
those who choose incomplete contracts, is "What are the process
elements that de termine the size of those ex post negotiation
costs?"
It should be noted that while two dyads may be governed by similar
incomplete contracts, they may differ significantly in the extent and
type of relational norms that support the contract (Dore, 1983; Macneil,
1980). Thus, two exchange relationships with similar incomplete
contracts may have very different levels of ex post negotiation costs
(e.g., Joskow, 1987) and success. Consequently, despite having similar
relational contracts, and similar levels of asset specificity and
uncertainty, two dyads may incur different ex post negotiation costs
because they have different relational norms supporting that contract.
A number of specific relational norms, including trust, information
sharing, the expected length of a relationship, partner flexibility, and
joint problem solving (Heide and John, 1992; Noordeweir et al., 1990;
Zaheer and Venkatraman, 1995), have been hypothesized to impact ex post
negotiation costs. Regardless of the specific norm examined, researchers
agree that increasing the relational content of an exchange encourages
cooperation between partners and thereby discourages opportunistic
behavior.
Three such relational norms are considered here: collaboration
(e.g., Goldberg and Erickson, 1987), commitment (e.g., Heide and Miner,
1992), and communication strategies (e.g., Dwyer et al., 1987).
Preliminary field interviews indicated that these three relational norms
have particular relevance in the present context. In general, we expect
that as these three relational norms become prevalent, opportunistic
behavior will decline and ex post negotiation costs will fall.
Collaboration. Collaboration refers to the willingness of the
parties to work together to create a positive exchange relationship.
Collaborative actions can enhance a relationship and curtail
opportunistic behaviors (Goldberg and Erickson, 1987). For example,
joint planning and forecasting allow both parties to participate in
determining each other's roles and responsibilities and may foster
mutually beneficial expectations (Dwyer and Oh, 1988). Similarly,
bilateral efforts to share information (e.g., production requirements
and future design changes) implies a more open and complete disclosure
of relevant information (Schuler, 1979). Moreover, if maintaining the
overall health of the exchange is emphasized, the transactors are likely
to be more willing to seek efficient adaptation to unexpected
environmental changes (Mohr and Spekman, 1994). Thus, a high level of
collaboration provides a context in which contract renegotiations are
simplified and ex post negotiation costs are reduced. Thus:
Hypothesis 4: Collaboration by the exchange partners will be
negatively related to ex post negotiation costs.
Commitment. Commitment concerns the extent to which exchange
partners expect their relationship to continue for the foreseeable
future (Dwyer et al., 1987; Heide and John, 1990). Such expectations can
encourage cooperation by providing the opportunity for one partner to
retaliate if the other behaves opportunistically (Parkhe, 1993).
Opportunistic behavior by one party in one period can be matched by
opportunistic behavior by the other partner in the next, and cooperation
can be met with cooperation. While non-cooperative behavior has been
found to be the dominant strategy for discrete exchanges, the
expectations of reciprocity encourage partners to cooperate in ongoing
exchanges (Parkhe, 1993). In addition, exchange partners in long-term
relationships are more likely to consider the impact of current actions
on the present negotiation as well as anticipated future interactions.
Thus, they may be more willing to incur short-term disadvantages since
they anticipate future opportunities to recoup their concessi ons (Heide
and Miner, 1992; Parkhe, 1993). Hence, we hypothesize the following:
Hypothesis 5: Commitment by the exchange partners will be
negatively related to ex post negotiation costs.
Communication strategy. Communication strategy, which has received
considerable attention in the marketing channels literature (e.g., Dwyer
et al., 1987; Frazier and Rody, 1991), refers to the type of
communications that transactors use to try to influence negotiations.
Coercive communication strategies involve applying direct pressure and
stressing the adverse consequences of non-compliance (e.g., threats or
legalistic pleas, which suggest that compliance is required by the
formal contract terms). When one firm uses coercion to gain a more
favorable negotiation outcome, the partner is likely to view that firm
as exploitative rather than accommodative and to engage in retaliatory
behavior (Cool and Henderson, 1998). Coercive communications promote
opportunistic behaviors such as deliberately altering information,
making promises that are never delivered, and outright lying--all of
which lead to interfirm conflict (Frazier and Rody, 1991). Furthermore,
coercion causes negotiators to become more rigid in their views, making
adaptation to uncertainty more difficult (Cadotte and Stern, 1979). In
contrast, non-coercive strategies attempt to persuade rather than demand
by focusing on beliefs about business issues and applying little direct
pressure. An example is recommendations, which are simple requests made
by one party that stress the benefits the other party will receive by
complying (Dwyer et al., 1987). Non-coercive negotiation strategies
promote flexibility and accommodation and encourage the parties to work
together to resolve problems (Frazier and Rody, 1991).
Communication strategies may significantly impact ex post
negotiation costs (Cool and Henderson, 1998). Specifically, the use of
non-coercive strategies reduces the likelihood of opportunism and
improves the exchange partners' adaptive capabilities. Thus, we
hypothesize the following: Hypothesis 6: Non-coercive communication
strategies by the exchange partners will be negatively related to ex
post negotiation costs.
METHOD
This study focused on the exchange relationship between OEMs and
their component suppliers. Traditionally, these relationships have been
governed by relatively complete contracts. Recently, a trend toward
greater supplier partnering and an increase in environmental uncertainty
has prompted greater use of incomplete contracts (Dyer, 1997). Thus,
OEMs and suppliers now use a wide range of different contract types and
provide a good context to test our model.
Using the OEM-supplier dyad as the unit of analysis, this study
examined the OEM's view of its relationship with a self-selected
supplier. Respondents filled out the survey with reference to a major
component supplier with whom they had an exchange relationship for at
least three years and who was either the sole contact or the leader of
the team responsible for the supply relationship.
Consistent with Parkhe (1993), we targeted the highest level
individuals who play a significant role in managing supply relationships
rather than the most senior managers in each firm. Since these
individuals are located in the purchasing function (Bhote, 1989),
purchasing agents have frequently been used as respondents in research
examining interorganizational exchanges (Perdue et al., 1986; Rubin and
Carter, 1990). Presurvey interviews with OEM purchasing managers
indicated that in the majority of cases one individual is responsible
for strategic and operational issues associated with a supplier. Thus,
only that person possessed the detailed knowledge necessary to respond
to the survey questions. Consequently, responses were gathered from only
one informant. This approach is generally consistent with the
recommendation to use the most knowledgeable informant (Huber and Power,
1985).
Surveys were sent to a random sample of 1,400 purchasing managers
from a national mailing list of purchasing agents. These individuals
were from OEMs in the two-digit SIC groups 35, 36, 37 and 38 (industrial
and machining equipment, electronic and electrical machinery, computer
equipment, and transportation machinery). Manufacturing firms in these
industries have been restructuring their relationships to increase their
competitiveness and are heavy purchasers of component parts (Kalwani and
Narayandas, 1993). In addition, using several industry codes increases
the number of observations and increases the generalizability of
findings. Four hundred and fifteen responses were received from this
group. After eliminating surveys with incomplete information and those
with respondents who indicated they had insufficient knowledge of the
purchasing relationships, the final sample size was 393.
Because collecting data from one informant introduces the
possibility of common method variance, steps were taken to minimize
potential problems. To assess informant competency, survey items
measured the respondent's knowledge of, and involvement in, the
focal issues (Kumar et al., 1993). Only respondents reporting at least a
four (on a five-point scale with "5" representing the highest
knowledge and involvement) on both dimensions were retained in the final
sample. Mean scores for respondent's knowledge and involvement were
4.5 and 4.7, respectively. Thus, it appears reasonable to assume that
the respondents possessed considerable expertise concerning the
particular supply relationship. To reduce the potential of biased
performance assessments, the measures for contract choice and
negotiation costs were placed after the measures of transaction-specific
assets, environmental uncertainty and the relational variables
(Podsakoff and Organ, 1986). In addition, several factors emerged in a
factor analysis with all variables, none of which accounted for the
majority of variance. These results indicate that common method variance
is not a significant problem (Harman, 1967).
We assessed non-response bias by using t-tests to compare early to
late respondents on all variables in the model and other variables such
as annual purchases and length of relationship with the supplier. The
only significant difference (p < .05) was a tendency for early
respondents to be smaller than late respondents. Thus, non-response bias
does not appear to be a significant issue.
Measures
When constructing our measures, we examined factor loadings of the
individual items and item-to-total correlations in order to determine
which of the individual items were meaningfully correlated with the
overall factors. Using the cutoff suggested by Pedhazur and Schmelkin
(1991), only those items with loadings above 0.5 were included in the
final scale.
Contract Type (Dependent). Contract type indicates the degree of
completeness. The most restrictive and complete contract is the
FirmFixed Price (FFP) contract, which specifies all terms upfront and
allows no ex post adjustments (Garrett, 1997). The Fixed Price with
Economic Price Adjustment (FP/EPA) is less complete and generally uses
labor or material indices to determine prices according to a negotiated
formula. Some ex post negotiations are required to adjust the labor or
material measures (Garrett, 1997). Fixed-Price Incentive (FPI) contracts
are the most incomplete of the contract types studied. In FPI contracts,
performance targets are successively negotiated as events unfold and the
parties acquire more information (Garrett, 1997). These three contract
types were coded so that higher values of contract type imply more
incomplete contracts (FFP = 0, FP/EPA 1, FF1 = 2).
Environmental Uncertainty (alpha =.77). Six items measured
environmental uncertainty. The six items address both price uncertainty
(the inability to estimate prices for the focal supplier's product)
and volume uncertainty (difficulty in forecasting expected demand)
(Noordeweir et al., 1990).
OEM Transaction-specific Assets (alpha = .84). Seven items measured
the OEM's specific assets. These include specialized physical
assets as well as personnel, knowledge and training that is specialized
to the focal supplier (Anderson, 1985).
Availability of Alternatives (alpha -.72). We constructed a measure
of the ease with which the OEM could find an alternative supplier. Three
items assessed how dependent the OEM was on the supplier, how easily
they could get components from another supplier, and how much the
OEM's performance would suffer if the current relationship were
terminated.
Ex post Negotiation Costs (Dependent) (alpha = .83). A negotiation
occurs whenever parties bargain on essential contract elements (e.g.,
price, warranties) to reach an agreement (Rubin and Carter, 1990). We
define Negotiation Costs as the resources expended by the OEM in
negotiating contract changes with its supplier. Nine items measured ex
post negotiation costs. These items assessed the number of OEM personnel
involved and total hours spent in contract preparation and negotiation,
the number of bargaining sessions, preparation time and the time
required to reach agreement, and the amount of conflict in the
relationship (Kutschker, 1985).
Collaboration (alpha = .86). Collaboration was measured by 9 items,
adapted from scales used by Heide and John (1992), Mohr and Spekman
(1994) and Noordeweir et al. (1990). Items assessed the following: OEM
and supplier efforts to share information, the extent to which the
exchange partners make efforts to assist one another, the amount of
joint planning and problem solving, and the extent to which the parties
share the responsibility for maintaining the relationship.
Commitment (alpha = .83). Commitment was measured by three items.
These items assessed the extent the exchange partners expect the present
relationship to continue for the foreseeable future and the degree to
which each party takes actions to maintain the relationship (Heide and
Miner, 1992).
Non-coercive Communications (alpha = .84). A three-item scale was
developed to measure recommendations, one specific type of non-coercive
communications. Specifically, these items measured the extent to which
communications stressed how requests would benefit each party and to
what extent communications were absent of threats.
Control Variables. Three control variables are included in the
analysis. First, relationship length was measured by the log of the
total number of years that the parties have had a purchasing
relationship. Over time, behavioral routines affecting negotiation
processes develop and may influence ex post negotiation costs (Madambi
and Helper, 1998). Second, relationship importance, the extent to which
the supplier can impact OEM's performance, was assessed by the
potential impact of the contract negotiation on OEM performance and the
impact of the supplier's component on OEM end-product quality.
Suppliers providing components that have a relatively large impact on a
buyer's product cost or quality warrant more attention than other
partners (Spekman, 1988). One way this attention can manifest itself is
in the effort expended in negotiations. When the potential impact of a
contract renegotiation is large, we expect more resources to be devoted
to insuring that the contract is appropriately structured than when the
potential impact is small. Third, we use the log of the number of
employees in the OEM divided by the number of employees in the supplier
to assess the impact of organization size. This relative size metric
allows us to examine whether size differentials impact our model
variables.
Data Analysis
The first phase of this research used ordered probit analysis to
examine the factors associated with choice of contract type. Contract
type is a categorical dependent variable that is ordered with respect to
an underlying latent variable (i.e., contract completeness). Higher
values of contract type indicate more incomplete contracts. The second
phase of this research used OLS regression to predict ex ante
negotiation costs, a continuous dependent variable. Because ex ante
negotiations are applicable only to relationships governed by incomplete
contracts, this analysis used only the 133 dyads using incomplete
contracts. Diagnostic analysis revealed that regression assumptions were
met (e.g., normality of the residuals) and that no problems existed with
outliers (Neter et al., 1990) or multicollinearity.
RESULTS
Descriptive statistics and correlations are shown in Table 1. The
results of the probit (Column 1, Table 2) and regression (Column 2,
Table 2) analyses generally supported the hypotheses. Hypothesis 1
predicted a positive relationship between environmental uncertainty and
incomplete contracts. Increases in environmental uncertainty (p<.001)
increased the use of incomplete contracts. Support was also found for
hypothesis 2, which stated that investments in transaction-specific
assets increase the likelihood that relatively incomplete contracts will
be used (p<.05). Hypothesis 3 was also supported. Greater
availability of alternative suppliers increased the use of incomplete
contracts (p<.01).
The regression results support all hypothesized relationships
(hypotheses 4.6) between relational norms and ex post negotiation costs.
Specifically, collaboration (p<.001), commitment (p<.0l) and
non-coercive communications (p<.05) lowered ex post bargaining costs.
Relationship importance was the only significant control variable and
increased ex post negotiation costs (p<.001).
DISCUSSION
Although numerous authors have investigated the impact of
incomplete contracts and the incentives created by these contracts
(e.g., Crocker and Masten, 1991), here we have sought to provide insight
into the incentives that encourage transactors to enter into contracts
that are left intentionally incomplete. Agents face a tradeoff between
the cost of drafting more complete agreements and the exposure to
opportunism from incomplete contracts. Understanding contract choice,
and the conditions that influence it, may provide important insights
into effective contracting practices and successful interfirm
collaboration.
Research Implications
The results of this empirical work strongly support the predictions
of the TCE framework, and validate that the degree of contractual
completeness is a function of the characteristics surrounding the
exchange (Crocker and Reynolds, 1993; Williamson, 1996). Complex and
uncertain conditions, in the form of price and volume uncertainty,
increase the costs of creating more complete agreements, and prompt
transactors to select the greater flexibility of incomplete agreements.
Similarly, the finding that OEM investments in specialized assets lead
to the negotiation of incomplete agreements strongly suggests that the
complexity of writing contracts associated with such assets is
prohibitively expensive.
While the findings concerning contract choice provide valuable
insights into the process of contract selection, the insights from
examining factors affecting ex post negotiation costs shed light on how
transactors manage incomplete contracts so that rent-dissipating
activities are minimized. Indeed, each of the relational
norms--collaboration, commitment and noncoercive communications--were
found to reduce ex post negotiation costs, supporting the theoretical
predictions of relational exchange theory. These findings clearly
support the argument that these norms play a significant role in the
performance of purchasing relationships (Macneil, 1980; Ring and Van de
Ven, 1992). These norms can improve relationship flexibility and
increase the ability of exchange partners to respond to unexpected
environmental contingencies. This research supports that of Goldberg and
Erickson (1987), who in their seminal case study of petroleum coke found
that the costs of renegotiation need not be prohibitively high if
appropria te relational norms exist between exchange partners.
It is worth noting that relationship importance, a control
variable, was also found to increase ex post negotiating costs. This
confirms the expectation that OEMs place more emphasis on managing
important suppliers. It is also interesting that, in our findings,
relationship length was not related to bargaining costs. One could
reasonably expect that over time, OEM-supplier negotiations would become
more accommodative as the exchange partners become more familiar with
the others' routines and preferences. It may be, however, that
purchasing relationships can be built on stable histories of
non-cooperation as well (Madambi and Helper, 1998; Heide and Miner,
1992). Thus, contract negotiations may not become more accommodative
simply because the parties have worked together longer.
Managerial Implications
Many firms are turning to long-term, buyer-supplier relationships.
Developing close buyer-supplier relationships is presented as a way to
increase customer value, while lowering costs (Cannon and Homburg,
2001). These benefits, however, are not automatic. The findings of this
study show that incomplete contracts may be necessary under certain
conditions, such as high uncertainty. When incomplete contracts are
used, relational norms are important in reducing renegotiation costs.
Given the importance of relational norms, particularly when incomplete
contracts are used, partner selection decisions should consider a
partner's likely adherence to relational norms.
This study has shown that investing in the development of
relational norms can lower the cost associated with future negotiations.
Thus, firms should also be willing to invest in activities that foster
the development of relational norms. The cost of these investments are
likely to be recovered, at least in part, from the savings in
negotiation costs. While we examined the renegotiation of existing
contracts, these same benefits are likely to accrue in the subsequent
negotiation of new contracts as well. Therefore, investments made in
developing cooperative relationships should be more than offset by the
reduced costs of managing ongoing relationships.
Future Research and Limitations
Although our hypotheses were supported, other questions need to be
answered. For example, even though relational norms were found to reduce
an OEM's ex post bargaining costs, questions remain about the
robustness of the benefits derived from relational norms (Artz and
Brush, 2000). Commitment, for instance, lowered bargaining costs,
because of the OEM and supplier's expectations of a long-term
relationship (Hill, 1990). In contrast, if the exchange were in a
vertically integrated firm, negotiating costs would be lowered by the
force of organizational authority (Dow, 1987). However, suppose that the
exchange partners continued to invest in specific assets, which would
increase the potential gain from opportunistic behavior. Would the
relational norms continue to be strong enough to deter opportunistic
behavior, or at some point would basic OEM-supplier incompatibilities
arise, thereby restricting relational norms' ability to deter
self-serving behaviors (Walker and Poppo, 1991)? Similarly, other than
relationa l norms, what other mechanisms exist that can be used to
discourage opportunistic behavior and encourage productive interfirm
exchange (Anderson and Welts, 1992)?
It should also be noted that the measure of ex post negotiation
costs in this study focuses only on OEM bargaining costs. Future studies
should consider other types of transaction costs (e.g., monitoring
costs). Another useful advance would be to consider negotiation costs on
both sides of the dyad. While we argue that OEM negotiation costs are a
critical determinant of the exchange success, a more complete picture of
the total costs associated with contract maintenance in the relationship
would be provided by examining costs on both sides of the dyad. Indeed,
as Dyer (1997) points out, potential differences between an OEM and
supplier in terms of their commitment to the exchange, the type of
monitoring systems and the like may lead to different levels of
negotiating costs for the two parties. Moreover, the measure of
negotiation costs in this study is based primarily on examining the
labor component of these costs. While the literature argues that these
labor-based costs are an important component of transac tion costs,
other factors such as monitoring and overhead costs may also need to be
considered (Noordeweir et al., 1990).
We have drawn on TCE and social exchange theory for this study. By
drawing on other theories, future studies may provide additional
insights into the relationship between exchange partners. For example,
the procedural justice literature may shed light on relational norms.
Tyler and Bies (1990) note that relational norms that emerge during
ongoing relationships have procedural properties. Thus, the success of
interfirm exchange may be affected by whether the partners perceive that
the procedures used in the relationship (e.g., problem solving,
performance reviews) are fair.
Future research would also benefit from identifying and avoiding
some other limitations of this study. The cross-sectional nature of the
data prevented tests for causality. For example, although the results
support the hypothesis that the presence of specific assets leads to
greater use of incomplete contracts, our analysis supports only the
existence of a relationship between the constructs. It is plausible that
a reverse sequence of events is operating and that the presence of an
incomplete contract is an antecedent to investing in specific assets.
While our results are generally consistent with the theoretical
specification of events (Williamson, 1985), alternative explanations of
the results cannot be completely eliminated with cross sectional data.
Moreover, research would also benefit from examining both the buyer and
supplier perception of the relationship. While steps were taken to
minimize the problem of only collecting data from one side of the dyad,
different results may have been obtained had the supplier's
perceptions also been integrated into the analysis. However, as others
have argued (e.g., Provan and Skinner, 1989), this limitation should not
invalidate our results. Another limitation of our study is that we were
unable to assess response bias using waves as suggested by Armstrong and
Overton (1977). We did compare early and late respondents; however, a
stronger test of non-response bias would compare waves of respondents to
detect differences that may affect the results of the study.
TABLE 1
Descriptive Statistics and Correlations
Variables Mean s.d. 1. 2. 3. 4.
1. Negotiation Cost 11.58 4.35 1.00
2. Contract Type 1.13 0.26 0.15 1.00
3. Environment. Uncertainty 15.30 1.84 0.24 0.24 1.00
4. Specific Assets 14.79 5.33 0.27 0.09 0.25 1.00
5. Alternative Suppliers 6.87 1.86 0.11 0.27 0.06 0.06
6. Collaboration 17.03 4.43 -0.16 0.21 0.15 0.18
7. Commitment 7.65 1.85 -0.13 0.15 0.06 0.05
8. Non-coercive 6.86 2.26 -0.16 -0.10 0.09 0.07
9. Relationship Length 2.24 0.67 0.07 -0.08 0.12 0.11
10. Relationship Importance 8.68 1.09 0.10 0.11 0.09 0.08
11. Relative Size 6.22 4.02 0.04 0.08 0.09 0.05
Variables 5. 6. 7. 8. 9. 10. 11.
1. Negotiation Cost
2. Contract Type
3. Environment. Uncertainty
4. Specific Assets
5. Alternative Suppliers 1.00
6. Collaboration -0.26 1.00
7. Commitment -0.22 0.16 1.00
8. Non-coercive -0.12 0.03 0.23 1.00
9. Relationship Length -0.23 0.23 0.18 0.20 1.00
10. Relationship Importance 0.25 0.21 0.34 0.29 0.11 1.00
11. Relative Size 0.07 0.04 0.08 0.03 0.09 0.14 1.00
Correlations with absolute values greater than 0.09 are significant at
the .05 level.
TABLE 2
Results
Independent Variables Column 1 Column 2
Contract Type Negotiation Costs
Intercept 1.291 *** 10.610 ***
(0.297) (1.620)
Environmental Uncertainty 0.316 ***
(0.084)
Specific Assets 0.176 *
(0.114)
Alternatives 0.614 **
(0.227)
Collaboration -0.549 ***
(0.047)
Commitment -0.247 **
(0.104)
Non-coercive Communication -0.263 *
(0.124)
Relationship Length 0.314 0.357
(0.287) (0.511)
Relationship Importance 0.772 1.186 ***
(0.566) (0.228)
Relative Size 0.111 0.132
(0.161) (0.254)
Chi-squared 15.64
Adjusted R-squared 0.291
F 4.078 ***
* p<.05
** p<.01
*** p<.001
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