Kyle J. Mayer

We explore how firms govern exchanges that require innovation. Transaction cost economics focuses on the role of overcoming bounded rationality and mitigating opportunism when designing governance mechanisms such as contracts. While TCE is very powerful in illustrating how to prevent negative events during transactions, it is less able to explain how to design contracts that can help foster a strong positive environment that facilitates innovation. By incorporating insights from social psychology to complement TCE, we argue that firms can improve their chances to generate innovative outcomes in inter-firm transactions. Contracts can do more than simply eliminate negative outcomes and can help set a frame that can encourage a positive outcome. A major challenge occurs when a transaction involves a need for innovation and a significant exchange hazard. While innovation often leads firms to use more detailed task descriptions, because these can be framed in ways that don’t necessarily imply distrust or negative expectations, the presence of exchange hazards makes this framing challenge more difficult and leads firms to rely less on detailed task descriptions. We also explore how firms structure the payment mechanism in the contract to help foster the flexible, creative environment that is most suitable for innovation. We examine and find support for these effects in a sample of contracts from the information technology services industry.

A central theoretical premise is that firms internalize transactions that are not suited for formal contracting. Yet, there is growing evidence that firms rely on formal contracts to govern some of their transactions within the firm. This paper discusses why firms use formal contracts between units and develops propositions for when formal contracts arise. Internalization does not eliminate transactional problems, and informal agreements for transactions between units often suffer from problems understanding what the other unit will do and whether it will do what it promises. We argue that many of the features that make formal contracts valuable tools for market exchange are beneficial within firms, even if court enforcement of the contract is not possible. We suggest that formal contracts between units serve as communication and commitment devices that address coordination and incentive problems within the firm by providing clarity and credibility on the rights allocated to the units in the transaction.

Despite the large literature on alliance contract design, we know little about how transacting parties change and amend their underlying contracts during the execution of strategic alliances. Drawing on existing research in the alliance contracting literature, we develop the empirical question of how contract detail and prior ties influence the amount, direction and type of change in such agreements during the collaboration. We generated a sample of 115 joint ventures by distributing a survey to JV board members or top managers and found that the amount of contract change is negatively associated with the level of detail in the initial contract but is positively associated with the number of prior ties between alliance partners. In relation to the direction of contract change, we find that the level of detail of the initial agreements negatively correlates with the likelihood of removing or weakening existing provisions and that prior collaborative experience positively correlates with the likelihood of strengthening of existing provisions or adding of new ones. We also find that prior ties affect the type of change in that JV parents prefer to change enforcement provisions more so than the coordination provisions in the contract. Our paper generates new insights on the complementarities between relational governance and transaction costs economics (TCE) perspectives on alliance contracting.

The formation and maintenance of long-term inter-firm relationships form an important part of a firm’s corporate strategy. We examine how exchange partners learn to adapt and contract together again following a contract violation. We develop a typology of contract violations based on the intentionality of the specific violation by integrating the behavioral assumptions of transaction cost economics (TCE) with insights from contract law and psychology. Unintentional violations raise concerns about the violating party’s competence, while intentional violations raise concerns about the violating party’s integrity. The degree to which integrity concerns are raised by a violation depends on whether the violation was committed with or without guile, adding a nuance to the traditional understanding of opportunism in TCE. We discuss the development of contracting capabilities and firm learning that occur as exchange partners implement governance changes to encourage the exchange relationship to continue following a violation. We discuss how exchange partners learn from each type of contract violation in our typology, emphasizing how the repeated and long-term nature of exchange relationships between firms makes the question of violation intentionality more salient to developing contracting capabilities. In so doing, we also add to the burgeoning literature on contract violations and firm learning in contracting.

Provides a research agenda for scholars interested in the new institutional economics that focuses on cognition and governance. Rather than assuming that people always act rationally within their cognitive limitations, we can unpack much more about governance if we look at cognitive biases and other challenges that affect how people perceive things. This chapter spells out key research questions for scholars interested in this area.