Buyer-Supplier Contracting: Contract Choice and Ex Post Negotiation Costs

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). …