Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts

Abstract

The master agreements that nominally govern the transactions between mid-western Original Equipment Manufacturers and their suppliers are not, for the most part, designed to create legal obligations. Rather, they create a space in which private order can flourish, much like the role played by firm boundaries in the Coase-Williamson theory of the firm. This Article explores how sophisticated transactors in this market have combined governance techniques associated with arm’s-length contracting, intrafirm hierarchy, and trust-based relational contracting to create relationships that are long-term, highly cooperative, and characterized by significant relationship-specific investment. It suggests that these transactors have been able to accomplish these outcomes with only minimal reliance on the legal system, in large part because they operate in a market of highly interconnected firms — a network that itself functions as a contract governance mechanism. It then explores the implications of these contract structures and the availability of network governance for firms’ make-or-buy decisions and the likelihood of innovation.

Keywords: networks, relational contracts, supply chains, reputation

JEL Classification: L1, L23, L60, A14, D83