Reputation Effects and the Limits of Contracting: A Study of the Indian Software Industry

Abstract

This paper examines evidence of the role that reputation plays in determining contractual outcomes. We conduct an empirical analysis of the Indian customized software industry. We analyze a data set containing detailed information about 230 projects carried out by 125 software firms that we had previously collected. The evidence supports the view that reputation matters. Ex ante contracts as well as the outcome after ex-post renegotiation vary with firms? characteristics plausibly associated with reputation. We argue that this pattern is not consistent with optimal risk sharing and propose a model of the industry where reputation determines contractual outcomes, whose predictions are consistent with several facts observed in the data. We argue that there is no obvious alternative explanation to the patterns present in the data.

Key words: Reputation, contracting, software

JEL Classification: L22, L86