Contracting to Dis-Incentivize
55 Pages Posted: 29 Nov 2015 Last revised: 6 Feb 2018
Date Written: Auguest 31, 2017
Research on collaborative ties in business markets has pre-dominantly studied how governance forms balance potential gains and transaction hazards within the relationship. Using an incomplete contracting approach, we examine how the OEM trades off gains obtained within the relationship with its supplier against protection of resources that were developed outside such relationship. Adapting the recent theoretical model by Zanarone, Lo, and Madsen (2016) to the context of industrial markets, we hypothesize that OEMs with more valuable pre-existing resources choose closed-price contracts over open-price contracts to dis-incentivize suppliers from overinvesting in capabilities that may enable them to appropriate those resources.
Consistent with this model, but not with alternative governance theories, our data on component procurement contracts show that:
(1) OEMs tend to use closed-price contracts when their pre-existing resources are more valuable, and the use of closed-price contracts reduces both,
(2) the supplier’s dedicated investment and,
(3) its value-add to the OEM’s end product.
Our work provides evidence on how parties, cognizant of the “dark side” of entering inter-firm collaborations, strategically balance the conflicting goals of safeguarding pre-existing resources and creating value.
Keywords: Contract, Governance, Firm resources and capabilities, Transaction Cost Economics, Resource-Based View, Pricing
JEL Classification: D23; L14; L22; M21; M31
Suggested Citation: Suggested Citation