Contracting to Dis-Incentivize

55 Pages Posted: 29 Nov 2015 Last revised: 6 Feb 2018

See all articles by Desmond (Ho-Fu) Lo

Desmond (Ho-Fu) Lo

Santa Clara University, Department of Marketing

Giorgio Zanarone

Washington University in St. Louis - John M. Olin Business School; CUNEF

Mrinal Ghosh

University of Arizona, Department of Marketing

Date Written: Auguest 31, 2017

Abstract

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

Lo, Desmond (Ho-Fu) and Zanarone, Giorgio and Ghosh, Mrinal, Contracting to Dis-Incentivize (Auguest 31, 2017). Available at SSRN: https://ssrn.com/abstract=2696240 or http://dx.doi.org/10.2139/ssrn.2696240

Desmond (Ho-Fu) Lo (Contact Author)

Santa Clara University, Department of Marketing ( email )

500 El Camino Real
Santa Clara, CA California 95053
United States

HOME PAGE: http://www.scu.edu/business/marketing/faculty/lo.cfm

Giorgio Zanarone

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

CUNEF ( email )

Leonardo Prieto Castro 2
Madrid, Madrid 28040
Spain

HOME PAGE: http://gzanarone.cunef.edu

Mrinal Ghosh

University of Arizona, Department of Marketing ( email )

Tucson, AZ 85721-0108
United States

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