Managerial Contracting: A Preliminary Study

Abstract

In the modern outsourced economy, important types of contractual relationships—among them those related to industrial procurement—are neither fully transactional nor fully relational. Rather, the agreements that govern these relationships incorporate highly detailed written terms that focus not only on what is promised but also on the details of how it is to be achieved and how the suppliers’ actions will be monitored over the life of the agreement. These provisions are not, for the most part, effectively backed by the threat of legal sanctions. Nevertheless, they have the potential to add significant value to contracting relationships. Many of these provisions—termed here “managerial provisions”—employ techniques used to organize relationships and increase productivity within firms. Known in the literature as elements of hierarchy, the techniques introduced by managerial provisions are used to provide a roadmap for carrying out the transactors’ work-a-day actions and interactions in ways that are likely to facilitate successful contracting relationships. Among the many intra-firm practices that managerial provisions commonly import into contracting relationships, are analogues of each of the eighteen management practices that the World Management Survey reveals are closely associated with persistent performance differences across similarly situated enterprises. This raises the possibility that more fully integrating some or all of these (and other) managerial practices into supply agreements may add value to these (and other types of) contracting relationships, particularly when attempts to do so are implemented with an understanding of the intrafirm organizational hierarchy and culture within each of the contracting parties.

Drawing on a study of over a hundred firms, this paper suggests that managerial contract provisions together with the contract administration mechanisms designed to implement them, have created a contract governance regime that is well-structured to support the creation and maintenance of cooperative relationships, strengthen the force of network governance, and scaffold the emergence of inter-firm trust--thereby creating the conditions needed for firms to enter into credible relational contracts that supplement their legally enforceable agreements and enable them to capture most of the benefits of vertical integration without vertically integrating.