Managerial Contracting: A Preliminary Study

Abstract

Important types of contractual relationships — among them those between integrated product manufacturers and their suppliers — are neither fully transactional nor fully relational. 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 suppliers’ actions will be monitored and responded to over the life of the agreement. Together with the implicit relational contracts that support their operation, these provisions create an economic hybrid that lies between markets and hierarchies, a set of relatively standard institutional arrangements that give buyers the right (but not the obligation) to exercise a package of quasi-integration rights that enables them to obtain many of the most important benefits of vertical integration while simultaneously reaping most of the core benefits of outsourcing.

The contract provisions used to govern these relationships are termed here “managerial provisions” because they employ the techniques of intra-firm hierarchy that managers use to organize relationships and increase productivity within firms. This article focuses on a subset of these provisions, namely those that are analogous to each of the 18 management practices that the World Management Survey (“WMS”) reveals are closely associated with persistent performance differences across similarly situated enterprises. After documenting the convergence between these practices and the terms of procurement contracts, the article suggests that the contract governance regime these practices create is well designed to support the creation and maintenance of cooperative relationships, strengthen the force of network governance, and scaffold the emergence of the type of inter-firm process-based trust that is associated with better supplier performance.

More generally, the article concludes that in the modern economy, where the value of so many types of contracts — from research and development alliances to business process outsourcing agreements and beyond — depends on employees of the contracting entities working together much as if they worked for a single firm, lawyers would be well advised to look to the broad array of managerial techniques successfully used within firms (not only those based on WMS practices) to develop new ways to better govern transactions between firms.

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