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Contract Governance

Paper Session

Sunday, Jan. 7, 2018 10:15 AM - 12:15 PM

Loews Philadelphia, PSFS
Hosted By: Society for Institutional and Organizational Economics
  • Chair: Robert Gibbons, Massachusetts Institute of Technology

Beyond Relational Contracts: Social Capital and Network Governance in Procurement Contracts

Lisa Bernstein
,
University of Chicago

Abstract

The master agreements that nominally govern the transactions between mid-western
OEMs and their suppliers are not, for the most part, designed to create legal obligations.
Rather, like the role played by firm boundaries in the Coase-Williamson theory of the firm,
they create a space in which private order can flourish. This article explores how sophisticated
transactors in this market have combined governance techniques associated
with arm’s-length contracting, intra-firm hierarchy, and trust-based relational contracting
to create relationships that are long-term, highly cooperative, and characterized by
significant relationship-specific investment. It suggests that these transactors have been
able to accomplish these outcomes with only minimal reliance on the legal system, in
large part because they operate in a market of highly interconnected firms—a network
that itself functions as a contract governance mechanism. It then explores the implications of these contract structures and the availability of network governance for
firms’ make-or-buy decisions and the likelihood of innovation.

Scaffolding: Using Formal Contracts to Support Informal Relations in Support of Innovation

Gillian Hadfield
,
University of Southern California
Iva Bozovic
,
University of Southern California

Abstract

In a study that follows in Stewart Macaulay’s (1963) footsteps, we
asked businesses what role formal contract law plays in managing their
external relationships. We heard similar answers to the ones Macaulay
obtained fifty years ago from smaller companies that described important
but non-innovation-oriented external relationships. But we also uncovered
an important phenomenon: companies, large and small, that described
innovation-oriented external relationships reported making extensive use of
formal contracts to plan and manage these relationships. They do not,
however, generate these formal contracts in order to secure the benefits of a
credible threat of formal contract enforcement. Instead, like Macaulay’s
original respondents, they largely relied on relational tools such as
termination and reputation to induce compliance. In this paper we first
present examples of this phenomenon from our interview respondents, and
then consider how conventional models of relational contracting can be
enriched to take account of a very different role for formal contracting,
independent of formal enforcement. In particular, we propose that formal
contracting—meaning the use of formal documents together with the
services of an institution of formal contract reasoning—serves to coordinate
beliefs about what constitutes a breach of a highly ambiguous set of
obligations. This coordination supports implementation of strategies that
induce compliance—despite the presence of substantial ambiguity ex ante at
the time of contracting—with what is fundamentally still a relational
contract.

Braiding: The Interaction of Formal and Informal Contracting in Theory, Practice, and Doctrine

Ronald Gilson
,
Columbia University
Charles Sabel
,
Columbia University
Robert Scott
,
Columbia University

Abstract

This Article studies the relationship between formal and informal contract
enforcement. The theoretical literature treats the two strategies as separate
phenomena. By contrast, a rich experimental literature considers
whether the introduction of formal contracting and state enforcement
“crowds out” the operation of informal contracting. Both literatures focus
too narrowly on how formal contracts create incentives for parties to perform
substantive actions, while assuming that informal enforcement depends on
preexisting levels of trust. As a result, current scholarship misses the relationship
between formal and informal contract mechanisms that characterizes
contemporary contracting in practice. Parties respond to rising uncertainty
by writing contracts that intertwine formal and informal
mechanisms—what we call “braiding”—in a way that allows each to assess
the disposition and capacity of the other to respond cooperatively and effectively
to unforeseen circumstances. These parties agree on formal contracts
for exchanging information about the progress and prospects of their joint
activities, and it is this information sharing regime that “braids” the formal
and informal elements of the contract and endogenizes trust. We argue that
the low-powered enforcement associated with the formal governance structure
in these braided contracts complements rather than crowds out the informal
mechanisms that rely on increasing levels of trust. We examine the braiding
phenomenon in a variety of contexts characterized by increasing uncertainty.
In each instance, courts appear to have harnessed the braiding phenomenon
by using low-powered sanctions to protect formal contractual “preliminaries.” This technique allows potential collaborators to explore and develop their
relations, but it does not impose mutually enforceable obligations to pursue a
particular project. Despite the wisdom of temperate enforcement of braided
contracts, however, courts that emphasize the contemporary duty to negotiate
in good faith are often tempted to expand the legal sanction. We conclude by
explaining how courts can best support the braiding strategies that are critical
to the success of an integrated regime of formal and informal contracting.
Discussant(s)
Avinash Dixit
,
Princeton University
Robert Gibbons
,
Massachusetts Institute of Technology
JEL Classifications
  • K2 - Regulation and Business Law
  • L2 - Firm Objectives, Organization, and Behavior