Contracting to (Dis)incentivize? An Integrative Transaction-cost Approach on How Contracts Govern Specific Investments
Desmond Lo, Department Chair, William T. Cleary Professor, Associate Professor of Marketing
Lo, D.-F., Zanarone, G., & Ghosh, M. (2022). Contracting to (dis)incentivize? An integrative transaction-cost approach on how contracts govern specific investments. Strategic Management Journal, 43(8), 1528–1555. https://doi.org/10.1002/smj.3376
Buyer–supplier collaborations are plagued by multiple frictions—haggling, non-contractible adaptation, and resource appropriation. This article examines how contracts govern relationship-specific investment in the face of these frictions. In our model, investment increases the value the supplier creates for the buyer ex post by adapting a component to her needs. At the same time, specific investment exposes the supplier to haggling, while providing him with knowledge needed to appropriate the buyer's preexisting resources. By muting both haggling and adaptation incentives, “closed price” contracts elicit higher investment than “open price” contracts when adaptation is unimportant, and lower investment otherwise. Moreover, an optimal price format seeks to incentivize investment when resource appropriation is unimportant, and to disincentivize investment otherwise. Our evidence on component procurement contracts supports both predictions.