1. Presented by – Amit Darekar
Complementarity and Evolution of Contractual Provision An Empirical Study of IT Services Contracts
Nicholas S. Argyres
Janet Bercovitz
Kyle J. Mayer
Presented by – Amit Darekar

2. Introduction
Literature on managing outsourcing relationships  Structure of agreement is important to determine performance of relationship
The gap  How contracts are actually designed? How structures of contracts evolved?
Reason? Heavy emphasis in literature on role of “Trust” in inter-organizational relationships
Literature on alliances and interfirm relations  sophisticated contracts are important, especially in high technology industry
The empirical economic literature  Determinants of contract structure
Gap?  Co-evolutionary patterns in contract structures and mechanisms of learning to contract
Determinants of contract structure – contract duration, payment terms, intellectual property rights, and equity participation

3. Research Objective and Question
Understand nature of contractual learning process by investigating the relationships among different elements of contract design and their coevolution over time.
2 categories of contractual provisions
Task description
Contingency planning
Research Question
How learning processes are reflected in systematic relationships between contingency planning and task description contractual provisions?

4. Theory contd… Transaction Cost Economics (of contract design)
Actors have bounded rationality  cant foresee all future contingencies  incomplete contracts
Contracts may contain key characteristics – degree of bilateral dependency
Degree of protection to property rights to assets deployed in relationship
(Bilateral dependency)↑ + (Legal protection)↓  Contracts will contain additional “safeguards” against opportunism
Safeguards –
Exchange of contractual hostages(Williamson, 1985) – e.g. equity participation (Pisano, 1989)
More complete contracts
Contingency planning clauses – relatively generic OR more specific
More detailed specification of tasks
Trade-off for degree of completeness of contract
Identifying additional contingencies & incorporating in contract is costly due to bounded rationality  but leaves flexibility
Highly incomplete contracts  opportunism
Safeguards – can be incorporated in agreement in several different ways.

5. Theory contd…
Learning and Complements – Does various types of contractual provisions act as complements OR substitutes for each other?
Agency Theory
Task definition and contingency planning are alternative mechanisms for monitoring and controlling behavior  they are substitutes.
Organizational Theory
Firm’s incentive arrangements tend to be highly complementary
Empirical Economics
Because contracts are similar to organization as they are mechanisms for organizing and governing business activity, they are complementary.
Recent research in organizational complementarities show that relationship betn features of org structure & activities only discoverable by its members || to “Learning Processes” (Mayer & Argyres, 2004)
Agency Theory  By developing more detailed task descriptions, a supplier is better controlled. Alternatively, more detailed task description  limit severity of any –ve consequences of opportunism. So, more detailed task description  reduce value of additional contingency planning. Similarly, more contingencies identified ex ante & detailed procedures are established to deal with them  detailed task description is unnecessary. Hence “Task description” and “Contingency Planning” are substitutes for each other
Organizational theory  Holmstrong and Milgrom (1991) showed that when organizational members carry out multiple tasks, their incentives must be aligned or else inefficient allocation of efforts will result.

6. Hypotheses
H1 – Contingency planning and task description have reciprocal positive effects on one another, suggesting that they act as complements in complex, high-technology contracts
H2A – Prior experience with contingency planning is associated with more detailed task description in subsequent contracts between the same firms
H2B – More detailed task description in prior contracts is positively associated with contingency planning in subsequent contracts between the same firms
H3A – As an exchange relationship between two parties continues, the parties will be more likely to include contingency planning clauses in their contracts with each other
H3B – As an exchange relationship between two parties continues, the parties will include more detailed task description in their contracts with each other
H1 – The authors suggest that learning about contingency planning may tend to spill over to learning about task description, and vice versa, and that this creates a relationship of complementarity that dominates any substitution effect between the two contract provisions. More efforts on identifying and providing for contingencies  more opportunities are revealed to clarify the tasks to avoid these contingencies. Conversely, more efforts to clarify roles and responsibilities  potential problematic contingencies are more likely to be identified and marginal cost to include them in contract falls.
H2A – prior experience is used to identify and elaborate problematic tasks with the same partners
H2B – vice versa of H2A
H3A – Partner specific learning. They learn about idiosyncrasies of each other and use it to include contingencies planning.
H3B – vice versa of H3A

7. Data
Single firm, code-named “Compustar”, data. Firm engaged in high technology activities and is from “emerging industry”
Period – 1986 to 1998.
Population – All the contracts with Compustar’s 141 partners for the given period
Samples – 405 (25% of population) randomly chosen based on first letter of partner’s name. Final sample = 386 after removing missing data contracts
“Emerging Industry” – perfect setting to study “Learning Effects” which this study has hypothesized

8. DV / IV / CV DV IV CV Task description Contingency planning
Relationship history CV
Interdependence
Proprietary
Measurement cost
Mainframe
Innovation
Fixed fee
Dollar value
Programming
Time
CV1 – Control for holdups. CV2 – Proprietary technologies. CV3 – To assess difficulty to verify quality of tech. CV4 – Degree of uncertainty. CV5 – Degree of innovation required for project. CV6 – Incentive structure for contract. CV7 – Total money value for project. CV8 – Need for programming. CV9 – Time trend

9. Method Probit Regression OLS i Indicates index of the contract
Task Description – Likert scale, hence continuous variable. Effect of Contingency planning on Task Description in an OLS regression would be endogenous. So used two-stage least square in STATA to test it. Results showed that it is exogenous
Contingency Planning is Dichotomous variable. So used Probit regression. Effect of task description on contingency planning in regression would be endogenous. So used Smith-Blundell test it. Results showed it is endogenous. To correct it, used “Predicted value of task description” from a regression on all the exogenous variables.
i Indicates index of the contract

10. Results contd..

11. Results

12. Discussion
Contingency planning and task description act as complements likely to be result of learning spillovers
The firms in the sample were learning to contract such that contingency planning become prevalent over time
Contingency planning was more likely to be included in partners with longer relationships history
For the specific case of Compustar, task description become less detailed over time
Result 2 & 3 are quite contradictory to “Theories of Contract Evolution”
4. Possibly due to – Compustar’s reputation for honest dealing become strong in its clients, OR Compustar realized that some types of details are unnecessary,

13. Conclusion Implications of research Limitations
Investigating the determinants of each term in contract in isolation could be misleading
Examining contract designs assuming that they are equilibrium outcomes can be misleading to parties in contract
Limitations
The problem of limitations on generalizability of the results