1. Theoretical aspects of contracting
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2. Contract Legally enforceable agreement
Opportunity to invoke (state) dispute resolution mechanisms and coercive power to enforce promises
Contract designcontract enforcement
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3. Role of contracts Specify commitment Constrain opportunism
Reduce uncertainty, transfer risk
Goal alignment and incentives
Reduce transaction costs
Ex ante  negotiations
Ex post  conflict resolution
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4. Contract problems Moral hazard (ex post) Adverse selection (ex ante)
Information
asymmetry
Moral hazard
(ex post)
Adverse selection
(ex ante)
Opportunism*
* For example withholding information
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5. Two economic theory streams
Agency theorystudy the contract
Objective: goal alignment and risk distribution
Transaction cost theorystudy the transaction
Objective: minimisation of transaction costs
The contracting parties want to obtain control so as to be able to achieve their goals and reduce their costs
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6. Some basic agency theory
Interests of
the principal
Interests of
the agent
Bounded
rationality
Risk aversion
Opportunism
Incentives
Asymmetric
information
Control
Goal
alignment?
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7. Then, some basic transaction cost theory
Asset specificity +
Governance
through legal
contracts*
Opportunism** - +
Uncertainty
* Originally: hierarchy vs market
** Self-interest seeking with guile
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8. How formal & detailed should a contract be?
What are the factors impacting on contract formalisation/specification?
When does contract formalisation and specification pay off?
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9. Costs and benefits of loose vs rigid contract terms
More detailed contract terms
Keeping contracts open
Enables managers to
Set goals
Clarify expectations
Reduce misunderstandings
Reduce counter-party opportunism
Requires expenditures in
Searching for information
Projecting scenarios
Identifying feasible contingencies
Negotiating acceptable solutions
Enables parties to make value-enhancing adjustments
Is likely to foster trust between parties because parties do not hold each other to precise terms of the contract
May lead to opportunism because counter-party can exploit unspecified loopholes that lead to wasteful renegotiations and hold-ups
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10. Governing relationships
1. Relational contracting
Informal governance through credible commitments
2. Legal contracting
Formal governance through (written) contracts
So the question then is:
What factors favour legal/relational contracting?
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11. Control of operations through relational norms and contracts
Legal contracting
Choice of law
“Private laws” = contracts
Guideline to working relationship
Litigation/arbitration
Goal
alignment + +
Control -
Relational norms
Common worldview
Common goals
Benevolence
Reciprocity
Flexibility
Loyalty
Trust
Oppor-
tunism +
Uncertainty factors
Cultural differences
Economic volatility
Legal/political uncertainty
Control of operations through
relational norms and contracts
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12. Contract formalisation and effectiveness
Relationship factors
- Dependence on agent
- Relationship length
Relationship factors
- Dependence on agent
- Relationship length
Product/market factors
- Market volatility
- Product standardisation
Contract
formalisation
Performance
Economic uncertainty
difficult to anticipate demand/competition, prices, inflation, exchange rates
 calls for contractual flexibility
Legal uncertainty
difficult to anticipate outcomes of litigation  calls for relational contracting and trust building activities
Exporter factors
- Exporter host market experience
- Export ratio
Host country uncertainty
- Economic uncertainty
- Legal uncertainty
Based on Aulakh and Genctürk 2008
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13. ? Impact of culture Legal contracting Relational contracting
Uncertainty avoidance
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14. ? Impact of culture Legal contracting Relational contracting
Individualism
Collectivism
Relational
contracting
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15. ? Contract Performance formalisation and specification
Difficult to anticipate demand/ competition, prices, inflation, exchange rates
calls for contractual flexibility
Host country uncertainty
Economic uncertainty
Legal uncertainty
Cultural dimensions
Difficult to anticipate outcomes of litigation  calls for relational contracting and trust-building activities
Uncertainty avoidance  relational contracting?
Individualism  formal contracting?
Power distance  formal contracting?
Masculinity  formal contracting?
Long-termism relational contracting?
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16. Contract specificity and transaction costs
Contracts more specific than predicted -
Buyer lock-in +
Ex post transaction costs +
Transaction complexity +
Contract specificity
Ex ante contract drafting costs - +
Performance ambiguity
Contracts less specific than predicted -
Mooi and Ghosh 2010
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17. Transaction stages model
Activities/Issues
Governance costs
1. Partner selection/
contract negotiation
How to create and
claim values?
1. Direct contracting/search costs
- Performance evaluation (screening/selection)
- Safeguarding (legal/contingencies search)
- Adaptation (communication/negotiation)
2. Opportunity costs of foregone transactions
Ex ante stage
2. Value creation
Difficult to observe
transaction specific costs
Direct monitoring costs
due to performance
evaluation problems
Observing what happened
in stage 2
3. Realising the
state of the world
Outcome not as anticipated
need for adaptation
4. Value claiming
Renegotiation to
appropriate rents
Direct enforcement/adaptation costs
Renegotiation, haggling, coordination,
communication, conflict resolution
Refusal of partner to adapt
Ex post stage
Depend on decisions made in earlier stages
5. Receiving payoffs
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Based on Gibbons 2005

18. Incentive scheme Contract design
The party with the “upper hand” should be left at least as well off maximising the joint gain as taking any other feasible action.
Incentive scheme
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19. Relational or legal governance of partners?
Exporter experience
Legal
Governance mode:
relational or legal
Trust
Relational
Relational
Mutual
adaptation
R *
Legal
Control & role specification
Relational or legal governance of partners?
Based on Deligonul and Cavusgil 2006
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* Nagelkerke R2

20. Some basic premises Control through relationships Performance/ goal
alignment
Control through
legal contracts
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21. Incentives to attain goals
and risk distribution
 Commission (depends on outcome)
Agent’s risk
 Salary (fixed)
Principal’s risk
 Goal attainment
“Balanced risk”
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22. Relationship- vs transaction-oriented exporter–middleman relations
Relationship oriented
None
No certainty for middleman
Opportunities to expand (for middleman)
Yes
Limited uncertainty for middleman
Limited opportunities to expand (for middleman)
Geographic
exclusivity
High
Goal alignment through (short-term) sales volume
Low
Other levers of goal alignment more important (social/investment) with a view to achieve long-term results
Level of incentives
Commission
Risks at middleman level
Salary
Exporter investment in long-term relations exporter risk
Type of incentive
Short/medium-term perspective
Flexibility needed
Information exchange?
Clan control less prevalent?
Opportunism contained by risk of losing agency?
Long-term perspective
Social relations warranted
Asset specificity?
Clan control more prevalent?
Opportunism contained by social relations (and clan control)?
Source: Unpublished research project, BI Norwegian School of Management
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23. Geographic exclusivity
Drivers of relationship quality under different incentive schemes
Standardised beta values
Source: Unpublished research project, BI Norwegian School of Management
Geographic exclusivity
Level of incentives
Type of incentive
None
Yes
High
Low
Commission
Salary
Clan control
Process control
Outcome control
Social relations
Investment in relations
Information exchange
Flexibility
F-value
R2 Adj.
.45a
-.15
.23
.12
.05
.32b
6,776a
.419
.43a
-.15
.01
.31a
.11
.10
.08
11,066a
.484
.43a
-.26c
.08
.19
-.03
.17
.24c
6,379a
.473
.53a
-.24
-.11
.34b
.29c
.07
-.07
6,750a
.467
.30a
-.11
-.05
.17
.03
.16
.28b
8,347a
.394
.46a
-.24c
-.17
.36b
.03
-.02
2,312a
.532
a: p<=.01; b: p<=.05; c: p<=.10
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