Contracts and Trust in Alliances: Discovering, Creating and Appropriating Value

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Contracts and Trust in Alliances

Contracts and Trust in Alliances Discovering, Creating and Appropriating Value

Paul W.L. Vlaar Vrije Universiteit Amsterdam, The Netherlands

Edward Elgar Cheltenham, UK • Northampton, MA, USA

© Paul W.L. Vlaar 2008 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited The Lypiatts 15 Lansdown Road Cheltenham Glos GL50 2JA UK Edward Elgar Publishing, Inc. William Pratt House 9 Dewey Court Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library

Library of Congress Control Number: 2008927958

ISBN 978 1 84720 517 9 Printed and bound in Great Britain by MPG Books Ltd, Bodmin, Cornwall

Contents vi vii ix x xi

About the author List of ﬁgures List of tables and textboxes Preface Acknowledgements 1 2 3 4 5 6 7 8 9

Introduction on contracts and trust in alliances Mainstream literature: coordination and control Need versus ability to contract How trust and contracts coevolve Functions of negotiation and contracting Duality and dialectic tensions Contract standardization Governance trajectories Discussion and conclusion

1 46 65 85 105 149 179 204 231 263 280 327

Appendices References Index

v

About the author Paul W.L. Vlaar (Obdam, The Netherlands, 4 January 1978) obtained his Masters in Economics (Cum Laude) from Wageningen University and his PhD degree (Cum Laude) from RSM Erasmus University. He currently works at the Vrije University Amsterdam, The Netherlands. His research interests include interorganizational cooperation, strategy and context, and cross-disciplinary initiatives focusing on organizational structuring and design processes, new business development and strategic change. His research has been published, amongst others, in MIS Quarterly, Organization Studies, Group & Organization Management, European Management Journal, and several edited books by Elsevier and Palgrave.

vi

Figures 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 1.10 3.1 3.2 4.1 4.2 4.3 4.4 5.1 5.2 5.3 6.1 6.2 6.3 6.4 7.1 7.2 7.3 8.1

Evolution of alliance portfolios in the US software industry Starbuck’s coﬀee creating value through a set of relationships Accenture creating value through a set of relationships Three attributes of contracting Antecedents–governance–performance framework Integrative research framework on the role of contracts and trust The organization of economic activity Purpose of alliances worldwide Joint ventures versus alliances Distribution of contract length in words for diﬀerent kinds of agreements Research framework: focus of theme one Antecedents of the need and the ability to contract Research framework: focus of theme two Evolution of trust, distrust and contracting in interorganizational relationships Trust, distrust and interorganizational performance Formal contracts and interorganizational performance Research framework: focus of theme three Relationships between contracting, sensemaking and understanding Ring and Van de Ven’s process framework Research framework: focus of theme four A dialectic perspective on formalization in interorganizational relationships Interorganizational structure of the QUICK–STEADY alliance Three ways of coping with tensions arising from formalization Research framework: focus of theme ﬁve Generic research model extended with standardization Moderating eﬀects of standardization Research framework: focus of theme six vii

3 4 5 12 20 21 29 38 39 41 65 69 87 89 92 92 106 112 121 151 153 163 172 181 181 197 206

viii

Contracts and trust in alliances

8.2 8.3 8.4 8.5 8.6

Governance trajectories Prior cooperation Advance payment Standard contract Relationships between governance decisions and sets of antecedents Research framework: overview contributions of the six themes A simple bargaining game Major opportunities for cross-disciplinary research Research opportunities regarding pre- and post-contracting processes Future research on governance: creating, appropriating and discovering value

9.1 9.2 9.3 9.4 9.5

210 218 218 218 226 233 246 255 256 259

Tables and textboxes TABLES 1.1 1.2 1.3 1.4 2.1 3.1 3.2 5.1 6.1 6.2 7.1 7.2 7.3 7.4 8.1 8.2 8.3 8.4

Number of alliances, top 10 drug development companies (2000–2003) Signiﬁcance of and criticism on interorganizational governance research Need for alternative explanations of formal structures Variation in contractual complexity Agency theory: behaviour-based versus outcome-based contracts Correlation matrix need versus ability to contract Results: multiple regression analysis need versus ability to contract Overview of diﬀerent perspectives on formal interorganizational governance Functions of formalization Dysfunctions of formalization Some major beneﬁts and drawbacks of contract standardization Correlation matrices for both subsamples Model ﬁt for both subsamples Comparison of eﬀect sizes for both subsamples Bivariate correlations Compilation of classiﬁcation and ﬁt statistics Results: binary logistic regression analyses Results: multiple regression analyses

2 9 25 40 54 78 79 108 155 156 183 194 196 197 218 219 220 224

TEXTBOXES 5.1 6.1 6.2

Formal governance among prairie travellers Overview of key characteristics data collection Exemplary comments on the alliance’s performance

ix

106 161 164

Preface Interorganizational relationships – e.g. alliances, joint ventures, outsourcing and oﬀshoring initiatives – feature prominently in contemporary business society. Such relationships are generally attractive, but complex, because members from diﬀerent organizations with diﬀerent backgrounds and experiences need jointly to discover and create value. To complicate matters further, they have to make sure that their organization appropriates part of this value and they have to safeguard against opportunistic behaviour by partners and undesired knowledge spillovers. In this manuscript, I explore how contracts and trust relate to the creation, appropriation and discovery of value in interorganizational relationships. More particularly, I capitalize on the observation that contracts and negotiation and contracting processes are frequently hardest when you need them most (Chapter 3), that they assume a non-trivial relationship with trust (Chapter 4) and that they can be conducive to giving, making, demanding and breaking sense (Chapter 5). Moreover, I develop the notion that contracting and other acts of formalization eventuate in tensions with which people have to cope (Chapter 6) and I discuss the implications of standardizing contracting practices (Chapter 7). Finally, I contend that contracts and the processes from which they emerge should not be studied in isolation, as they interact with various other governance mechanisms (Chapter 8). In further developing and exploring these insights, l attempted to accommodate and cherish existing research on contracting and trust in interorganizational relationships, while simultaneously attending to and developing alternative notions and viewpoints. I believe this manuscript gives testimony to the way such endeavours can enrich our thinking on the governance of interorganizational relationships. I wish to thank Margret, Sam and Casper, my parents, family, friends and colleagues in the Netherlands and many other places around the world for their tremendous support during the journey that has eventuated in this manuscript. They are the ones that made my voyage a precious intellectual experience. Paul Vlaar, Amsterdam, October 2007

x

Acknowledgements Earlier versions of Chapters 4, 5 and 6 have been published before. I wish to thank Sage Publications for its permission to reprint those chapters. The original publications respectively appeared under the following titles: Vlaar, P.W.L., F.A.J. Van den Bosch and H.W. Volberda (2007a), ‘On the evolution of trust, distrust, and formal coordination and control in interorganizational relationships: towards an integrative framework’, Group & Organization Management, 32 (4), 407–428. Vlaar, P.W.L., F.A.J. Van den Bosch and H.W. Volberda (2006), ‘Coping with problems of understanding in interorganizational relationships: using formalization as a means to make sense’, Organization Studies, 27, 1617–1638. Vlaar, P.W.L., F.A.J. Van den Bosch and H.W. Volberda (2007b), ‘Towards a dialectic perspective on formalization in interorganizational relationships: how alliance managers capitalize on the duality inherent in contracts, rules, and procedures’, Organization Studies, 28 (4), 437–466.

xi

1. Introduction on contracts and trust in alliances Managers take one narrow perspective or another [. . .]. Much of this writing and advising has been decidedly dysfunctional, simply because managers have no choice but to cope with the entire beast. (Mintzberg and Lampel, 1999: 21) Several competing lines of reasoning seem possible, although they might prove to be complementary rather than exclusive, since organizations are complex realities whose dynamics are ‘overdetermined’ and not typically amenable to a monocausal explanation. (Adler, 1993: 172)

The central aim of this book is to explore how contracts and trust relate to the discovery, creation and appropriation of value by partners in interorganizational relationships. This introductory chapter serves as a foundation for such a study. Here I brieﬂy touch upon the growing prominence of interorganizational collaboration and the signiﬁcance that is attributed to the governance of cooperative initiatives. I then argue that existing studies on interorganizational governance generally take one narrow perspective or another, neglecting the fact that managers have no choice but to cope with the entire ‘beast’, and ignoring the fact that most organizational phenomena are not amenable to monocausal explanations (see Adler, 1993; Mintzberg and Lampel, 1999). Moreover, I contend that these studies have been dominated for decades by theories that have assumed an almost paradigmatic status. The challenge lies in accommodating and cherishing these existing theories, while at the same time attending to and developing new ideas that could possibly result in scientiﬁc progression. I therefore introduce an integrative research framework, incorporating six research themes that promise to shed new light on the relations between contracts, trust and the discovery, creation and appropriation of value in interorganizational relationships. Subsequently, I discuss each of these themes and the associated research questions, as well as the empirical and methodological basis for the manuscript. The chapter concludes with an overview of the structure of the book.

1

2

Contracts and trust in alliances

INTERORGANIZATIONAL COOPERATION Drucker (1995) suggests that the greatest change in the way business is being conducted is the accelerating growth of relationships based on partnership instead of ownership. Grant and Baden-Fuller (2004: 61) even contend that ‘one of the most important trends in industrial organization of the past quarter century has been the growth of collaboration between independent companies’. Several other researchers have advanced the argument that organizations are increasingly forming external collaborative relationships, which they deﬁne as voluntarily initiated, formal, cooperative agreements between two or more organizations that involve exchange, sharing, or co-development, and that include contributions by partners of capital, technology or organization-speciﬁc assets (e.g. Ariño, 2003; Gulati, 1998; Parkhe, 1993a). Support for this assertion is ubiquitous. Kang and Sakai (2001), for example, observed that the number of interorganizational alliances was six times as high in 1999 compared to a decade earlier. The top 500 global businesses have been estimated to participate in an average of 60 major strategic alliances each (Dyer et al., 2001), while public reports indicate that BP Amoco, Dow Chemical, Hearst, Johnson & Johnson and Sony had more than a hundred alliances in their corporate portfolios by 2001 (Bamford and Ernst, 2003). Large pharmaceutical companies and software ﬁrms constitute major examples of the hunger for interorganizational cooperation (see Table 1.1). From 2000 to 2003, the top 10 companies in the pharmaceutical industry had established, on average, 61 new alliances (Rasmussen, 2004). Table 1.1 Number of alliances, top 10 drug development companies (2000–2003) Company Pﬁzer GlaxoSmithKline Merck Aventis Roche Novartis Eli Lilly Bristol-Myers Squibb Abbott AstraZeneca Source: Rasmussen (2004, based on Recap, March 2004).

# of worldwide alliances 103 88 62 57 56 56 51 47 45 44

3

Introduction

Number of alliances per firm

35

100% 90%

30

80% 25

70%

20

60% 50%

15

40% 30%

10 5

Average portfolio size % firms engaging in alliances

0

20% 10%

Percentage of firms engaging in alliances

In a similar vein, Lavie (2007) observed that the percentage of publicly traded ﬁrms in the US software industry engaging in alliances increased from 32 per cent to 95 per cent between 1990 and 2001, with the average number of alliances in their portfolio rising from four to more than 30 (see Figure 1.1). Further evidence is derived from estimates by Goldman Sachs that a typical Fortune 1000 organization is currently maintaining between 20 000 and 40 000 contracts (upsidesoft.com, 2005) and from Schifrin’s interviews among toplevel managers (2001), revealing that more than 80 per cent of them regarded strategic alliances as a primary growth vehicle for the future. Support also comes from the worldwide market for IT outsourcing, which has been forecast by Gartner to grow at an annual compound rate of 7.2 per cent between 2003 and 2008 (Caldwell et al., 2004). These examples suggest that interorganizational relationships have grown in volume and number and that we can expect this trend towards collaboration to continue. These and other examples suggest that activities of organizations are increasingly embedded in complex networks of interorganizational relations and in constantly reconﬁguring value chains (Wirtz, 2001). Changes in communication technologies and increasing openness of economies have ampliﬁed the potential value that may be created through interorganizational cooperation, permitting organizations to set up closer relationships with

0% 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Year

Source: Lavie (2007). The ﬁgure presents the percentage of publicly traded ﬁrms in the US software industry that engage in alliances and their corresponding alliance portfolio size, measured in terms of number of alliances.

Figure 1.1 Evolution of alliance portfolios in the US software industry

4

Contracts and trust in alliances

Shinsegne (Korea) Alsea (Mexico) Dreyer’s (Premium coffee ice-cream)

PepsiCo (Bottled coffee beverages)

Sazaby (Japan)

Rustan (Philippines) Bonvests (Singapore)

Geographic expansion partners

New products, marketing and sales partners

Barnes & Noble (In-store stores)

Starbucks Coffee

Retail format partners

Channel partners (corporate sales)

Westin Hotels and Resorts (coffee served in hotels)

United Airlines (in-flight coffee)

Chapters (Canada bookstores)

Host Marriott Services (Worldwide airport kiosks and in-hotel coffee cafes)

Source: Ernst (2003, based on press reports and McKinsey Analysis).

Figure 1.2 Starbuck’s coﬀee creating value through a set of relationships partners than hitherto possible (Mol, 2005). Take the example of Starbucks Coﬀee, which has leveraged a brand and a concept by means of a large set of interorganizational relationships (see Figure 1.2). Starbuck’s partners include ﬁrms that facilitate entry into new markets; customers, including United Airlines and Westin Hotels; retail formats, such as Mariott, Barnes & Noble and Chapters; and producers of complementary products, including PepsiCo and Dreyer’s Ice Cream (see Ernst, 2003). Another example constitutes Accenture (see Figure 1.3), which has developed relationships in the areas of application infrastructure, business intelligence, customer relationship management, data warehousing, enterprise integration and management, platforms and supply chain management. Nowadays, cooperation is even extended to strategically sensitive areas, such as R&D. Boeing, for example, is working with India’s HCL Technologies to co-develop software for everything from the navigation systems and landing gear to the cockpit controls for its upcoming 7E7 Dreamliner jet. Similarly, pharmaceutical giants such as GlaxoSmithKline and Eli Lilly are teaming up with Asian biotech research companies in a bid to cut the average $500 million cost of bringing a new drug to the market (Engardio and Einhorn, 2005: 52–3).

5

Introduction Business intelligence and operation Business Objects, Cognos, CERA, Retek, Hyperion, Informatica

Application infrastructure Avanade, BEA, EMC/Documentum, Microsoft

Customer relationship management Callidus Software, Siebel Systems, Genesys

Enterprise integration and management SeeBeyond, TIBCO, BEA, Microsoft, Oracle, SAP, PeopleSoft

Accenture

Supply chain management Ariba, Aspen Tech, i2 Technologies, PeopleSoft, SAP Manugistics

Data warehousing Teradata (a division of NCR), Acxiom, Oracle

Platforms EMC, HP, Sun

Others Mercury, Meridea, Reuters Group, Answerthink,

Source: Composed on the basis of data located at www.accenture.com.

Figure 1.3

Accenture creating value through a set of relationships

What drives these organizations to ally, sometimes even with their closest competitors? Lerpold (2003) and Ariño (2003) have composed excellent overviews of the motives for forming interorganizational relationships. These include reducing production and transaction costs (Hennart, 1988; Williamson, 1985), expanding business activities and exploiting business opportunities abroad (Mohr and Puck, 2005), accelerating the pace of organizational growth (Grant and Baden-Fuller, 2004; Shane, 1996; Uzzi, 1997), tapping resources for entrepreneurial activities (Teng, 2007) and accessing complementary resources and capabilities (Doz and Hamel, 1998; Dyer and Singh, 1998). In addition, interorganizational relationships are used to confer status, legitimacy and reputation on organizations (Baum and Oliver, 1992; Dacin et al., 2007; Stuart et al., 1999), augment their identity (Lerpold, 2003), enable conformance to isomorphic bandwagon behaviour (DiMaggio and Powell, 1983), increase market power through competitive positioning (Kogut, 1988) and enhance ﬂexibility (Volberda, 1996, 1998; Schilling and Steensma, 2001). Collaboration among organizations is further driven by the need to respond to networks of competitors (Gimeno, 2004). In fact, competition frequently extends

6

Contracts and trust in alliances

beyond rivalry between individual organizations (Ireland et al., 2002) and increasingly involves constellations of ﬁrms (Van Haverbeke and Noorderhaven, 2001) or cliques (Rowley et al., 2004). In a sense, interorganizational relationships thus create ‘new forms of competition that supersede ﬁrms and on which ﬁrms depend for their competitive advantage’ (Gomes-Casseres, 1996: 204). A good example consists of the battles among airline constellations Star and Oneworld in the early 2000s (Bamford et al., 2003). External cooperative agreements also enable organizations to draw ‘their boundaries around narrower spheres of activity’ (Whittington et al., 1999: 587), allowing them to focus on their core competences (Prahalad and Hamel, 1990). They aﬀord beneﬁts, in the form of a larger volume, diversity and richness of information available to organizations (Koka and Prescott, 2002). This opens up possibilities to learn and access, transfer, transform and harvest knowledge (Beamish and Berdrow, 2003; Grant and Baden-Fuller, 2004) and it may reinforce the pace of innovation and reduce the risks associated with exploration (Sivadas and Dwyer, 2000). Moreover, it can give way to strategic renewal processes that enable organizations to pursue new developments in technologies, products and markets (Crossan and Berdrow, 2003; Lorenzoni and Lipparini, 1999; Volberda, 1996; Volberda et al., 2001). At the same time, collaboration tends to ‘lower the costs of restructuring and transforming business by facilitating learning’, and reducing the time that is needed to change (Gomes-Casseres, 1996: 45). Crossan and Berdrow (2003), for example, convincingly describe how Canada Post Cooperation transformed itself from a distribution company into a network management organization by outsourcing its retail activities. Furthermore, Lorenzoni and Lipparini (1999), in their study of supplier networks in the Italian packaging machine-building industry, illustrate that the ability of companies to interact with other organizations enabled them to renew their competences, while reducing resistance to change. These and other examples show that achieving competitive advantage sometimes becomes inextricably linked to interorganizational cooperation (Dyer and Singh, 1998; Larson, 1992) and that the locus of production is often no longer within the boundaries of a single organization, but occurs instead at a nexus of relationships (Schilling and Steensma, 2001). In fact, ‘the very unit of economic behaviour is becoming larger than the ﬁrm’ (Gomes-Casseres, 1996: 5). Accordingly, we are challenged to complement the traditional picture of ﬁrm-driven production and growth with a view in which interorganizational relationships are used to organize economic activity and gain competitive advantage (Dyer and Singh, 1998; Koza and Lewin, 1998; Larson, 1992). This means that we need to replace traditional

Introduction

7

deﬁnitions of the ﬁeld of strategic management focusing on ‘coordination and resource allocation inside the ﬁrm’ (Rumelt et al., 1991: 19) with deﬁnitions emphasizing ‘coordination and resource allocation both within and across ﬁrm boundaries’ (Madhok, 2002: 547).

THE CRITICAL ROLE OF GOVERNANCE Thus far, I have concentrated on the virtues of interorganizational cooperation.1 However, interorganizational cooperation exhibits a ‘mix of promise and peril’ (Fryxell et al., 2002: 866). Although managers ‘perceive the need for interorganizational cooperation, they ﬁnd it diﬃcult to manage those relationships satisfactorily’ (Madhok, 1995: 57).2 This becomes manifest, for example, when one considers that alliance researchers have reported typical failure rates between 50 and 70 per cent (e.g. Harrigan, 1988; Heimeriks and Duysters, 2007; Parkhe, 1993a). It appears that many interorganizational relationships do not live up to their expectations (Hoang and Rothaermel, 2005). Problems arise, among others, from inherent conﬂict, goal divergence, asymmetrical objectives and opportunism by one or more partners (Doz, 1996; Ireland et al., 2002; Kale et al., 2000; Luo, 2007). Other issues pertain to cultural and organizational diﬀerences (Barkema and Vermeulen, 1997; Lane and Lubatkin, 1998; Mohr and Puck, 2005), improper partner selection (Ireland et al., 2002) and deﬁciencies or breaches of trust (Gill and Butler, 2003). These concerns are reinforced by variations in expectations regarding the possibilities for value creation and partner interaction (Inkpen and Beamish, 1997; Madhok and Tallman, 1998; Ring and Van de Ven, 1994). They are also exacerbated by unexpected contingencies, strategic changes by partner organizations and permutations in industries or environments, which may trigger instability (Gill and Butler, 2003; Yan and Gray, 2001), shifts from cooperative toward competitive behaviour and the dissolution of relationships. Park and Ungson (2001) argue that the adaptation of appropriate governance mechanisms may alleviate or mitigate these and other potential problems, as governance mechanisms are means to infuse order, relieve conﬂict and realize mutual gain (Williamson, 2002). Contract design, for instance, ‘can play an important role in facilitating joint problem-solving aimed at creating and preserving value’ in interorganizational exchanges (Argyres and Mayer, 2007: 1061). This assertion receives support from, amongst others, a McKinsey study of more than 500 alliances involving large US, European, Asian and Latin American companies, revealing that many cooperative ventures fail because of unclear decision-making rights (Bamford et al., 2003). It is also empirically substantiated with results from

8

Contracts and trust in alliances

a study on alliances in the drug industry conducted by Accenture (2003), indicating that interorganizational eﬀectiveness frequently suﬀers from inadequacies in governance and relationship management. In line with this, Ernst (2003) concludes that about half of alliance failures result from governance issues and Madhok (2002: 540) adds that ‘governance skills, both within and across ﬁrm boundaries, can result in performance diﬀerences and competitive advantage’. Several other authors have also emphasized the signiﬁcance of interorganizational governance. Dyer and Singh (1998), for instance, stress that eﬀective governance might lead to interorganizational competitive advantage, either by lowering transaction costs or by providing incentives for partner organizations to pursue value creation initiatives, such as investing in relation-speciﬁc assets, sharing knowledge or combining complementary strategic resources. Bagley (2005), Ireland et al. (2002), Mayer and Argyres (2004) and Argyres and Mayer (2007) note that organizations possessing appropriate governance skills for managing and controlling interorganizational relationships extend their productive opportunity sets. Such organizations are able to address complementary resources and technologies from other organizations (Child and McGrath, 2001; Sanchez and Heene, 1997) and they may be in a better position to renew themselves, as their governance skills enable the internalization of cooperative experiences. In summary, the extent to which gains can be obtained from interorganizational collaboration appears to depend on the appropriate use of governance mechanisms (Sampson, 2004a; Mayer and Nickerson, 2005; Williamson, 2002). Unfortunately, the issue of how to manage and govern external relationships in order to gain competitive advantage has remained unsolved (Takeishi, 2001). To improve managerial practices and enhance the performance of interorganizational relationships (Barringer and Harrison, 2000), we thus need to increase our understanding of the governance structures and processes that are used to design and manage interorganizational relationships, and we have to improve our comprehension of the forces shaping collaborative agreements (Olk and Elvira, 2001; Osborn and Hagedoorn, 1997). Table 1.2 provides an overview of comments issued by various authors indicating that governance mechanisms and processes constitute important determinants of interorganizational performance (e.g. Grandori and Soda, 1995; Masten and Saussier, 2002; Reuer, 1999; Sampson, 2004a; Zollo and Singh, 2004). Table 1.2 also includes calls for further investigating the skills, mechanisms and processes associated with the governance of interorganizational relationships (Colombo, 2003; Thatcher, 2004; Wright and Lockett, 2003) and it points at opportunities for making progress in this ﬁeld (Anderson and Dekker, 2005; Shapira, 2000; Sobrero and

Introduction

9

Table 1.2 Signiﬁcance of and criticism on interorganizational governance research Authors

Citation

Masten and Saussier (2002: 273)

‘The growth in the analysis of inter-ﬁrm contractual relationships that has occurred in recent years is an indication of the importance economists associate with the issue of contracting and contract design’

Grandori and Soda (1995: 198)

‘. . . the whole body of literature on networks shows that the extent to which inter-ﬁrm relationships are formalized [. . .] is an important dimension of inter-ﬁrm organizing’

Reuer (1999: 13)

‘[Deriving value from alliances] . . . requires companies to select the right partners, develop a suitable alliance design, adapt the relationship as needed, and manage the end game appropriately’

Zollo and Singh (2004: 6)

‘Generally, it might be possible to achieve synergy only when ﬁrms carefully design and execute integration processes focused on extracting the gains associated with the combination of the two organizations. Accordingly [. . .] it is important to include as explanatory variables the activities necessary to extract those rents’

Sampson (2004a: 484)

‘One possible explanation for this performance diﬀerence across alliances is variation in alliance governance; speciﬁcally, whether alliance governance is appropriately chosen given the characteristics of the alliance’

Thatcher (2004: 92)

‘The growing enthusiasm for partnerships has created great demand for the skills required to manage them as well as for scholarship that can shed light on what those skills might be’

Wright and Lockett (2003: 2074)

‘Although examples of collaborative agreements are becoming increasingly common, our understanding of their operation and management does not reﬂect their expanding role in economic activity’

Colombo (2003: 1226)

‘More direct and ﬁne-tuned consideration of the speciﬁc coordination and control mechanisms incorporated in diﬀerent alliances [. . .] would be very useful to gain further insights’

Sobrero and Schrader (1998: 601)

‘A ﬁrst reading of the empirical studies collected for the metaanalysis reveals the absence of an integrated perspective that simultaneously considers the relationships between task characteristics, the contractual and procedural dimensions of inter-ﬁrm relationships, and the outcome of the relation’

Shapira (2000: 64)

‘The next step should be a more comprehensive perspective on governance. As Grandori (1997) suggested, it may be less fruitful to attempt to resolve past debates than it is to foster crosspollination among diﬀerent perspectives’

10

Table 1.2

Contracts and trust in alliances

(continued)

Authors

Citation

Anderson and Dekker (2005: 1751)

‘. . . a great deal of work is needed to understand management control practices that are emerging at the blurry boundaries of ﬁrms. This work [. . .] requires the researcher to become conversant in a broader body of business research’

Schrader, 1998). In particular, authors have noted that ‘an integrated perspective that simultaneously considers the relationships between task characteristics, the contractual and procedural dimensions of inter-ﬁrm relationships, and the outcome of the relation’ has remained absent (Sobrero and Schrader, 1998: 601; see also Faems et al., 2007). Others observe that ‘the next step should be a more comprehensive perspective on governance’, as ‘it may be less fruitful to attempt to resolve past debates than it is to foster cross-pollination among diﬀerent perspectives’ (Shapira, 2000: 64). Anderson and Dekker (2005: 1751) explain that this ‘requires the researcher to become conversant in a broader body of business research’. These comments indicate that a critical examination of the role of governance in interorganizational relationships is both timely and warranted. However, such an endeavour is unlikely to be valuable in the absence of a clear focus. The number of governance mechanisms that one could consider is so large, and the types of governance decisions that one could take into account is so diverse, that including them all would only obfuscate our view and hamper progression. In exploring the role of governance in interorganizational relationships, I therefore focus particularly on two types of governance that have received considerable and growing attention in the literature over the last decades, being contracting and trust.

DEFINITION AND TYPOLOGY OF CONTRACTING Parties in interorganizational relationships tend to ‘regulate their future conduct [as well as inputs and outcomes] ex ante by means of mutual forbearance and more or less formally speciﬁed contractual mechanisms’ (Dacin et al., 2007: 170). In fact, contracting constitutes a principal means of formalization in interorganizational relationships. A comprehensive deﬁnition of contracting therefore necessitates a closer look at formalization. Most concepts ending in ‘-tion’ are ambiguous with regard to process and outcome: ‘between the way one gets there, and the result’ (Baum and Rowley, 2002: 1). This also accounts for formalization, which refers both to

Introduction

11

the process of negotiating, codifying and enforcing inputs, outputs and behaviours (Ouchi and Maguire, 1975; Ouchi, 1979), and to the outcomes of this process in the form of contracts,3 rules and procedures (Aiken and Hage, 1966). The same distinction holds for contracting, which consists both of a ‘process of projecting exchanges into the future’ (Macneil, 1980: 4, italics added) and of the actual promises or obligations to perform particular actions in the future, which may be recorded in formal contracts, being the outcome of negotiation and contracting processes (Macneil, 1980). My ontological view of contracting covers both contracting processes (i.e. negotiation, codiﬁcation and enforcement) as well as contractual structures (i.e. clauses and terms). I focus as much on the contracting process – involving things such as deﬁning partners’ performance, duties and rights in future circumstances; deﬁning what should happen when parties do not hold to agreements; and assessing to what extent the contract can be legally enforced (Luo, 2007; Macaulay, 1963) – as on the contractual structures in which they eventuate, because I believe that contracting ‘accomplishes part of its purpose not just with the words agreed upon’, but also by means of the process through which parties arrive at these words, and through the ‘words discussed and ultimately rejected’ (Hill, 2001a: 56). Next to a deﬁnition, I develop a typology of contracting based on three of its main attributes (see Figure 1.4). The ﬁrst and most commonly discussed attribute refers to the degree to which inputs, behaviour and outcomes are codiﬁed and enforced, which may range from low to high (Faems et al., 2007; Luo, 2007). Before I proceed, let me explain what is meant by codiﬁcation and enforcement. Codiﬁcation conveys that explicit, systematic procedures are involved (Pearce et al., 1987), which help to create perceptual and conceptual categories that facilitate the classiﬁcation of phenomena (Boisot, 1998). It refers to explicitly recording or writing down aspects of inputs, outcomes and/or behaviour. Enforcement, instead, signiﬁes that codiﬁed agreements are ‘in force’. It permits parties to make believable promises to each other, so that the execution of agreements can ultimately be exacted (Luo, 2007; Schwartz and Scott, 2003).4 Enforcement does not necessarily mean that partner organizations are ‘forced to comply’; it implies that they act with the negotiation and contracting process and its outcomes in mind. Enforcement seldom takes place by actually appealing to courts or authority.5 Instead, the sheer existence of sources for ultimate appeal (Galanter, 1981; Salbu, 1997; Williamson, 1999),6 the wish to avoid ruining relationships and reputations, and considerations related to cost eﬃciency are generally suﬃcient to guarantee compliance by partner organizations (Antia and Frazier, 2001; Elfenbein and Lerner, 2003; Klein, 2002; Lazzarini et al., 2007). Moreover, contracts may be in force just

12

Contracts and trust in alliances Degree of contractual detail, complexity or specificity Low

Inputs/ outcomes

High

Domain of contracting

Processes/ behaviour

Intention behind contracting Coercive

Figure 1.4

Enabling

Three attributes of contracting

because partners are highly dependent on each other (Blois, 1972; Lazzarini et al., 2007; Richardson, 1972; Telser, 1980; Zollo et al., 2002). In these cases, ‘formalization into contracts is redundant because interests are convergent’ (Grandori, 2006: 129). As has been mentioned before, the attribute of contracting that is most commonly used by researchers concerns the degree of detail, speciﬁcity or complexity of contracts (e.g. see Anderson and Dekker, 2005; Barthélemy and Quélin, 2006; Makhija and Ganesh, 1997) and the length and intensity of negotiation and contracting processes associated with it. Variation on this dimension may stem, amongst others, from the prohibitively high costs involved with specifying, monitoring and enforcing all elements of economic performance for a wide range of possible contingencies. As a result, contracts are necessarily incomplete (Grossman and Hart, 1986) and parties are encouraged to align degrees of contractual detail, complexity or speciﬁcity with organizational, exchange and contextual characteristics (Williamson, 1991, 1996, 1999). It may also stem from diﬀerences in relative bargaining power, with lower bargaining power reducing a focal party’s ability to include speciﬁcations in the contract (Faems et al., 2007). A second attribute pertains to the domain of contracting, which may involve either the inputs and outcomes of a relationship or the behaviour of the contracting parties and the processes that take place during the course of the relationship (e.g. see Grandori and Furlotti, 2007; Koza and Lewin, 1998; Ouchi, 1979; Ouchi and Maguire, 1975; Schwartz, 2004; Stinchcombe, 2001). This distinction derives from the work of Katz and Kahn (1966), Simon (1947/1997) and Stinchcombe (2001), who have examined these concepts on an intraorganizational level. Katz and Kahn (1966: 298), for example, propose two major categories of policy making: ‘the formulation of organizational goals and objectives, and the formulation of

Introduction

13

strategies and procedures for achieving and assessing progress towards such goals’. In a similar vein, Simon (1997: 307) contends that someone ‘may be told what to do, but given considerable leeway as to how [he or she] will carry out the task’. Stinchcombe (2001: 51) refers to this distinction by stating that ‘abstract versions of procedures and technologies may be formulated in terms of their outcomes [. . .], or by the sequence of actions that are thought to reliably produce the best results’. Contracting of the expected outcomes of a relationship concerns the delineation of goals and the scope of a relationship (Cyert and March, 1963; Cheng and Van de Ven, 1996; Oxley and Sampson, 2004). It entails the inclination, determinedness and means to be able to hold on to this scope and work according to the goals set earlier on (McGrath, 2001). Contracting of inputs and outcomes further refers to the codiﬁcation and enforcement of what is to be accomplished (e.g. scope, goals), and by what means this has to be done. Contracting of processes and behaviours, instead, entails the coordination and adjustment of activities of interdependent parties (Sobrero and Schrader, 1998). It encompasses the speciﬁcation and supervision of operational or post-formation activities (McGrath, 2001), so that control can be exerted over these (Burns and Stalker, 1961). When contracting pertains to processes and behaviour, contracts specify, for example, terms and clauses concerning how to set up the relationship, how to operate and manage the relationship, and how to cooperate and resolve conﬂict between partners (Luo, 2002). In this case, contracting refers to the codiﬁcation and enforcement of how outcomes are to be realized.7 The resulting contracts contain series of clauses linking combinations of various possible elementary events to prescriptions of behaviour or elementary actions (Schwartz, 2004). The diﬀerence between contractual clauses pertaining to inputs and outcomes and contractual terms specifying behaviours and processes is illustrated here with an example of a contract aimed at the development of a custom-made printhead in an R&D alliance between an imaging company (GRAPH) and an inkjet technology ﬁrm (JET), as discussed by Faems et al. (2007: 24–5). [A]part from programme milestones, target dates, and performance standards that formalized JET’s expected outputs (i.e. delivery of the printheads), the ESH contract also contained contractual statements regulating the activities that JET was supposed to conduct in order to meet these milestones. For instance, it was stipulated that, during the ﬁrst six months of the ESH alliance, JET had to execute the following activities: ‘allocate resources to the programme and establish working practices . . . Deﬁne the detailed printhead speciﬁcation required by GRAPH . . . At the end of this stage the [JET] development team will produce a recommendation for the printhead design, and plans and detailed ﬁnancial estimates for the remainder of the development programme through to full production’. (ESH Agreement Annex 1: Project Description ESH)

14

Contracts and trust in alliances

Faems et al. (2007: 25) conclude that ‘In this way, GRAPH could not only monitor the outputs of JET’s activities but could also follow up the activities that JET had to conduct in order to arrive at these outputs.’ Finally, a third attribute of contracting refers to the intentions underlying contracting practices (Chaserant, 2003). In this respect, Adler (1993: 165) has noted that ‘subsequent generations of researchers have tended to focus on the punishment-centred form and the associated compliance logic of bureaucracy’ and the processes associated with it, such as contracting. In a study on the formalization of workﬂows in an intraorganizational context, Adler and Borys (1996) take issue with this observation and they distinguish enabling types of formalization, designed to enable employees or partner organizations to master their tasks, from coercive types of formalization, aimed at coercing eﬀort, forcing reluctant compliance and displacing opportunism.8 The purpose of the enabling type of formalization is to achieve ‘coordination and higher levels of understanding’ (Zollo and Singh, 2004: 16) and to motivate participants in interorganizational relationships by other means than oﬀering extrinsic rewards (Lindenberg, 2003). In contrast to coercive types of formalization, the focus is no longer on ‘the sanctioning of modes of social conduct’, but on ‘the constitution of meaning’ (Giddens, 1984: 18).9 In line with this dichotomy, I distinguish coercive from enabling types of contracting, and I suggest that the eﬀectiveness of negotiation and contracting processes as well as their outcomes – contract clauses and terms – may vary owing to the manner in which they are initiated, whether by imposition or agreement. A description of two subsequent R&D alliances between an imaging company (GRAPH) and an inkjet technology ﬁrm (JET) provided by Faems et al. (2007) oﬀers a neat illustration here. In the ﬁrst alliance, GRAPH’s managers saw that things went wrong, but they were contractually forced to stay on the sidelines. As a comment of one of GRAPH managers illustrates, the contract for the second alliance was therefore designed to reduce control by JET regarding the sharing of proprietary knowledge (Faems et al., 2007: 25): From the SSH project we had learned that the ESH project should be deﬁned in an alternative way. Therefore, the ESH project was initiated from another perspective. Now, GRAPH wanted to know more details and wanted to understand why some processes had a low yield.

DEFINITION AND TYPOLOGY OF TRUST Trust features as the second major construct in this book. Rousseau et al. (1998: 395) deﬁne trust as ‘a psychological state comprising the intention

Introduction

15

to accept vulnerability based upon positive expectations of the intentions or behaviour of another’. Their deﬁnition implies that trust involves choice (Luhmann, 1988) and the existence of risk (Mayer et al., 1995). Nooteboom also explicitly addresses these points in his deﬁnition of trust, stating that it ‘entails that one does not expect to be harmed by a partner even though she has both the opportunity and the incentive to be opportunistic’ (1999: 203). His deﬁnition indicates that trust consists of a subjective state of positive expectations (Das and Teng, 2001) and that the partner and its behaviour are the objects of trust (Inkpen and Currall, 2004). In an attempt to distinguish the diﬀerent components of trust, Zaheer et al. (1998: 143) deﬁne trust as an exchange partner’s expectation that the other party can be relied on, will behave as predicted, and will act fairly. This deﬁnition emphasizes the reliability, predictability and fairness as focal components of trust (Poppo et al., 2008), which coincide with the three ‘factors of trustworthiness’, being ability, benevolence and integrity. Ability concerns the context-speciﬁc skills and competencies that enable one to trust another to fulﬁl a given task. Benevolence regards the extent to which one is believed as wanting to do ‘good’. Finally, integrity relates to one’s willingness to follow mutually acceptable principles (Mesquita, 2007: 73). Trust thus not only encompasses the belief in the ability of a partner organization to accomplish a task, but also the belief in the goodwill or positive intentions of this partner, and the perception that it adheres to acceptable values (Mayer et al., 1995; Serva et al., 2005). Such expectations are conﬁrmed ‘when parties (1) demonstrate reliability by carrying out their promises, (2) act fairly when dealing with each other, and (3) exhibit goodwill when unforeseen contingencies arise’ (Krishnan et al., 2006: 895). They are further reinforced and supported through the ‘socialpsychological bonds of norms, sentiments and friendships’ as well as the faith in the morality and goodwill of others (Ring and Van de Ven, 1994: 93; Uzzi, 1997). In line with the aforementioned, I follow Mayer et al. (1995: 712) in deﬁning trust as ‘the willingness of a party to be vulnerable to the actions of another party based on the expectation that the other will perform a particular action important to the trustor, irrespective of the ability to monitor or control that other party’. Moreover, I recognize that individual managers and not organizations as a whole trust their partners (Dodgson, 1993; Zaheer et al., 1998). I therefore refer to interorganizational trust and not interpersonal trust, or ‘the extent of trust placed in the partner organization by the members of a focal organization’ (Zaheer et al., 1998: 142). Trust is frequently argued to develop from prior interactions. It is important to note, however, that trust does not only have its origins in the shadow of the past, but also in the shadow of the future. In fact, Poppo et al. (2008)

16

Contracts and trust in alliances

advance and empirically substantiate that both aspects are strongly intertwined, having a synergistic eﬀect on trust building. They contend that ‘the past represents exchanges that have developed strong social institutions that support the development of trust – yet, without a shadow of the future, an end game looms large on the horizon and parties deviate from the prevailing norms and routines in order to maximize self-interest’ (Poppo et al., 2008: 3). Poppo et al. (2008: 7) advance the point of view that expectations of continuity mediate the relationship between experience and trust, which ‘is based on the logic that prior history generates learning of a non-trivial degree, which increases perceptions of stability and thus continuity of the interorganizational exchanges’ from which trust emerges. In contrast, even when continuity is expected, without a long history the requisite social institution is relatively weaker and underdeveloped, leading to low levels of trust’ (Poppo et al., 2008: 3). At the same time, past experience also moderates the relationship between expectations of continuity and trust, as developing trust is only sensible when continuity is required or desired.10 After all, a longer shadow of the future leaves more opportunities to proﬁt from the shadow of the past (Poppo et al., 2008). In fact, without it, exchanges revert to the classic market ‘atomistic’ transaction (Macneil, 1980: 854). In this case, contracts gain in signiﬁcance, at the cost of trust and other forms of relational governance (Lazzarini et al., 2007).

INTERORGANIZATIONAL PERFORMANCE Next to contracting and trust, interorganizational performance concerns a third major construct in this study. Unfortunately, a precise and consistent deﬁnition of collaborative success and failure is still lacking in the literature, the diversity of measures that have been used is high and consensus on measuring the construct does not yet exist (Krishnan et al., 2006; Mohr and Puck, 2005; Sarkar et al., 2006; Yan and Gray, 2001). Researchers have tried to make sense out of the breadth of performance measures available, in several ways. Some authors have developed conceptual frameworks for organizing the available approaches to interorganizational performance measurement (e.g. Gray, 2000; Olk, 2002; Park and Ungson, 2001).11 Others have empirically evaluated the compatibility of various measures (e.g. Ariño, 2003; Geringer and Hébert, 1991; Glaister and Buckley, 1998; Hagedoorn and Cloodt, 2003). Finally, authors have argued that diﬀerent contexts and research questions call for distinct performance measures (e.g. Gulati and Zajac, 2000; Reuer and Koza, 2000; Yan and Gray, 1995). These performance measures all appear to have their own problems. Relationship mortality, for example, does not account for the fact that

Introduction

17

termination may indicate that partner organizations have attained their strategic objectives, or that they exit a relationship in a better competitive shape (Das and Teng, 2000; Gulati, 1998). It also does not consider the fact that organizations could pursue an options strategy to accomplish their objectives, developing large portfolios of relationships from which only one or a few need to be successful to prosper (Vassolo et al., 2004). In such cases, termination of a relationship may hinge on the comparative beneﬁts generated in other initiatives. Moreover, it does not make allowances for gradations of performance (Gulati, 1998), although ‘it is only realistic to expect alliances to fail in some respects (e.g. attaining original purposes) and to succeed in others (e.g. generating spin-oﬀs)’ (De Rond, 2003: 9). In addition, continuation of a relationship is not always in the partner’s best interest (Reuer and Koza, 2000), as becomes apparent from a comment issued by the divisional president of a US ﬁrm, who ended a long-standing joint venture with a Japanese ﬁrm. He indicated that ‘although the partnership was sound and the alliance had been very successful, the alliance no longer ﬁts with ﬁrm strategy’ (Inkpen and Li, 1999: 35).12 A more general problem with many performance measures is their focus on outcomes of relationships. Lately, several researchers have stressed that new insights may emerge by shifting the focus from solely measuring outcome performance to a view in which process performance measures are included (Ariño, 2003; Kumar and Nti, 1998). These measures can capture the fact that participants in interorganizational relationships might simply appreciate collateral experiences such as a bold move or a good meeting (March, 1999), and they could account for the fact that participants do not only judge results, but also the intentions behind the behaviour of others (Chaserant, 2003) and the extent to which they are satisﬁed with the patterns of interaction with their partner (Kumar and Nti, 1998). Support for the signiﬁcance of process performance is aﬀorded by De Rond (2003), who found that assessments of interorganizational performance and success in two alliances between pharmaceutical and biotechnology ﬁrms were based not solely, or even primarily, on economic or strategic considerations, but rather on cognitive processes of individuals in these alliances. A deﬁnition of interorganizational performance should therefore capture both outcome and process performance. Outcome performance then captures the eﬀectiveness and eﬃciency of a relationship, including the degree of overall performance satisfaction, the presence of net spillover eﬀects, the extent to which strategic goals are fulﬁlled, and parties’ adherence to schedules and budgets (see Ariño, 2003; Hoang and Rothaermel, 2005; Mayer, 2006). Process performance, instead, pertains to the relational quality of cooperative endeavours (Ariño, 2003). It entails things such as the ease or smoothness of cooperation (Luo, 2002), the extent to which conﬂicts

18

Contracts and trust in alliances

prevail in the relationship, and partners’ satisfaction with coordination and communication processes (Poppo and Zenger, 2002). Outcome performance and process performance have been argued to inﬂuence each other (Kumar and Nti, 1998; Zajac and Olsen, 1993) or to be inseparable (Parkhe, 1993b). Researchers have suggested, for example, that ‘the pattern and quality of interaction between partners throughout the life of the [alliance] relationship determines the value created’ (Madhok and Tallman, 1998: 333). Findings from Ariño (2003) and Hagedoorn and Cloodt (2003) support this assertion, suggesting that managers may need no complex metrics to evaluate interorganizational performance, as these measures are highly correlated. Accordingly, I refer to both processes and outcomes when discussing interorganizational performance in this study and I deﬁne interorganizational performance as ‘the degree of accomplishment of the partners’ goals [. . .], and the extent to which their pattern of interactions is acceptable to the partners’ (Ariño, 2003: 23). Evidence on the relationship between contracting, trust and interorganizational performance is mixed and narrow (Jap and Ganesan, 2000; Mayer and Nickerson, 2005; Poppo and Zenger, 2002; Sampson, 2004a; Sobrero and Schrader, 1998), something which might stem from the fact that diﬀerent performance measures are being used in diﬀerent analyses (Sobrero and Roberts, 2001, 2002). Moreover, the majority of these studies does not take into account the fact that ﬁrms arrive at their governance solutions purposefully, as opposed to randomly (Hamilton and Nickerson, 2003: 520; for exceptions, see Geyskens et al., 2006; Mayer and Nickerson, 2005; Rooks et al., 2006; Sampson, 2007). The most one can say is that the relationships between contracting and interorganizational performance is likely to follow a curve-linear path, where too little contracting gives rise to chaos and destructive or opportunistic behaviour and where too much contracting causes rigidity and curbs creativeness and entrepreneurial activities (Foss et al., 2007; Luo, 2002; Mintzberg, 1994; Sampson, 2004a).13 In this respect, Mintzberg (1994: 386) notes that ‘formalization is a double-edged sword, easily reaching the point where help becomes hindrance’. The same accounts for the relationship between trust and interorganizational performance (see also Chapter 4), where very low levels of trust lead to suspicion and very high levels of trust entail naïveté. Establishing unequivocal relationships between contracting, trust and interorganizational performance is not an easy task, since these relationships may be contingent on the stage of development (Jap and Ganesan, 2000), the type of relationship and the collaborative context in which it is embedded (Oxley, 1997; Sampson, 2003). They may also vary with the domains (inputs, outcomes, processes or behaviour) to which trust and contracting pertain (Ouchi and Maguire, 1975; Ouchi, 1979, 1980), and

Introduction

19

with the aims that managers have in mind when deciding on the governance of their relationships (Adler and Borys, 1996; Madhok, 2002). In addition, trust and contracting may have distinct eﬀects on a range of performance measures (Sobrero and Roberts, 2001, 2002) and other governance forms may moderate these eﬀects. Finally, trust and contracting are only two of the variables among a myriad of factors and processes aﬀecting interorganizational performance (Beamish and Berdrow, 2003).

NEED FOR AN INTEGRATIVE PERSPECTIVE ON INTERORGANIZATIONAL GOVERNANCE To summarize the discussion thus far, I have advanced that there is a paramount need for a more integrative perspective on interorganizational governance, while any eﬀort at developing such a perspective should at least focus on a limited number of governance mechanisms so as to minimize possible confusion and indeterminacy. I then suggested that, throughout recent decades, contracting and trust have emerged as crucial aspects of interorganizational governance, which leads to a more reﬁned research question: what role do contracts and trust play in interorganizational relationships? To explore this issue, I build on the two main theoretical perspectives currently prevailing in the literature, which tend to focus either on the control or on the coordination function of interorganizational governance (Foss and Foss, 2005; Gulati and Singh, 1998; Madhok, 2002; Salbu, 1997). I contend that contributions to this literature typically inquire into the relationship between various governance mechanisms or processes and its antecedents, or into their relationship with performance (e.g. see Anderson and Dekker, 2005; Leiblein, 2003; Mayer and Nickerson, 2005; Poppo and Zenger, 2002; Sampson, 2004a; Sobrero and Schrader, 1998; Stinchcombe, 2001). The ﬁrst group of inquiries presumes that antecedents of governance mechanisms and processes, such as complexity, asset-speciﬁcity or measurability are associated with the need or the ability to coordinate and control interorganizational behaviour and outcomes (e.g. Barthélemy and Quélin, 2006; Carson et al., 2006; Gerwin, 2004; Geyskens et al., 2006; Helm and Kloyer, 2004; Luo, 2002; Reuer and Ariño, 2007). The second category of studies focuses on the relationship between governance and interorganizational performance (e.g. Sobrero and Schrader, 1998; Mayer and Nickerson, 2005; Poppo and Zenger, 2002; Rooks et al., 2006; Sampson, 2004a, 2007).14 I capture these generic approaches to the research problem in what I call the ‘antecedents–governance–performance model’. A visual representation of this framework is depicted in Figure 1.5.

20

Contracts and trust in alliances Research stream one

Antecedents Organization level Exchange level Context level

Governance Forms Mechanisms Processes

Performance Value discovery Value creation Value appropriation

Research stream two

Source: Adapted from Vlaar et al. (2007).

Figure 1.5

Antecedents–governance–performance framework

Although the richness and variety of previous studies focusing on the antecedents–governance–performance framework have signiﬁcantly contributed to our understanding, an integrative perspective on the role of contracts and trust in interorganizational relationships has remained absent in the literature thus far (e.g. Faems et al., 2007; Foss, 1999; Leiblein, 2003; Sobrero and Schrader, 1998; Stinchcombe, 2001). Similar to research on interorganizational collaboration in general (Oliver and Ebers, 1998), studies on interorganizational governance have built upon a cacophony of seemingly heterogeneous concepts, theories and research results, which generally prohibits a clear accumulation of knowledge and conceptual consolidation. In order to establish a less fragmented, disjointed and myopic perspective (Bell et al., 2006; Oliver and Ebers, 1998), throughout the manuscript I develop an integrative research framework, which is depicted in Figure 1.6. The framework illustrates that contracting and trust are aﬀected by organization-, exchange- and context-level antecedents. These antecedents may inﬂuence the ability as well as the need to write and apply contracts and to trust a partner. Moreover, the framework shows that contracting and trust aﬀect performance, as both governance mechanisms exhibit positive as well as negative consequences, or functions and dysfunctions. Finally, yet importantly, the framework suggests that performance eﬀects of contracting and trust can be categorized in terms of value creation and value appropriation – constructs that are common to the literature – as well as value discovery. Although the discovery of value has received little attention in research on interorganizational governance, it assumes a central position in the remainder of this book.

21

Introduction

Positive consequences

Need to govern Antecedents Organization level Exchange level Context level

Performance Value discovery Value creation Value appropriation

Governance Contracting Trust

Ability to govern

Negative consequences

Figure 1.6 Integrative research framework on the role of contracts and trust

RESEARCH THEMES AND QUESTIONS Based on the discussion thus far and the research framework presented in Figure 1.6, six research themes were identiﬁed that deserve further inquiry. I selected these themes because each of them promises to extend the antecedents–governance–performance model dominating the literature, and because they function as arenas for joining two or more theories, disciplinary ﬁelds or perspectives on the role of contracting and trust in interorganizational relations. By doing so, I capitalize on the remark of Oliver and Ebers (1998: 573) that ‘there might be a greater opportunity for fruitful cross-disciplinary and cross-perspective dialogue than is often realized’ in interorganizational research. I also embrace Kogut’s (1988) idea that attempts to melt diﬀerent theories should be encouraged as they facilitate the development of richer, more insightful explanations for interorganizational phenomena. At the same time, I cherish existing perspectives on alliance governance to a certain extent by accepting the antecedent–governance–performance model as a basis for my work. Starting from such a framework facilitates theoretical progress, as it allows us to start from a coherent knowledge foundation (Bell et al., 2006). By investigating the research questions connected to each of the six themes, I seek to develop new insights and unite apparently disparate research contributions, while preventing research on governance issues in interorganizational relationships from degenerating into a chorus of dissonant voices. More speciﬁcally, the purpose of this study is twofold. First, I seek to develop a more integrative and comprehensive perspective on the role of contracting and trust in interorganizational relationships than is currently envisaged in the literature. I complement the generic antecedents–governance– performance framework on interorganizational governance that dominates

22

Contracts and trust in alliances

the literature, with insights grounded in a variety of theoretical perspectives and backgrounds (e.g. dialectics; sensemaking; mindfulness; law; psychology). By doing so, I answer calls for integrative theory development in a chaotic research ﬁeld (e.g. see Faems et al., 2007; Koza and Lewin, 1998; Osborn and Hagedoorn, 1997). This should allow researchers and practitioners to better deﬁne the governance issues with which they are struggling, and it should assist them in positioning these issues in a broader perspective. Second, I purport to close the gap between theories of what people do and observations of their actual behaviour (Jarzabkowski, 2004). This hiatus emerges because theoretical developments on interorganizational governance are highly fragmented, predicting behaviour on the basis of isolated sets of arguments, disconnected from the versatile nature of actual experience. I address this issue by viewing the role of contracting and trust in interorganizational relationships from diﬀerent angles, and by highlighting their multifaceted nature and intricate relationships. The six research themes all build on the generic approach to the research problem presented in the literature, but they also stipulate complementary explanations as to the role of contracting and trust in interorganizational relationships. Each of them focuses on a peculiar part of the research problem, as visualized in Figure 1.6. The order in which the themes are discussed is far from arbitrary. I have deliberately chosen to start with a discussion on several ﬁrm and exchange characteristics that are generally acknowledged to inﬂuence the complexity, detail or speciﬁcity of contracts in interorganizational relationships. The ﬁrst theme thereby addresses when and to what degree contracting is likely to occur. Theme two subsequently elaborates on the multifarious relationships between contracting and trust, whereas theme three emphasizes the functions of negotiation and contracting in an attempt to reveal why contracting takes place. Building on this, theme four explores how the development and application of formal contracts, rules and procedures inﬂuences interorganizational performance. If the locations of these ﬁrst four research themes were highlighted in Figure 1.6, one would realize that theme one is situated on the left, and that we move further to the right with themes two, three and four. Theme ﬁve further qualiﬁes the generic antecedents–governance–performance framework by showing that standardization, an attribute of negotiation and contracting processes, may moderate the relationships captured in this framework. Finally, theme six challenges us to look beyond negotiation and contracting practices, showing that they are intricately related to other governance forms and mechanisms, such as partner selection and advance payments. As has been memorized before, the common denominator of the six research themes consists of their focus on intersections. The ﬁrst theme, for

Introduction

23

example, confronts theories that are primarily concerned with the need to contract with theories that focus on the ability to contract. In the second theme, I juxtapose diﬀerent notions on the relationships between contracting and trust. In theme three, I explore a range of theories attributing distinct virtues or functions to contracting. Theme four, which is labelled ‘duality and dialectic tensions’, reconciles arguments on the functions and dysfunctions of formalization, illustrating how managers may cope with their coexistence. Theme ﬁve discusses contract standardization and unites research on standardization stemming from the contracting and law literatures with studies on mindfulness deriving from cognitive psychology and inquiries into interorganizational cooperation conducted by management scholars. Finally, theme six capitalizes on contributions from various research streams to scrutinize contracting’s relationships with other governance mechanisms. Throughout the book, I thus combine diﬀerent theories, disciplinary ﬁelds and perspectives on the role of contracting and trust in interorganizational relationships, so as to subvert ‘the provincialism that comes with paradigm conﬁnement’ (Gioia and Pitre, 1990: 588) and arrive at a more reﬁned and comprehensive view on their role in interorganizational relationships. Theme One: Need versus Ability to Contract In theme one, I deviate from the antecedents–governance–performance framework by elaborating on the tensions that arise between the need and the ability to contract inputs, behaviour and outcomes. In this study, the ‘need to contract’ denotes the fact that contracts are requisite, desirable or useful. The ‘ability to contract’, instead, concerns one’s capacity, competence or position to write a contract. Brieﬂy stated, I posit that existing studies either tend to discuss the inﬂuence of antecedents on the need, or on the ability to contract (see Carson et al., 2006; Gerwin, 2004; Kirsch, 1997). In this respect, Carson et al. (2006) suggest that the main part of the literature has paid attention to factors which are presumed to increase the need for formal governance, such as asset-speciﬁcity, whereas factors representing the ability to govern relationships, such as measurement diﬃculty or monitoring problems, have received far less attention (see also David and Han, 2004). I take this argument further by proposing that antecedents of contracting as advanced by transaction cost economists (e.g. Williamson, 1985, 1991), researchers on prior cooperation (Gulati, 1995; Uzzi, 1997), and researchers examining dynamic capabilities (Gulati and Singh, 1998) bring about conﬂicting forces. In light of these theories, I expect that assetspeciﬁcity, exchange complexity, the absence of prior cooperation and

24

Contracts and trust in alliances

small organizational sizes aggravate a focal actor’s perceived need to contract, while concurrently decreasing its ability to do so. In theme one, I therefore investigate the concurrent eﬀects of such antecedents on the complexity of contracts. This promises to shed light on several contradictory ﬁndings emerging from the literature. An example concerns prior cooperation, which is believed to act as a substitute for formal governance, because it reduces the need for safeguards (Das and Teng, 2001; Dyer and Singh, 1998; Gulati, 1995; Inkpen and Currall, 2004). At the same time, however, prior cooperation may also act as a complement to formal governance, because it raises the ability to write more detailed, complex and speciﬁc contracts (Mayer and Argyres, 2004; Mellewigt et al., 2007; Poppo and Zenger, 2002). To illuminate such apparent contradictions, I investigate to what extent relationships between diﬀerent antecedents – on both organization and exchange levels – have opposite eﬀects on the ability and the need to contract. Moreover, I explore how organizations deal with the resulting tensions. Theme Two: Coevolution of Contracting and Trust In theme two, I assert that, despite the fact that ‘there is a basic question concerning the role of formal versus informal approaches to the management of’ interorganizational relationships (Heckman, 1999: 142), most studies on contracting in interorganizational relationships pay insuﬃcient attention to its relationship with relational governance, in particular trust. Empirical results, however, ‘suggest a need to explore more carefully and predict more cautiously the relationship between formal contracts and relational governance’ (Poppo and Zenger, 2002: 721). This chimes with the observation that the relationship between trust and control remains far from clear (Maguire et al., 2001; Sydow and Windeler, 2003) and that much theoretical input is still needed to understand how trust and formal contracts work as governance mechanisms (Bachmann, 2001). More speciﬁcally, researchers have noted that little attention has been paid to the evolution of both phenomena in cooperative relationships (De Wever et al., 2005; Inkpen and Curall, 2004; for notable exceptions, see Ferrin et al., 2005; Klein Woolthuis et al., 2005; Serva et al., 2005). As a result, practitioners are frequently confronted with conﬂicting recommendations (see Huxham and Beech, 2003) and academics are left with unclear perspectives on the evolution of contracting and trust in interorganizational relationships. In the second theme, I therefore investigate how contracting and trust evolve in interorganizational relationships, highlighting the salience of and the interplay between both governance forms in interorganizational relationships.

Introduction

25

Theme Three: Functions of Negotiation and Contracting Theme three is born out of the observation that most studies on contracting and other forms of formal interorganizational governance tend to focus on aspects of coordination, control and, to a lesser extent, legitimacy (see for instance Dacin et al., 2007; Gulati and Singh, 1998; Kale et al., 2001; Madhok, 2002; Meyer and Rowan, 1977; Salbu, 1997). Mainstream theories generally pass over the fact that contracts and the negotiation and contracting processes from which they emerge may have other functions (some notable exceptions are Ariño and Ring, 2004; Kaghan and Lounsbury, 2006; Lindenberg, 2003). Nevertheless, several authors suggest that alternative explanations and novel understandings of formal organizational structures and practices have become imperative (see Table 1.3). Meyer and Rowan (1977), for example, note that control and coordination are not the only functions of formal governance. In a similar vein, Hatch (1999) argues that changes in business environments cause traditional understandings of organizational structure to break down, thereby implicitly calling for alternative views on the functioning of formal governance mechanisms in modern society. Relatedly, Foss (2001: 4) posits that there is still little Table 1.3

Need for alternative explanations of formal structures

Meyer and Rowan (1977: 343)

‘Formal organizations are endemic in modern societies. There is need for an explanation of their rise that is partially free from the assumption that, in practice, formal structures actually coordinate and control work’

Hatch (1999: 75)

‘As business becomes more adaptable and ﬂexible in response to shifting demands and opportunities in their globalizing markets, traditional understandings of organizational structure are breaking down’

Simons (1990: 142)

‘Management theorists must strive to understand better the dynamic relationship between strategy and management control processes. This means [. . .] opening up the meaning of management control to a broader notion . . .’

Foss (2001: 4)

‘There is still little understanding of how formal control impacts processes of knowledge sharing (transfer), integration, and creation’

Klein Woolthuis et al. (2005: 834)

‘The general conceptualization of contracts as unidimensional legal safeguarding instruments is wrong. Our cases show that contracts may have diﬀerent functions, which can also be social in nature’

26

Contracts and trust in alliances

understanding of how formal control inﬂuences processes related to the sharing, integration and creation of knowledge. Klein Woolthuis et al. (2005: 834) add that contracts may have many functions beyond control. Finally, Simons (1990) concludes that theorists have to open up the meaning of management control to a broader notion. Consistent with the work of other authors (e.g. Kaghan and Lounsbury, 2006; Klein Woolthuis et al., 2005), Simons stresses that formal control systems may be deployed for multiple reasons and purposes, and that they may have a multitude of functions and dysfunctions. These arguments elicit the question as to whether contracts serve functions beyond coordination, control and legitimacy. They call for research on the interrelationships between contracts and contracting processes, the functions that can be attributed to contracting, and its performance consequences (see Faems et al., 2007; Luo, 2002; Madhok, 2002). By delving into these issues, theme three complements views on contracting as being a means to coordinate, control or legitimize interorganizational activities and outcomes with an alternative perspective viewing it as a ‘means to give, make, demand and break sense’. This helps to explain why contracts are encountered in situations where, regarded from existing perspectives, one would not expect them. It also clariﬁes how contracting might assist partners in solving problems of understanding, transferring pre-existing understandings and co-creating novel understandings so as to discover, create and appropriate value. Theme Four: Duality and Dialectic Tensions Theme four deviates from the mainstream literature by explicitly considering a particular duality inherent in formal contracts, rules and procedures (see Das and Teng, 1998). Earlier studies (e.g. Mintzberg, 1994; Luo, 2002; Williamson, 1985) have recognized that formalities may have functions or ‘observed consequences of social patterns that change existing conditions in the direction of socially valued objectives’, as well as dysfunctions: ‘observed consequences of social patterns that change existing conditions in the direction opposite to socially valued objectives, or consequences that interfere with the attainment of valued objectives’ (Blau, 1955: 11). However, they generally suggest that managers have to match these formalities with organization- and exchange-level characteristics in such a way that transaction costs are minimized (Williamson, 1985, 1991) and transaction value is maximized (Foss and Foss, 2005; Ghosh and John, 1999; Madhok, 2002). These inquiries presume that managers are mainly preoccupied with assessing the ‘right’ degree of formalization, in light of a bunch of organization and exchange characteristics.

Introduction

27

However, these studies oﬀer little guidance on how managers can cope with the tensions arising from the coexistence of formalization’s functions and dysfunctions. These tensions cannot always be solved by spatial or temporal separation (Ring and Van de Ven, 1989) and instead have to be managed (Huxham and Beech, 2003). Likewise, I draw theorizing away from generic perspectives in which formalization is determined by organization or exchange characteristics. More speciﬁcally, I shift the attention towards a view leaving more room for managerial inﬂuence and the management of tensions deriving from coexisting positive and negative consequences of formalization (see Das and Teng, 2000; De Rond, 2003; De Rond and Bouchikhi, 2004). In this way, I illuminate the trade-oﬀs that managers face when ascertaining the most appropriate degree of formalization for a particular relationship. Moreover, I show how managers may cope with and capitalize on these tensions, by analysing a case study of an alliance between two multinationals. Theme Five: Standardized Contracting Practices Theme ﬁve extends the generic antecedent–governance–performance framework with an inquiry into an important attribute of negotiation and contracting processes. It oﬀers an arena for discussing how the common practice of using standard contracts and standardized procedures for negotiating and contracting, provisionally deﬁned as established contractual methods that are followed routinely (Cohen and Bacdayan, 1994) and which are created and reﬁned over multiple cycles of exchange (Subramani and Venkatraman, 2003), inﬂuences the role of contracting in interorganizational relationships. Although standard contracts and standard procedures for negotiating and contracting are omnipresent (Korobkin, 2003), generic perspectives on the role of contracting in interorganizational relationships do not yet incorporate the inﬂuence of standardization. Apart from some incidental research in law schools (e.g. Epstein, 1999; Goetz and Scott, 1985; Kahan and Klausner, 1996, 1997; Korobkin, 2003), hardly any inquiries are undertaken on this subject. In theme ﬁve, I address this imbalance between research and practice. I ﬁrst explain why managers of interorganizational relationships deploy standard contracts and standard procedures for negotiation and contracting. Subsequently, I discuss the disadvantages related to the standardization of negotiation and contracting practices. Most notably, I exploit the assumption that standardization of contracting practices may reduce the degree of mindfulness with which contracts are negotiated and formulated (see Langer, 1989; Ryle, 1949). The results of this theme may serve as a basis for researchers and practitioners to decide whether and when standardization is appropriate.

28

Contracts and trust in alliances

Theme Six: Governance Trajectories Finally, in theme six, labelled ‘governance trajectories’, I signal that empirical inquiries following the generic antecedent–governance–performance framework tend to be rather static, concentrating on only one or a few governance modes in isolation (Geringer and Hébert, 1989; Kirsch, 1997).15 This is at odds with observations that governance mechanisms are strongly interconnected, that multiple governance mechanisms may have their bearing on interorganizational performance and that managers have various governance mechanisms at their disposal for managing interorganizational relationships. Reuer (1999), for instance, contends that potential value creation in interorganizational relationships involves not only appropriate partner selection, but also the adoption of speciﬁc interorganizational designs. Moreover, Klein (2002: 62) notes that ‘increased contractual speciﬁcation involves rent-dissipating search and negotiation costs’. Similarly, research on the relationship between formal and relational governance mechanisms (see Gulati, 1995; Luo, 2002; Poppo and Zenger, 2002) gives testimony to the existence of highly intricate and dynamic relationships between diﬀerent governance mechanisms. Anderson and Dekker (2005) therefore suggest that an important direction for future research involves investigating larger sets of governance mechanisms simultaneously. I therefore establish the concept of governance trajectories, which comprise sequences of interrelated decisions that are made to control, direct or inﬂuence the actions and conduct of participants during successive stages of the life cycle of interorganizational relationships. By examining how a number of organization-level and exchange-level factors impinge on various governance choices, and by demonstrating how these governance choices relate to each other, I illuminate the fact that interorganizational management comprises a series of governance decisions. My results indicate that researchers and managers should view interorganizational governance as a dynamic process rather than a static series of decisions.

SCOPE OF THE STUDY The principal factor used to delineate the scope of this study pertains to the forms by which economic activities can be organized (see step one in Figure 1.7). The choice for either of these governance forms is frequently labelled in terms of the ‘make-buy-or-ally’ decision. Williamson (1991) refers to this as ﬁrst-order economizing, that is, getting the governance mode right. The most commonly used basis for this choice concerns a

29

Introduction

1

Market transactions

2

Mode 1, Mode 2, ……………………………………………………Mode N

3

Contractual complexity, trust and governance processes

Figure 1.7

Interorganizational relationships

Hierarchies

The organization of economic activity

comparative assessment of transaction cost across governance forms (Williamson, 1985). However, others have suggested alternative assessments of discriminating alignment. Hsieh et al. (2007) and Nickerson and Zenger (2004), for example, suggest that the complexity of a problem has to be aligned with the governance form chosen. In this case, problems with low levels of interaction between knowledge sets tend to be organized by the market, problems requiring moderate interaction between knowledge sets tend to be organized by authority-based hierarchy, and problems demanding high levels of interaction among knowledge sets tend to be organized by consensus-based hierarchies. I do not focus on such a ‘make-buy-or-ally’ decision, as ‘perhaps the type of governance mode does not matter so much [compared to] as what actually goes on within a mode’ (Carson et al., 2006: 1072). The organization of activities within diﬀerent governance modes may, for example, show strong commonalities. Some collaborating ﬁrms, for example, gain ‘the advantages of vertical integration, without assuming the risks or rigidity of ownership’, a situation which is described as vertical quasi-integration (Blois, 1972: 253). Such a situation may occur when prospects of future gains and the degree of interdependence between partners, deriving from such factors as relation-speciﬁc investments, a limited number of alternatives, the need for highly specialized knowledge and qualitative coordination, and time compression diseconomies to internalization, render it diﬃcult for ﬁrms to maintain managerial independence from their partners (Blois, 1972; Richardson, 1972). Similarly, diﬀerent governance modes may involve similar governance mechanisms and processes (e.g. negotiation and contracting), rendering inquiries into the latter applicable across a larger number of situations (Thatcher, 2004). Moreover, ‘[a]rguments designed to prove the inevitability of this or that particular form of organization are

30

Contracts and trust in alliances

hard to reconcile [. . .] with the diﬀerences that exist within each of these’ (Richardson, 1972: 896). Finally, governance modes may be complementary, rendering comparative assessments of the appropriateness of governance modes less valuable (Grandori, 1997, 2007). I therefore exclude pure market-based transactions and vertically integrated forms of organization from the discussion. This means that I restrict the study to the role of contracting and trust within interorganizational relationships, such as joint ventures, strategic alliances and buyer–supplier, outsourcing and oﬀshoring relationships. Such relationships become pertinent when ‘vertical integration is neither economical nor technically feasible and arms-length transactions cannot meet demands for customization’ (Anderson and Dekker, 2005: 1737). As Richardson (1972: 892) stated: They exist because of the need to co-ordinate closely complementary but dissimilar activities. This coordination cannot be left entirely to direction within ﬁrms because the activities are dissimilar, and cannot be left to market forces in that it requires not the balancing of the aggregate supply of something with the aggregate demand for it but rather the matching, both qualitative and quantitative, of individual enterprise plans.

Richardson (1972: 885) oﬀers the example of plumbing work on a building contract, noting that: [it] may be subcontracted on the basis of competitive tenders for the individual job. Frequently, however, the relationship between the parties acquires a degree of stability, which is important for two reasons. It is necessary, in the ﬁrst place, to induce sub-contractors to assume the risks inherent in a rather narrow specialization in skills and equipment; and, secondly, it permits continuing cooperation between those concerned in the development of speciﬁcations processes and designs. [That is, it allows for qualitative coordination].

Partners in these relationships can exert only limited degrees of control (Gomes-Casseres, 1996) and they ‘seem to accept some degree of obligation – and therefore give some degree of assurance – with respect to their future conduct’ (Richardson, 1972: 886). Collaborating organizations thus lose the freedom to act independently (Van de Ven and Walker, 1984) and they have to work from a position that combines features of organizations and markets (Stinchcombe, 1985). Although interorganizational relationships remain separate entities, they entail higher degrees of interdependence than market transactions, making the outcome for any player in an exchange ‘fundamentally entwined with the actions of and outcomes for other players’ (Child and McGrath, 2001: 1139). Such relationships not only entail interdependency, they also inhabit collective strengths aimed at

Introduction

31

value creation and inter-partner conﬂicts deriving from, amongst others, desires to appropriate part of this value (Das and Teng, 2002). The second step in Figure 1.7, which comprises the selection of a particular collaborative form or cooperative mode, is not central to this study either. The key issue here is no longer whether cooperation should take place, but rather in which mode or form a particular relationship should be organized (Heide, 1994; Sampson, 2007). Possibilities include, amongst others, buyer–supplier relationships, outsourcing agreements, joint research projects, shared new product development, common distribution agreements, R&D alliances, joint ventures and franchising (Grant and Baden-Fuller, 2004). An inquiry into 463 R&D alliances in the telecommunications equipment industry by Sampson (2007) serves as an example here. Sampson’s analysis indicated that, in cases of high technological diversity among partners, choosing an equity joint venture instead of a contractual alliance form is more likely to preserve incentives and mechanisms to share information. However, Sampson (2007: 384) also notes that ‘variance clearly exists within each of these broad groupings, and many diﬀerent mechanisms for dealing with the coordination challenges inherent in R&D collaborations exist within each of these organizational forms’. She hints at the third step in Figure 1.7 here, suggesting that, after a collaborative mode or form is chosen, partners engage in governance processes such as selecting partners, negotiation and developing contracts and establishing trust to varying degrees (Nooteboom, 1999). Williamson (1991) refers to this as second-order economizing – i.e. executing adjustments within a particular governance mode. The processes and outcomes involved here constitute the focal phenomena examined in this book. They concern the management and implementation of interorganizational relationships, something which has received little attention compared to the decisions depicted in stages one and two of Figure 1.7 (Reuer and Ariño, 2007; Sobrero and Roberts, 2002). A second demarcation of scope relates to the literature that is being used. Following Anderson and Dekker (2005), throughout the book reference is made to theoretical and empirical contributions on governance at both the intra- and the interorganizational level. I consider this to be appropriate, since interactions within and between organizations show several fundamental similarities (Gittell and Weiss, 2004; Lorenzoni and Lipparini, 1999) and, as others have noted, research on the management of partnerships ‘can and perhaps should draw on many conventional managerial nostrums developed with hierarchical organizations in mind’ (Thatcher, 2004: 121). Adopting such a stance is further supported by ﬁndings from Gittell and Weiss (2004) and Håkansson and Lind (2004), indicating that various structuring practices commonly adopted within organizations are perfectly

32

Contracts and trust in alliances

adequate for coordination in interorganizational relationships. In their study of healthcare organizations, for example, Gittell and Weiss (2004) found that many of the same mechanisms that have been found to be eﬀective in linking units within organizations are also eﬀective for linking activities across organizations. Others have argued that collaborative relationships also resemble organizations in that they are frequently characterized by their own distinctive organizational systems, rules, routines and norms (Grandori and Soda, 1995; Thatcher, 2004). In line with these observations, Grandori (2000: 6) even proposes that ‘a unitary and general theory of governance – encompassing both [. . .] internal and external organization – is possible’. As I believe that some partnerships have more in common with conventional organizations than much of the literature suggests, I refer to literature on intraorganizational governance wherever it may be helpful in developing our understanding of the role of contracting and trust in interorganizational relationships. Nonetheless, I recognize that one cannot completely equate interorganizational structures and structuring practices with their organizational counterparts. There may be important diﬀerences between organizing activities in organizations and organizing them in interorganizational relationships, which inﬂuence the role of contracting and trust in each. One of the diﬀerences playing a role is that organizations contain ‘more forces against change’. They are characterized by ingrained interests, established ways of doing things, loyalties among employees, and so on (Gomes-Casseres, 1996: 85). This may result in situations in which formalities are met with less opposition when applied in interorganizational relationships as compared to organizations. Besides, contracts tend to be almost imperative for interorganizational cooperation, because a ‘tiebreaking authority higher up, and a common ownership interest by which to judge which side provides the greatest contribution’ are generally lacking (Gomes-Casseres, 1996: 92). In this case, they have few other preexisting mechanisms for control and coordination at their disposal (Kirsch, 1997). Moreover, participants in interorganizational relationships are more likely to face higher degrees of uncertainty and equivocality compared to their counterparts within organizations. They lack stable and time-tested governance structures, but they also face discontinuities in terms of experience, culture, technology and organizational practices. The absence of generic understandings further complicates sensemaking, and it is likely to inﬂuence the structures and structuring practices adopted by partners (Clegg et al., 2002a). This is reinforced by the fact that interorganizational relationships tend to occur less frequently and are more heterogeneous than other organizational activities (Reuer and Zollo, 2005).

Introduction

33

In contrast, the zone of acceptance of authority, deﬁned as the willingness to accept decisions from others (Simon, 1997: 185), is probably larger for departments cooperating within an organization compared to parties in interorganizational relationships, as the latter can opt out more easily. This may reduce participants’ willingness to conform to formalities and formal governance solutions. In addition, compared to internal organizational units, interorganizational relationships tend to have a much narrower mandate (Reuer and Zollo, 2005), something which reduces the need for formal governance. Finally, contracts comprise only one of the many means by which control can be achieved in interorganizational relationships (see Klein Woolthuis et al., 2005). Participants may use other governance mechanisms, which have little signiﬁcance when activities are organized within organizations, such as eﬀorts invested in partner selection, or equity exchange. We should keep these diﬀerences between organizing activities within organizations and organizing activities in collaborative relationships in mind when discussing the role of contracting and trust in interorganizational relationships.

METHODOLOGICAL CONSIDERATIONS Karl Weick (1995: 35) once asked, ‘If people have multiple identities and deal with multiple realities, why should we expect them to be ontological purists?’ He stated that this would only limit their capability for sense making. Stated diﬀerently, working from a single ontological paradigm frequently ‘produces a potentially valuable, but narrow view, incapable of exposing the multi-facetted nature of organizational reality’ (Lewis and Kelemen, 2002: 268). At the same time, however, ‘multiparadigm researchers live in a glasshouse open to attack’ from researchers tied to single paradigms (Lewis and Kelemen, 2002: 259). In the remainder of the book, I nonetheless adopt a pluralistic approach. This is likely to lead to the most comprehensive, nuanced and accurate picture of the role of contracting and trust in interorganizational relationships. It reduces the risk that only one aspect of the phenomenon under study is being highlighted (Knudsen, 2003; Mintzberg and Lampel, 1999) and it can provoke discourse and inquiry across a number of paradigms (Lewis and Kelemen, 2002), which may eventually oﬀer a more reliable guide to action than inquiries based on single paradigms (Volberda and Lewin, 2003). By starting from a variety of ontological stances and by using multiple methodological and conceptual lenses, it becomes less likely that erroneous conclusions are drawn, as has been vigorously illustrated in Allison’s (1971) seminal work, Essence of decision, in which the Cuban missile crisis was

34

Contracts and trust in alliances

analysed in terms of three alternative frames of reference. Consistent with Yin (1994), Gioia and Pitre (1990) and Azevedo (2002), diﬀerent methods, accompanied by diﬀerent methodological presuppositions, are being used to answer diﬀerent kinds of research questions, to highlight diﬀerent facets of the phenomenon, and to make diﬀerent sorts of information accessible. This should provide a richer understanding of the role of contracting and trust in interorganizational relationships than any one approach on its own (see Van de Ven and Poole, 2005). Some of the research questions posed in the book need to be explored by means of an inductive approach. Or, as Klein (2002: 69) puts it, to increase our understanding of contracts and other formalities ‘it is [sometimes] necessary to get one’s hands dirty and discover how particular contracts actually work in practice’. This approach conforms to Ronald Coase’s (1992) plea for economists to develop a much more detailed understanding of the actual process of contracting between companies in a ‘real-world setting’. Case studies are needed because contracts and other acts of formalization ‘do not constitute a closed universe’ (Brousseau and Glachant, 2002: 23); they are embedded in contexts that inﬂuence their functioning. Furthermore, case studies ‘allow an investigation to retain the holistic and meaningful components of real-life events – such as [. . .] organizational and managerial processes’ (Yin, 1994: 3). They enable us to get a feeling of which variables are involved, how they could be measured, and how relationships between the variables might be constructed (Eisenhardt, 1989a; Yin, 1994). When investigating the role of contracting and trust, case studies become particularly useful when organizational processes are involved which do not lend themselves easily to quantitative measurements (Siggelkow, 2007; Strauss and Corbin, 1998),16 and when history and context need to be incorporated (Pettigrew, 1990). Moreover, adopting the case study approach in research on contracting aligns with Simon’s (1997) advice on obtaining insights into the structure and functioning of organizations. He suggests that such insights may be gained by ‘analyzing the manner in which the decisions and behaviour’ of employees are inﬂuenced (Simon, 1997: 2). It also conforms to Siggelkow’s (2007: 22) observation that case studies help in ‘getting closer to constructs and being able to illustrate causal relationships more directly’. In doing so, the case study method meets the critique of existing research concerning the notable paucity of studies penetrating the operational level of interorganizational relationships (Marchington and Vincent, 2004; Parkhe, 1993b). It also connects to the growing attention for post-formation dynamics and developmental processes in interorganizational relationships (Ariño and de la Torre, 1998; Doz, 1996; Doz and Hamel, 1998; Ring and Van de Ven, 1994; Reuer et al., 2002; De Rond, 2003). Finally, it coincides

Introduction

35

with academic inquiries into the ‘human’ or ‘process’ side of contracting and, more generally, structuring activities and outcomes (Marginson and Ogden, 2005) enabling the development of perspectives on contracting that are ‘adequate at the analytical levels of meaning and of causality’ (see Ranson et al., 1980: 4). This has led to the use of the case study method in theme four, which focuses on a so-called ‘how-question’ (Yin, 1994), namely: how do managers of interorganizational relationships cope with the tensions arising from the coexistence of functions and dysfunctions of using contracts, rules and procedures? The case study that I discuss concerns a strategic alliance between a large European-based retailer (STEADY) and a global ﬁnancial services organization (QUICK) aimed at the integration of ﬁnancial services in a retail context. I selected it for this study, as it fulﬁls three practical and theoretical conditions. First, both companies oﬀered me unique access to their documents and participants in the relationship. Second, both organizations are large in size, something which is often linked to higher levels of formalization (Zeﬀane, 1989), and which enlarges the likelihood that formalization would be an issue in the alliance. Third, the alliance under study required innovative activities from both organizations, while simultaneously posing high demands for formalization, arising from the legitimacy, accountability and control characterizing ﬁnancial services (see Vermeulen, 2001). This setting oﬀered fertile ground for tensions arising from the coexistence of formalization’s functions and dysfunctions, which is central to theme four. In contrast to the case study method, the survey method is used to attain parsimony and external validity (Eisenhardt, 2000). It is a method that is helpful in illuminating the prevalence and incidence of certain phenomena (Yin, 1994). More speciﬁcally, surveys are utilized to establish generalizable relationships between contracting, trust, antecedents, interorganizational performance, moderators, mediators and other governance variables. Investigating these relationships requires large samples of interorganizational cooperative endeavours, which reduce the risk that ﬁndings are the result of highly context-speciﬁc or idiosyncratic confounding elements. Where the case study sacriﬁces breadth for depth (Gill and Butler, 2003), the survey oﬀers some compensation, enabling us to draw more generalizable conclusions. The data used to answer the research questions posed in themes one, ﬁve and six are obtained from a dataset called The External Management of Automation [MAT95] (Batenburg and Raub, 1995).17 This dataset captures data on 971 buyer–supplier relationships in which smalland medium-sized buyers have purchased IT solutions from vendors. The sample includes bilateral contracts: contracts which are in some substantial sense incomplete (Gomes-Casseres, 1996; Grossman and Hart, 1986), and which involve promises that possibly have their bearing on the partners

36

Contracts and trust in alliances

during a longer period of time (Ring, 2002), making at least one of the organizations in the relationship dependent on the other (Das and Teng, 2000). Although, at ﬁrst sight, these relationships might resemble market transactions, they constitute interorganizational relationships as they entail the delivery of products or services over longer periods of time. This means that interorganizational participants have to interact through series of stages in which they select their partners, reﬁne speciﬁcations of requirements and deliver goods or services (Bennett and Robson, 2004). I have selected this type of relationship as the object of analysis, for several reasons. First, buyer–supplier relationships are becoming more important, thanks to increased competition and a higher pace of innovation, which calls for close cooperation between buyers and suppliers (Noorderhaven et al., 1998). Second, survey data on buyer–supplier relationships could be obtained on a larger scale than data on other types of relationships (response rates for surveys under alliance managers, for example, generally approximate 10 per cent). Third, transactions involving the purchase of IT solutions oﬀer an appropriate context to test several of the hypotheses that are developed in later chapters, because such relationships generally entail numerous control and coordination problems. Buyers face various risks, stemming, among other factors, from the diﬃculty of remaining up-to-date with respect to technological developments and from suppliers that behave opportunistically, painting too rosy a picture of their technology, implementation costs or operational costs (Rooks, 2002; Rooks et al., 2006). Besides, buyers in such relationships regularly face low supplier capability, poor supplier performance, loss of control and overdependence (Poppo and Zenger, 2002). Moreover, buyer–supplier relationships are characterized by uncertainty and information-asymmetry between buyers and sellers, which complicate the speciﬁcation of desired behaviour and outcomes (e.g. Barthélemy, 2001). Accompanied by the relationspeciﬁc investments and product customization that are frequently required in such relationships, this ultimately demands the integration and coordination of actions by means of formal contracts and governance processes (Anderson and Dekker, 2005). Appendix A provides more data on the survey. The approach taken to study contracting and trust can be further classiﬁed along the typology of Van de Ven and Poole (2005). These authors distinguish ontological views of ‘organization as things’ from ontological views of ‘organization as processes’. They also discern ‘variance’ and ‘process’ epistemologies. This renders a two-by-two matrix of possible research approaches to studying particular organizational phenomena. From an ontological viewpoint, the studies presented in subsequent chapters both cover contracts and trust (i.e. nouns, real entities or

Introduction

37

things) and governance processes (i.e. negotiating and contracting, developing trust). The approach that is taken to explore the role of contracting and trust in interorganizational relationships is therefore necessarily pluralistic in nature (see Van de Ven and Poole, 2005). Moreover, the book builds both on variance methods and on process narratives. In the chapters entitled Need versus ability to contract, Contract standardization, and Governance trajectories, I attempt to explain lawful regularities, and adopt a rather mechanistic approach to organizational analysis (Child, 1997).18 In doing so, I do not presume that these regularities dominate human agency (Voss, 2003), but I assume that they can still be distinguished in spite of the existence of human agency. The research questions posed in the other chapters, instead, demand a research approach that is able to oﬀer insights into individuals’ unique interpretations of the phenomenal world, of their attributions of causality to events surrounding them, and of interpretations, social constructions and sense makings of others’ behaviours (Chia, 1997). Such an approach entails a process-based ontology, which opens up the possibilities for rethinking ‘organization’, or in this case governance as a process of ‘world-making’ (Chia, 1997: 685). In Chia’s terms (2003: 136), interorganizational governance could become ‘a ceaseless process of reality construction and maintenance that enables us to carve out our otherwise amorphous life-worlds into manageable parts so that we can act purposefully and productively amidst a ﬂood of competing and attention-seeking stimuli’. This draws ‘the logic of organizational theorizing away from structured entities, outcomes, and end-states, towards the underlying thought-structuring processes, which produce these outcomes’ (Chia, 1997: 703). In theme three, for example, I deviate from the conventional perspectives on contracting by depicting it as a structuring processes (Hatch, 1999), which entails the transformation of thought and meaning in individuals (Chia, 2003).19

EMPIRICAL BASIS The unit of analysis in this research is the interorganizational relationship. Congruent with this, the empirical basis for the study consists of interorganizational relationships involving at least one services organization, being an IT organization, a ﬁnancial institution, or a retail organization. The focus on services organizations is born out of the relative silence in previous research on interorganizational relationships including these types of organizations, and the increasing tendency towards external cooperation by such organizations. Recent ﬁgures of the OECD, for example, demonstrate that alliances involving services activities absorb a strongly growing

38

Contracts and trust in alliances 100%

80%

60%

40%

20%

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

0%

Business services Manufacturing, marketing, R&D Source: Kang and Sakai (2001).

Figure 1.8

Purpose of alliances worldwide

share of total worldwide alliance activity compared to manufacturing, marketing and R&D activities (Figure 1.8). More speciﬁcally, the number of interorganizational cooperative relationships involving services organizations in 2000 was more than ﬁve times as high as in 1995 (Kang and Sakai, 2001). In the empirical investigations, I further restrict myself to non-equity relationships, as it is now recognized that interorganizational cooperation increasingly takes place in less hierarchical forms. Although earlier research tended to concentrate on the choice between equity and non-equity forms of cooperation (Grandori and Soda, 1995; Heiman and Nickerson, 2004; Oxley, 1997; Reuer and Ariño, 2003), the relative importance of joint ventures compared to alliances is declining sharply (Figure 1.9). Hagedoorn and Osborn (2002) even ascertain that the percentage of joint ventures in newly established R&D partnerships declined from 90 per cent in 1970 to less than 10 per cent in 1998. Although the focus is on interorganizational relationships involving services ﬁrms, I refrain from emphasizing only one particular type of relationship. I thus deploy a kind of empirical pluralism, seeking progress ‘by applying basically the same set of theoretical principles to a broad class of

39

Introduction 7000 6000 5000 4000 3000 2000 1000

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

0

Joint ventures Alliances Source: Kang and Sakai (2001).

Figure 1.9

Joint ventures versus alliances

empirical phenomena’ (Buskens et al., 2003a: 5). Such an approach seems to be warranted by the fact that contracting and trust appear to play a role in almost any kind of interorganizational relationship, ranging from licensing agreements to strategic alliances. An indication of the signiﬁcance of contracts for diﬀerent types of interorganizational agreements can be derived, for example, from their length (Hill and King, 2004). Table 1.4 presents a basic analysis of the length of 591 licence agreements, 336 sales and marketing agreements, 161 manufacturing and supply agreements, 73 consultancy agreements, 87 R&D agreements and 137 strategic cooperation agreements (source: onecle.com). A simple word-count for each of the contracts, followed by a sorting procedure in which relationships are ordered according to ascending contract length, is summarized in Figure 1.10. Descriptive statistics reveal that contract length in this convenience sample ranges between 217 and 75 608 words. Mean values diﬀer signiﬁcantly between diﬀerent types of relationships, with consultancy agreements having the lowest mean value (2841 words) and strategic cooperation agreements displaying the highest value (11 844 words). Large diﬀerences in contract length, even within categories of relationships, are consonant with the core assumption that there is considerable variation in

40

Manufacturing & supply agreements

Consultancy agreements

R&D agreements

Strategic cooperation agreements

Mean (# words) Std. deviation Median Minimum Maximum N

Sales & marketing agreements

Variation in contractual complexity

Licence agreements

Table 1.4

Contracts and trust in alliances

8 729 7 480 6 961 421 65 286 591

7 575 6 832 5 868 127 38 168 336

8 893 9 454 6 927 256 75 608 161

2 841 2 438 2 176 262 14 288 73

9 058 7 120 6 815 217 28 865 87

11 844 12 201 7 097 423 64 834 137

Source: Data were obtained from onecle.com and analysed by the author.

the level of detail and complexity of contracts across interorganizational relationships and ﬁrms (Park and Ungson, 2001; Argyres et al., 2007). This variation may derive, for instance, from diﬀerences in exchange characteristics (Williamson, 1985), but it may also stem from the fact that some organizations are more skilled than other organizations in designing appropriate coordination and control structures (Anderson and Dekker, 2005; Argyres and Mayer, 2007; Mayer and Argyres, 2004). In this respect, Ring (2002: 145) proposes that ‘one of the elements that makes some organizations better at forming and sustaining cooperative relationships is that they have a better understanding of the consequences that ﬂow from a need to rely, in part, on contract in the governance of cooperative business relationships’.

OVERVIEW OF THE BOOK The purpose of Chapter 1 was to set the stage for a manuscript aimed at developing a series of alternative perspectives and a more integrative view on the role of contracting and trust in interorganizational relationships. Chapter 2 serves as the basis for all other chapters, as it discusses the coordination and control perspectives that have traditionally dominated inquiries into interorganizational governance (providing the antecedents–governance–performance framework with a theoretical basis). In Chapters 3 to 8,

41

Introduction Licence agreements

Sales & marketing agreements

– (N = 591, X = 8729)

– (N = 336, X = 7575)

Manufacturing/supply agreements

Consultancy agreements

– (N = 161, X = 8893)

– (N = 73, X = 2841)

R&D agreements

Strategic cooperation agreements

– (N = 87, X = 9085)

– (N = 137, X = 11844)

Figure 1.10 Distribution of contract length in words for diﬀerent kinds of agreements

42

Contracts and trust in alliances

however, I comply with Osborn and Hagedoorn’s (1997) request to abandon singular, clear-cut descriptions of interorganizational cooperation and replace them with more robust, comprehensive, multidimensional views. In these chapters, each of the six research themes identiﬁed before are explored in greater detail. The chapters are all written along similar lines, in that they start with a description of the themes’ relationship to the research problem and the research framework presented in Figure 1.6. These brief introductions are followed by descriptions of possible enrichments of, and complements to, the generic control and coordination perspectives on the role of contracts in interorganizational relationships. In Chapter 9, I contemplate a synopsis of the main theoretical developments and the key ﬁndings emanating from the case study and the survey data. I also highlight the theoretical and practical implications of the study, as well as the limitations of the study and several possibilities for future research.

CONCLUSION This chapter served as an introductory guide to a number of studies on the role of contracting and trust in interorganizational relationships. It started with the growing signiﬁcance of interorganizational cooperation, and then emphasized the need for a better understanding of contracting and trust in collaborative initiatives. In order to address this issue, I devised an integrative research framework and identiﬁed six research themes, which complement the coordination and control perspectives and the antecedent– governance–performance framework that currently dominate research on interorganizational governance. Subsequently, I discussed the scope of the research, its methodological and empirical bases, and the structure of the book. In the following chapter, I provide a comprehensive account of the coordination and control perspectives that currently seem to be most inﬂuential on our thinking about formal interorganizational governance.

NOTES 1.

2.

The question of why ﬁrms create interorganizational relationships is by now ‘standard fare’ in the literature (Gomes-Casseres, 1996: 13). The general argument is perhaps best represented by Durkheim, who remarked: ‘the hardness of bronze lies neither in the copper, nor in the tin, nor in the lead which have been used to form it, which are all soft and malleable bodies. The hardness arises from the mixing of them’ (Durkheim, 1982: 39–40). In this respect, Gomes-Casseres (1996) contends that cooperation is not a natural act for companies. Everything in their competitive environment and in their corporate histories drives them toward win–lose competition and a reliance on internal resources.

Introduction 3. 4.

5.

6.

7.

8.

9.

10.

11.

43

Bozeman and Kingsley (1998) explain that project documentation, change requests forms or notes of staﬀ meetings can also serve as contracts, as they protect participants from risks and control their behaviour. On a macroeconomic level, limited enforceability of contracts impairs the eﬃcient allocation of resources. It also results in greater volatility of outputs, and it delays the diﬀusion of new technologies (Cooley et al., 2004). There are no reasons to believe that similar eﬀects do not apply to interorganizational cooperation. When organizations are not able to guarantee a certain extent of compliance to agreements, potential partners will refrain from initiating relationships altogether, or they are handed over to the whims of their partner, which potentially results in a higher variability of the expected outcomes of relationships. Authority is deﬁned here as ‘the power to make decisions which guide the actions of another’ (Simon, 1997: 74). This power is ‘recognized as so vested, and [. . .] accepted as appropriate not only by the wielder of power, but by those over whom it is wielded and by the other members of the system’ (Katz and Kahn, 1966: 203). The threat of retaliation will generally deter non-compliance with agreements. From a control perspective, possibilities for legal enforcement only need to deal with states in which payoﬀs for deviations from the norm are very high (Eggleston et al., 2000). Friedrich’s ‘rule of anticipated reactions’ seems to be valid here, which suggests that expectations and anticipations govern behaviour (Simon, 1997: 182). Potential disputes, including many that under current rules could be brought to a court, are frequently resolved by avoidance, self-help and the like (Galanter, 1981). The distinction between the formalization of inputs and outcomes, and the formalization of processes is theoretically important but empirically hard to make. Ultimately, formalization is exercised to change behaviours (Kirsch, 1997; Ouchi, 1979). Simon (1997: 39) clariﬁes that there is no essential diﬀerence between a desired outcome and a process, but only a distinction of degree. A process is an activity whose immediate purpose is at a low level in the hierarchy of means and ends, while a desired outcome is a collection of activities whose aim is at a high level in this means–end hierarchy. The resemblance between this distinction and the two kinds of bureaucracy described by Max Weber is striking. Weber wrote about a ‘representative’ form of bureaucracy, based on rules established by agreement, rules which are technically justiﬁed and administered by specially qualiﬁed personnel, and to which consent is given voluntarily. However, he also described ‘punishment-centred’ bureaucracies, which are based on the imposition of rules and on obedience for their own sake (Gouldner, 1954: 24). Enabling types of formalization require ﬂexibility (Adler and Borys, 1996) and openness of all parties to each others’ requests to modify prior agreements in case unexpected situations arise (Bello and Gilliland, 1997). Enabling types of formalization also demand involvement from parties to an agreement during the contracting process and managerial encouragement for formulating improvements (Adler and Borys, 1996). After all, people prefer agreed-upon, rather than imposed conditions (Gouldner, 1954: 20). Continuity is more likely to play a role in the development of trust, when prior experience renders it more eﬃcient to do so. This occurs, for example, when parties have conducted relation-speciﬁc investments in developing processes and norms that support justice and cooperation during earlier exchanges (Ring and Van de Ven, 1994). In such instances, prior collaboration enables ‘continued savings from decreased transaction costs’ and it potentially enhances value creation, as parties have learned about the normative routines applying to the relationship, each other’s capabilities and objectives, and the kind of behaviour to expect from each other (Poppo et al., 2008: 8). Olk (2002) suggests one such an approach. Building on studies of organizational eﬀectiveness, he organizes diﬀerent approaches to performance measurement according to diﬀerent levels of analysis: that of the relationship and that of the partner organizations (see Gray, 2000; Yan and Gray, 1995). Moreover, he distinguishes performance measures according to their purpose or approach. Olk contends that, in an optimization approach, all parties use a single criterion for evaluation. In a strategic interest approach, one goal prevails as well, but a dominant coalition may use several representative

44

12.

13.

14. 15.

16.

17.

18.

Contracts and trust in alliances measures, and goals may change. In a multi-interest approach, there are multiple evaluators of interorganizational performance, which use diﬀerent and sometimes conﬂicting criteria. Finally, in a sequential perspective, multiple criteria are used for evaluation, which are assumed to be temporally related (Olk, 2002). Another example concerns performance measures assessing the degree to which strategic interests of cooperating organizations are accomplished. Criticism of these measures centres on the fact that they are perceptual (Olk, 2002), and that objectives may change over time (Gill and Butler, 2003). Besides, such measures are confronted with validity problems, due to a deﬁciency of common objectives and the coexistence of multiple strategic objectives (De Rond, 2003; Larson, 1992; Yan and Gray, 1995). Moreover, such measures do not take into account spillovers, or the beneﬁts and costs that accrue to one or both of the parties that go beyond the scope of the transaction (Khanna, 1998; Mayer, 2006). The latter has received little attention, despite the fact that spillovers can have signiﬁcant eﬀects on an organization’s competitive position by adding to or devaluing the ﬁrm’s resources (e.g., knowledge and reputation) (Mayer, 2006). Grandori (2006: 128) further speciﬁes this by stating that ‘The ﬂexibility rigidity outcome does not have to do with formalization [per se], but with the degree of detail in the speciﬁcation of proper behaviour [. . .]. Hence, we can have “ﬂexible formalization” – if rules are general and “constitutional” enough – and rigid social governance – if norms are very precept-like and detailed.’ Research on relational governance suﬀers from similar problems. Saparito et al. (2004: 400), for example, claims that ‘studies of interﬁrm trust have focused either on its antecedents or its consequences, but not [on] both.’ Studies that do examine multiple governance mechanisms frequently only analyse a few relationships between a limited number of governance mechanisms, such as the relation between formal governance and the selection of familiar partners (e.g., see Gulati, 1995; Poppo and Zenger, 2002) or trust (see Luo, 2002). More speciﬁcally, Siggelkow (2007: 22) argues that ‘In large-sample work, the distance between conceptual constructs and measurable variables is often rather large [. . .]. If the econometrics is done convincingly, the reader may well believe that an empirical relationship has been documented between proxies E and F. But whether this relationship really reﬂects the underlying conceptual arguments concerning constructs A and B is often quite unclear.’ The data set, The External Management of Automation, has been collected as part of the NWO-pioneer programme ‘The Management of Matches’ (PGS 50-370) and is available from the Steinmetz-Archive (study number P1512). For more details on the datacollection procedure, we refer to Anderson and Dekker (2005), Batenburg (1997), Batenburg et al. (2003), Buskens (2002), Dekker (2003) and Rooks (2002). Several of the items used in the study have been used in other studies (see for instance Rooks et al. (2006) and Dekker (2003)). This approach to research has not remained free of criticism. Piore (1995: 63), for example, notes that ‘the basic problem of this methodological stance is its commitment to an individualist ethos and its inability to recognize and accord a legitimate place to organic groups and cohesive social organizations’. Others signal that it leads to the lack of attempts to seek out underlying causes or generative mechanisms of observed phenomena. The most notable criticism of such an approach centres on (1) its conceptualization of agency, (2) its inattentiveness to meaning, and (3) the relations it presumes between structure and agency (Chia, 1997). Considering the ﬁrst point, researchers adopting this approach presume that the question of what an agent ‘does’ coincides with his or her ‘intentions’ (Giddens, 1984). However, the knowledgeability of human actors is always bounded on the one hand by the unconscious, and, on the other hand, by unacknowledged conditions or unintended consequences of action (Giddens, 1984; McKinley and Scherer, 2000; Weick, 1995). The second critical note refers to the fact that it keeps theories and ﬁndings of the social sciences wholly separate from the universe of meaning (Giddens, 1984). In doing this, nature becomes ‘a dull aﬀair, soundless, scentless, colourless; merely the hurrying of material, endlessly, meaninglessly’ (Whitehead,

Introduction

19.

45

1985: 68). Conducting research on structural parameters without considering the intentions that individuals have with these structures and the meaning they give them therefore appears inept (e.g., Weick, 1979). The third point of criticism concerns the relationship between structure and agency. Although it has been argued that structure comprises ‘forces that lie outside the control and often the comprehension of placebound actors’ (Kumar, 1995: 188), and that structures are frequently ‘irreducible to the activities of contemporary agents’ (Reed, 1997: 33), structures also exist only when they are socially reproduced and transformed (Barley, 1986). It seems unrealistic to presume that agents do not inﬂuence organizational structures. Criticism also applies to this methodological standing. Reed (1997), for example, proposes that a process view on structure – or structuring – leaves us with a conception of organization in which properties of structures that ‘can be understood to be relatively independent of the agents whose behaviour is subject to their inﬂuence’ (Layder, 1990: 23) are pushed aside by the ‘analytical fascination with the local, contingent, and indeterminate’ (Reed, 1997). He proceeds by stating that ‘ﬂat ontologies and miniaturized local orderings construct a seductive vision of our social world in which everything and everybody is constantly in a ‘state of becoming’ and never in a ‘condition of being’ (Reed, 1997: 29). To support his arguments, Reed refers to Schumpeter’s warning that ‘social structures, types, and attitudes are coins that do not readily melt. Once they are formed, they persist, possibly for centuries’. He remarks that this is ‘conveniently forgotten in a cacophony of celebrations to the essential ﬂux, fragmentation, and indeterminacy of social reality’ (Reed, 1997: 26).

2. Mainstream literature: coordination and control While diﬀerent theoretical perspectives or paradigms may be irreconcilable in their own philosophical terms, when applied to the study of organizational phenomena they are not necessarily incommensurable. (Child, 1997: 44)

INTRODUCTION In this chapter, I describe two perspectives on formal interorganizational governance that have dominated the literature for the last three decades. I label those relatively generic views on interorganizational governance the ‘control’ and ‘coordination’ perspectives. The ﬁrst approach to interorganizational governance is rooted in transaction cost theory and agency theory. The second approach draws its arguments from the behavioural theory of the ﬁrm and research on dynamic capabilities. Jointly, both perspectives function as a basis or platform for discussing each of the research themes, which build on and complement the coordination and control perspectives depicted here.

MAJOR THEORETICAL PERSPECTIVES ON FORMAL INTERORGANIZATIONAL GOVERNANCE The most common and inﬂuential theoretical perspectives describing the role of formal interorganizational governance can be grouped into two broad categories: (1) the ones focusing on formal governance as a mechanism for control, and (2) the ones viewing formal governance as a means of coordination. Although these theoretical perspectives may be irreconcilable in their own philosophical terms, I concur with Child (1997: 44) that ‘when applied to the study of organizational phenomena [diﬀerent perspectives] are not necessarily incommensurable’. In fact, each of them highlights diﬀerent aspects of the phenomenon, and both are argued to be deeply intertwined. Emphasizing both the coordination and control perspective connotes with Makadok’s (2003: 1043) statement that ‘future research on the genesis of competitive advantage should examine agency 46

Mainstream literature

47

and governance issues along with, not apart from, resource-based issues’. It is warranted by comments of several other eminent scholars as well. Gulati and Singh (1998: 811), for example, advance the view that ‘ﬁrms choose governance structures both to manage anticipated coordination costs and to address appropriation concerns’. Dyer and Singh (1998: 88) add that employing ‘governance mechanisms that lower transaction costs or [that] permit the realization of rents through the synergistic combination of assets, knowledge, or capabilities’ both contribute to achieving interorganizational performance and competitive advantage. In addition, Reuer and Ariño (2007) suggest that some contractual provisions are more directed at control and others more at coordination. They claim that ‘enforcement provisions’ are the most stringent, dealing with aspects such as intellectual property and more severe breaches involving lawsuits and third-party adjudication. ‘Coordination provisions’, instead, are primarily concerned with monitoring and adaptation during relationships.1 The coordination and control perspectives on interorganizational governance focus on problems of fundamentally diﬀerent origins, with control problems being rooted in diﬀerences in motivation and interest, and coordination problems arising from the cognitive limitations of individuals (Foss, 2001; Gulati et al., 2005). As diﬃculties related to aligning participants’ actions can persist even though their interests may be aligned, both perspectives are valid, and they deserve to be discussed as separate (Gulati et al., 2005; Salbu, 1997) but necessarily intertwined research streams (see Foss and Foss, 2005; Gottschalg and Zollo, 2007; Zenger and Argyres, 2007). Concluding, formal governance may have an incentive function (preventing conﬂicts and opportunistic behaviour) and a coordination function, comprising elements that bring together individual actions to meet a deﬁned set of goals (Avadikyan et al., 2001). I therefore discuss theories referring to problems of control and theories emphasizing problems of coordination to explain the role of formal governance in interorganizational relationships. Control Perspective The ‘control perspective’ on formal governance in interorganizational relationships alludes to the fact that eﬀorts to control outcomes and behaviour extend beyond the legal boundaries of individual organizations (Otley et al., 1995). It is based on the idea that partners wish to ‘ensure that the other in a relationship will perform in accordance with one’s desires or expectations’ (Salbu, 1997: 332). Following Ouchi (1979, 1980), control is deﬁned as the process by which one entity inﬂuences the behaviour and output of another entity. It encompasses all attempts to ensure that

48

Contracts and trust in alliances

participants in interorganizational relationships, being organizations as well as individuals, act in a manner that is consistent with the goals and objectives of the partner organizations. In the case of contracting, this not only involves the identiﬁcation and speciﬁcation of acceptable behaviours or outcomes, but it also concerns the evaluation of actual outcomes and behaviour (Eisenhardt, 1985; Kirsch, 1997). Advocates of the control perspective presume that gaining partial control over a partner organization is important, as interests of partners rarely coincide (Blumberg, 2001; Buskens et al., 2003a) and because of information asymmetries between them (Fama and Jensen, 1983; Lassar and Kerr, 1996; Shane, 1996). These diﬀerences between parties imply that any attempt to collaborate – however promising – contains the seeds for its own destruction (Gill and Butler, 2003) as cooperative relationships oﬀer fertile ground for opportunistic behaviour (Carson et al., 2006; Luo, 2007; Williamson, 1985, 1991). Correspondingly, the basic thrust in most contracting research – and particularly studies focusing on its control function – has been to conceptualize virtually any issue related to economic organization in terms of solving the resulting incentive conﬂicts (Foss, 2001: 361). Solutions to the problems indicated by proponents of the control perspective consist of vertical integration, contracting and monitoring. Contractual safeguards, for example, are thought to curb opportunism and raise the costs of self-interested activities as they can be used to change payoﬀ structures and incentives (Lui and Ngo, 2004; Lassar and Kerr, 1996) and because they increase the transparency of relationships and of the objects of monitoring (Reuer and Ariño, 2002). According to Reuer and Ariño (2007: 315–16), parties to interorganizational relationships may use contracts to set forth: [T]heir mutual rights and obligations through the speciﬁcation of inputs to the alliance, processes by which exchanges will occur and any disputes will be resolved and expected outputs from the joint undertaking [. . .]. For instance, before the alliance is operational, ﬁrms can limit information disclosures and, during the operation of the alliance, the contract may specify how the parties will interact with third parties [. . .]. The contract can also specify the way in which the alliance will end, [and delineate] ﬁrms’ claims on intellectual property.

Because actors can incorporate these and other safeguards and incentives in contracts, they are more willing to engage in new, potentially valuable exchanges with unfamiliar partners, even in situations for which exchange value uncertainty is high (Lazzarini et al., 2007).2 Authors emphasizing the control function of formal governance primarily draw on transaction cost economics and agency theory.

Mainstream literature

49

Transaction cost theory Prior research on formal governance in interorganizational relationships ‘has been primarily inﬂuenced by transaction cost economists’ (Gulati, 1998: 302). From a transaction cost economics view (TCE), governance is deﬁned as ‘the measures the actors involved in exchange use or implement in order to mitigate the risks associated with economic exchange’ (Buskens et al., 2003a: 2). TCE explains the use of formal governance mechanisms, such as contracts, by pointing out the risks to which partners in interorganizational relationships are exposed, and the costs that they have to incur to delimit those risks. The theory builds on several assumptions, including the belief that man is boundedly rational (Simon, 1947, 1997) and the presumption that human beings may behave opportunistically (Williamson, 1985). The ﬁrst assumption – bounded rationality – conveys the idea that ‘it is impossible for the behaviour of a single, isolated individual to reach any high degree of rationality. The number of alternatives he must explore is so great, the information he would need to evaluate them so vast that even an approximation to objective rationality is hard to conceive’. The human mind simply cannot ‘bring to bear upon a single decision all the aspects of value, knowledge and behaviour that would be relevant’ (Simon, 1997: 92, 117). Herbert Simon therefore argues that people’s behaviour is rational, given their goals, the information they possess, and their cognitive impediments. The latter diminishes their ability to foresee contingencies, potential problems and actions of partner organizations. Human beings thus strive for rationality but are restricted in doing so, leading Simon (1997: 88) to contend that behaviour is ‘intendedly rational, but only limitedly so’. Given bounded rationality, it is impossible to specify every possible contingency in a contract (Anand and Khanna, 2000a; Williamson, 1985). The second assumption underlying TCE concerns the likelihood that partners in interorganizational relationships exhibit opportunistic behaviour. Williamson (1985: 47) refers to opportunism as ‘self-interest seeking with guile’. In further specifying this type of behaviour, he points at ‘the incomplete or distorted disclosure of information, especially calculated eﬀorts to mislead, distort, disguise, obfuscate, or otherwise confuse’. Luo (2007: 41) adds that opportunism comprises ‘an act or behaviour performed by a party to seek its own unilateral gains at the substantial expense of another party and/or the joint venture entity [or another type of relationship] by breaching the contract or agreement, exercising private control, withholding or distorting information, withdrawing commitment, shirking obligation, or grafting joint earnings’. Underlying the assumption of opportunism is the idea that the interests of cooperating organizations generally do not coincide, and that these organizations

50

Contracts and trust in alliances

therefore simultaneously cooperate and compete (Adair and Brett, 2005; Ireland et al., 2002; Hamel, 1991; Kale et al., 2000; Khanna, 1998; Zeng and Chen, 2003). As the primary loyalty of participants in interorganizational relationships generally lies with their own organization (Hult et al., 2004) and because the optimum outcome for one partner is not the optimum for the other (Simon, 1997), frictions may arise. This implies that interorganizational relationships are, per deﬁnition, fraught with tensions (Madhok, 1995). Williamson puts adverse selection and moral hazard forward as two examples of opportunistic behaviour. Adverse selection implies that (potential) partners in interorganizational relationships may communicate incomplete or distorted information on purpose, in order to make sure that they become a preferred partner or can transact against beneﬁcial conditions. Moral hazard refers to the diﬃculty with which parties can infer ex post what the performance of each organization has been in relation to a transaction. In an attempt to further specify the construct, Wathne and Heide (2000) delineate diﬀerent types of opportunism. They conjecture that, in existing circumstances, passive opportunism involves shirking, or the evasion of obligations, whereas active opportunism means that one party is engaging in behaviours that were explicitly or implicitly prohibited. Moreover, under new circumstances, passive opportunism takes the form of inﬂexibility, or refusal to adapt, while active opportunism implies that a party uses changes in its own or its partner’s situation to extract concessions from the latter. To be sure, Williamson (1985) does not argue that all organizations or participants involved in interorganizational relationships behave opportunistically, but he remarks that there is always a chance that they do so, which gives rise to the need for formal safeguards. This implies that, however honest and dutiful partners may be, they can not be trusted to be entirely free of self-seeking behaviour (Hendry, 2002), and there is always a chance that they act against the interest of their partners when the beneﬁt of doing so is great enough. Parties to a collaborative relationship become more vulnerable to these types of opportunistic behaviour when they face lock-in conditions, when there is high information asymmetry regarding the other party’s attributes, actions and intentions, when information is diﬃcult to verify, and when contracts are more diﬃcult to enforce through law (Luo, 2007; Wathne and Heide, 2000). To recap, transaction costs economists believe that transactions are organized in such a way that they ‘economize on bounded rationality while simultaneously safeguarding against opportunism’ (Williamson, 1985: 32). TCE then advances that the governance of transactions entails transaction costs, which comprise (1) search costs; (2) contracting costs; (3) monitoring

Mainstream literature

51

costs; and (4) enforcement costs (Hennart, 1988; Williamson, 1985). Search costs include the costs of gathering information to identify and evaluate potential partners. Contracting costs refer to the costs of negotiating and writing an agreement. Monitoring costs include costs made to ensure that each party fulﬁls predetermined sets of obligations. Finally, enforcement costs refer to the costs connected with ex post bargaining and sanctioning of a partner that does not perform according to agreement (Dyer, 1997; Luo, 2007). Williamson (1985) proceeds with his line of arguments by claiming that several attributes of transactions, such as investments in relation-speciﬁc assets, uncertainty and transaction volume and/or frequency inﬂuence these costs. I restrict the discussion to the impact that transaction-speciﬁc investments are proposed to have on interorganizational governance here, as this eﬀect has received most empirical support (David and Han, 2004). Asset-speciﬁcity refers to durable investments undertaken in support of particular transactions, for which the opportunity costs are much lower than in their best alternative uses, or by best alternative users ‘should the transaction be prematurely terminated’ (Williamson, 1985: 55). As assetspeciﬁcity increases, redeployability diminishes and contracting hazards magnify (David and Han, 2004; Klein et al., 1978; Subramani and Venkatraman, 2003). For parties that have performed such investments, switching to another partner becomes more costly and termination of the relationship results in an irrevocable loss of the speciﬁc investments made (Heide and John, 1988). Organizations that have performed such investments run the risk that their investments are used as hostages (hold-ups) by their partners as well, making it diﬃcult for them to recoup value from the relationship (Jap and Ganesan, 2000; Williamson, 1985). In this case, partners threaten focal ﬁrms to terminate a relationship as soon as these have made relation-speciﬁc investments, in order to capture more value (Reuer and Ariño, 2007). In this case, the speciﬁc investments conducted by the focal party create, as it were, the possibility for the other party to bargain for higher rents in the exchange (Lazzarini et al., 2007). Solutions for the control problems emanating from idiosyncratic relationspeciﬁc investments as proposed by transaction cost theorists involve the deployment of appropriate control mechanisms, such as contracts and hierarchical integration (Dyer, 1997; Jap and Ganesan, 2000; Joskow, 1988; Williamson, 1985).3 Summarizing, TCE assumes that parties are boundedly rational and that they may behave opportunistically. This gives rise to a need for governance, which becomes larger for relationships in which parties have invested more in transaction- or relation-speciﬁc assets. The need to install governance mechanisms that help to ensure that partners make eﬃcient ex ante investments and that curb ex post bargaining and hold-up threats (Williamson, 1985),4 then has to be assessed against the costs involved with

52

Contracts and trust in alliances

search, contracting, monitoring and enforcement (Heide, 1994). The managerial focus from a TCE perspective is thus on limiting vulnerability to opportunistic behaviour by partners through choosing governance structures that minimize the costs of doing so (Williamson, 1991). Although transaction cost economics has contributed signiﬁcantly to our understanding of interorganizational cooperation, it has also received criticism. TCE has been argued to treat transactions as independent events (Doz and Prahalad, 1991), neglecting the relationships and social environments in which such transactions are embedded (e.g. Batenburg et al., 2003; Granovetter, 1985). TCE also discounts the fact that transaction ‘costs’ have the character of investments – with outlays and beneﬁts spread over a succession of periods (Furubotn, 2002) and it has been criticized for its normative implications, which may entail self-reinforcing cycles of increasing opportunism, possibly harming organizations’ performance (Ghoshal and Moran, 1996). Moreover, transaction cost theory is a school of thought in which transactional attributes alone determine ﬁrms’ governance design choices (e.g. Colombo, 2003), ignoring organizational attributes and capabilities (Ghosh and John, 1999; Madhok, 2002) and resulting in a rather mechanistic view regarding the origins of contracts (e.g. see Child, 1997). TCE also focuses on cost minimization of a single party, despite the fact that a relationship ensues between multiple partners and it stresses control over coordination (Gulati, 1998) and cost minimization over value maximization (Zajac and Olsen, 1993), although organizations seem to take both value creation and value claiming into account when forming interorganizational relationships (Heiman and Nickerson, 2004).5 Finally, the empirical support for TCE appears to be mixed (David and Han, 2004). Even when empirical results have ostensibly been positive for TCE, many of them appear to be open to interpretation from an alternative perspective, such as the resourcebased or dynamic capabilities view (Carter and Hodgson, 2006). In addition, some ﬁndings that seem to be consistent with TCE do not necessarily demonstrate that transaction costs are minimized, since the reduced-form equations that are generally used in empirical tests do not disclose the actual magnitude of transaction costs (Carter and Hodgson, 2006; Masten, 1996). Agency theory A second theory supporting the control perspective on formal governance is labelled ‘agency theory’. This theory originally described the relationship between the owners of organizations, so-called principals, and their employees or agents (Berle and Means, 1932). Nowadays, it is used to identify all kinds of agency problems, which may transpire in any situation involving cooperative eﬀorts between two or more parties that

Mainstream literature

53

have diﬀerent goals and that require a certain division of labour (Jensen and Meckling, 1976). Agency theory focuses on the reasons for disagreement between interdependent actors and on the means by which it is resolved (Lassar and Kerr, 1996). It suggests that agency problems arise because principals cannot determine if agents will behave or have behaved appropriately. Like TCE, agency theorists elaborate on moral hazard, referring to a lack of eﬀort on the part of an agent, which is hard to detect by the principal, and adverse selection, where an agent misrepresents its skills or abilities, which are again hard to verify by the principal, to explain the need for formal governance. Similarly to TCE, agency theorists attempt to determine the most eﬃcient solution for governing relationships, given assumptions about people (e.g. self-interest and risk aversion), interorganizational relationships (e.g. potential for conﬂict among participants) and information (e.g. information is a commodity that can be purchased). Agency theorists attempt to explain whether and when behaviouroriented contracts are more eﬃcient than outcome-oriented contracts by posing a trade-oﬀ between the cost of measuring and programming behaviour and the cost of measuring outcomes and transferring risk to the agent (Eisenhardt, 1989b; Prendergast, 1999). Note that this dichotomous choice between process-based or outcome-based contracts aligns with the links that Thompson (1967) and Ouchi (1979) have advanced between known means–ends relationships and behavioural control, and the connections they have established between crystallized goals and outcome control. That is, known mean–ends relationships (i.e. high-task programmability) are predicted to lead to behavioural control, whereas crystallized goals (i.e. high-outcome measurability) are envisaged to entail outcome control (Eisenhardt, 1989b). When the costs of monitoring agents’ behaviours are high, the more eﬃcient contract is outcome-based (Lassar and Kerr, 1996) and vice versa. Table 2.1 presents an overview of the variables aﬀecting the eﬃciency of behaviour-based and outcome-based contracts. Although agency theory and TCE display many similarities, they thus exhibit strong diﬀerences concerning the independent variables used to explain variation in formal governance. Whereas TCE emphasizes asset-speciﬁcity, environmental uncertainty and the frequency and volume of transactions, agency theorists focus on outcome uncertainty, behavioural uncertainty and the programmability of behaviour. In addition to describing the relationship between employees and owners of an organization, agency theory is used for analysing all kinds of relationships ‘that mirror the basic agency structure of a principal and an agent who are engaged in cooperative behaviour, but have diﬀering goals and diﬀering attitudes towards risk’ (Eisenhardt, 1989b: 59). Its application

54

Table 2.1

Contracts and trust in alliances

Agency theory: behaviour-based versus outcome-based contracts Behaviour-based contract is eﬃcient when:

Outcome-based contract is eﬃcient when:

High High Low

Low Low High

Relationship Goal conﬂict Length of relationship

Low Long

High Short

Risk Outcome certainty

Low

High

Monitoring Monitoring ability Task observability Clarity of outcome measures

Source: Lassar and Kerr (1996).

also pertains to interorganizational relationships (Fama and Jensen, 1983; Hendry, 2002; Lassar and Kerr, 1996; Shane, 1996), as partner organizations in such relationships experience conﬂicts of interest and information asymmetry. Manufacturers, for example, make trade-oﬀs between the amount of control required in their distribution channels and the levels of resource commitment and risk they are willing to bear (Lassar and Kerr, 1996). It is frequently not obvious to organizations, for instance, how large the actual costs incurred by their partners are, and which beneﬁts from the relationship exactly accrue to them. Furthermore, they do not always have a clear image of the eﬀorts their partners put into the relationship, while partners may abuse the responsibilities delegated to them (see Alchian and Demsetz, 1972) or consume resources and rents beyond what has been agreed on (see Jensen and Meckling, 1976). One of the main solutions to these problems advocated by agency theorists consists of the formulation of contracts between principals and agents (Berle and Means, 1932; Jensen and Meckling, 1976). Such contracting eﬀorts often go hand-in-hand with the acts of bounding and monitoring (Fama and Jensen, 1983). Through bounding, principals receive information from agents on their eﬀorts and on the outcomes that have been achieved. Monitoring prompts a more active role from the principal, as it encompasses supervision and checking of an agent’s eﬀorts and the outcomes accomplished by the principal. Empirical work substantiating the claims made by agency theorists is limited. More speciﬁcally, Swedberg (2003: 378) observes that, ‘while there

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exist a number of studies that have tried to test transaction cost analysis against empirical reality, this is much less true for agency theory’. Nevertheless, there is support for principal–agent hypotheses linking contract form with outcome uncertainty, outcome measurability and task programmability (Eisenhardt, 1989b). Lack of observability, for instance, has been shown to lead to less detailed task descriptions (Mayer, 2006; Argyres et al., 2007), less eﬀort to plan for contingencies that might arise during the exchange (Mayer and Bercovitz, 2004) and a lower likelihood of including early termination provisions (Mayer and Macher, 2006). A major point of criticism regarding agency theory is that it is supposed to determine whether behavioural or outcome control is the most appropriate way to govern a particular relationship, neglecting the idea that neither or both of them may be used. In particular, researchers have observed that projects for which measurement of the quality or outcome of work is diﬃcult are also likely to be the ones for which developing detailed task descriptions is diﬃcult (Argyres et al., 2007: 11), something which renders agency theory less applicable, for example, to some highly innovative or R&D-related exchanges. Furthermore, agents may simply be insuﬃciently competent to write outcome-based contracts, particularly in uncertain, ambiguous and complex situations (Hendry, 2002).6 Coordination Perspective Although important, control is not the only concern in interorganizational relationships. Sometimes, control is much less of an issue, because partners are highly dependent on each other, which renders their agreements selfenforcing. Such interdependencies may originate, amongst others, from the fact that they have conducted relation-speciﬁc investments or possess only a limited number of alternatives for the relationship. They may also stem from time compression diseconomies to internalization and from exit barriers in terms of the beneﬁts that partners derive from interorganizational routines and qualitative coordination with existing partners (Blois, 1972; Lazzarini et al., 2007; Richardson, 1972; Telser, 1980; Zollo et al., 2002). In fact, one of the primary drivers of collaboration and interorganizational governance concerns these quantitative and qualitative forms of coordination among ﬁrms (Richardson, 1972). Coordination refers to ‘the organization of goals, priorities, and programs for the future, the ordering of the desires and expectations between or among the transacting parties, and the adjustment of individual behaviours to accommodate the schedules and functions selected for mutual endeavour’ (Salbu, 1997: 332). The need to use contracts and contracting practices as means of coordination stems, amongst others, from the fact

56

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that ‘management information and control systems are invariably much less developed across organizations than they are within them’ (Thatcher, 2004: 112). Consequently, partner organizations may have trouble in aligning each other’s actions so as to produce collective eﬀorts, something which may hamper the realization of interorganizational rents (Dyer and Singh, 1998). Collaborating organizations therefore require coordination mechanisms that help them to decompose tasks and establish and communicate activities that have to be completed (Gulati and Singh, 1998). Unlike the control perspective on interorganizational governance, which tends to emphasize the avoidance of opportunism and the mitigation of risk, the coordination perspective emphasizes the role of formal governance in creating unique value (Prahalad and Hamel, 1990). Contracts, for instance, are regarded as means to clarify, specify and communicate the quantitative and qualitative characteristics of the exchange, such as the required features of a product or a production process, the timing and sequencing of actions performed by partners, the desired levels of output, et cetera. In this sense, contracts can be interpreted as technical aids to managing relationships, sometimes ‘in the same way that minutes of a meeting remind participants of arrangements that were made’ (Klein Woolthuis et al., 2005: 835). Such a coordination function is of particular signiﬁcance for interorganizational relationships in which tasks have to be continually geared to each other and for which joint decision making between interorganizational partners is required (Gulati and Singh, 1998). Support for the coordination function of interorganizational structuring arrangements is provided by Gulati et al. (2005), Hagedoorn and Hesen (2007), Mayer and Argyres (2004) and Ryall and Sampson (2006). In their analysis of 222 procurement relationships at the automobile producers Chrysler and Ford, for example, Gulati et al. (2005) found that diﬀerent modes of organizing procurement relationships varied not only in their ability to control hazards of opportunistic behaviour, but also in their capacity to generate coordinated responses to adaptive pressures in the task and transaction environment. In their study of technology alliance contracts, Ryall and Sampson (2006) noted that contracts often embodied nonenforceable clauses that appeared to serve coordination functions only. These clauses assisted parties in planning the collaboration, setting partner expectations and reducing misunderstandings and unintended consequences. In a similar vein, Hagedoorn and Hesen (2007) observed that the four alliance contracts that they studied included elaborate appendices containing project plans and explicit task and responsibility descriptions, which placed the relationships between the partners in the realm of the contract itself. In addition, Lassar and Kerr (1996) revealed a signiﬁcant correlation (0.34, p0.05) between the extent to which contractual restrictions were

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imposed on distributors by manufacturers of audio speakers and the level of coordination that they attempted to realize concerning ﬁve diﬀerent distributor activities. Finally, in examining a sample of 1570 alliances announced between 1970 and 1989, Gulati and Singh (1998) found that governance structures were not only inﬂuenced by appropriation concerns, but also by anticipated coordination costs arising from task interdependence and task complexity. These studies indicate that formal governance may not only be conducive to control, but also to coordination. In the following paragraphs, I brieﬂy discuss the theoretical foundations underlying this view, including March and Simon’s theory of organizational behaviour, and the resource-based and dynamic capabilities view. March and Simon’s theory of organizational behaviour In discussing March and Simon’s theory of organizational behaviour, I focus on formalization as a principal means of coordination, because of the central position that of acts of formalization – e.g. contracting – assume in this book. March and Simon outline the processes through which formalization contributes to rational behaviour in organizations, and they explain how such acts limit the negative eﬀects of bounded rationality (March and Simon, 1958; Simon, 1947, 1997). From the perspective of organizational behaviourists,7 formalization enables coordination by supporting rational decision making, ‘not only by parceling out responsibilities among participants, but also by providing them with the necessary means to handle them’ (Scott, 2003: 52). Specialized roles and rules, and standard operating procedures are viewed as mechanisms that restrict the range of decisions organizational participants make and that assist participants in making appropriate decisions within that range (Scott, 2003). Moreover, as ultimate goals of organizations can be vague and imprecise, general goals serve as starting points for raising means–ends chains in which goals and the means to achieve these goals are subdivided into sub-goals and sub-means until a suﬃcient level of detail is attained (March and Simon, 1958). In this way, formalization enhances procedural coordination. It establishes lines of authority, and outlines the sphere of activity and authority of each member (Simon, 1997), so that the division of labour and interactions between partners become more predictable. In other words, by clarifying boundaries on activities and decisions, formalization simpliﬁes decision making (Galbraith, 1977). It serves the purpose of enabling communication, reducing uncertainty about future tasks and preventing disputes on how to achieve tasks (Pondy, 1977). Other arguments for the coordination function of formalization, which implicitly or explicitly refer to the work of March and Simon, emphasize its role in raising clear expectations (Organ and Greene, 1981; Shenkar and Zeira,

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1992; Simonin, 1999), and helping participants to translate complex issues into ‘terms that are clear and understandable’ (Simon, 1997: 345). In addition, formalization reduces the interdependence and complexity of activities as perceived by participants in interorganizational relationships (Singh, 1997) and it renders coordination less dependent on individual actors (Scott, 2003), thereby enabling personnel replacements and participation of newcomers in later stages of development (De Rond, 2003). It thereby also reduces the risk that things are ‘forgotten’ (Argote, 1999; Mintzberg, 1994). Finally, formalization tends to entail a common language (Simons, 1990) enabling participants to communicate their goals, and to signal each other’s preferences (Milewicz and Herbig, 1996). Resource-based and dynamic capabilities views A second stream of research pointing at the coordination function of formal governance consists of the dynamic capabilities school. Building on the resource-based view, proponents of this research stream maintain that organizations can be regarded as bundles of resources (Rumelt, 1984). Those resources that are valuable, rare, imperfectly imitable and imperfectly substitutable can become sources of sustainable competitive advantage (Barney, 1991; Peteraf, 1993). In case of interorganizational cooperation, these critical resources may span across organizational boundaries and they may be embedded in interorganizational processes and activities (Dyer and Singh, 1998). In this case, value is created and rents are earned through the synergistic combination of resources from diﬀerent organizations (Dyer and Singh, 1998; Madhok and Tallman, 1998) or through the eﬃcient and eﬀective development, deployment, allocation, exchange and utilization of resources (Lado et al., 1997). Organizations can capture value from combinations of these resources over longer periods of time when they are protected by isolating mechanisms (Lepak et al., 2007; Rumelt, 1984) such as time compression diseconomies to imitation (Dierickx and Cool, 1989) or causal ambiguity prohibiting copying by competitors (Lippman and Rumelt, 1982). In order to realize this synergistic potential, partner organizations have to bundle their resources and capabilities eﬀectively (Ghoshal and Moran, 1996). This prompts the incurrence of expenditures for eﬀecting and combining resources and it requires capabilities from partners to actively manage resources in order to extract value from them (Madhok and Tallman, 1998; Sirmon et al., 2007). It requires partners to gear interdependent tasks to each other (Colombo, 2003; Gulati and Singh, 1998; Kogut, 1988; Ring and Van de Ven, 1992), something presenting unique coordination challenges (Sampson, 2004b; Grandori and Soda, 1995). It is needless to say that this is often not an easy task, as resources of partner

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organizations are frequently embedded and distributed throughout their organizations and because many resources have a tacit or causally ambiguous character (see Madhok and Tallman, 1998; Simonin, 1999). Mechanisms for addressing these challenges could include a clear deﬁnition of authority relations, allocation of formal responsibility for decision making and the creation of standardized procedures and rules for action (Colombo, 2003). To make sure that these mechanisms are only applied in cases where this is appropriate, partner ﬁrms require managerial capabilities associated with the formation and management of interorganizational relationships (Gulati and Gargiulo, 1999; Mayer and Argyres, 2004). These capabilities help them in ‘adapting, integrating, and reconﬁguring internal and external organizational skills, resources and functional competencies’ (Teece et al., 1997: 515). They enable them to overcome the considerable challenges associated with forming and managing interorganizational relationships (Gulati and Gargiulo, 1999). Advocates of the dynamic capabilities school hold that such capabilities may aﬀect organizations’ preferences for particular collaborative governance structures (Chen and Chen, 2003; Hoetker, 2005; Leiblein, 2003; Mayer and Salomon, 2006).8 This may explain why ﬁrms facing similar levels of contractual hazards might rationally select diﬀerent governance solutions (Ghosh and John, 1999; Mayer and Salomon, 2006). In line with this, Ghosh and John (1999) and Madhok (2002) suggest that the reason that ﬁrms organize similar transactions in diﬀerent ways is that it is not just transaction particulars that matter, but also organizational particulars, including resources, governance skills, experience and the like. By focusing on the latter, the dynamic capabilities school shifts the emphasis away from the best generic institutional form for organizing a particular transaction towards the best way for a speciﬁc organization to organize such a transaction (Madhok, 2002; Williamson, 1991). Adherers to the dynamic capabilities school thus aﬃrm the possibility that some organizations are more inclined to formalize their relationships than others, irrespective of exchange characteristics. Organizations may diﬀer in their ability to select attractive sourcing partners, negotiate contracts, design systems to manage relationships or monitor and enforce contractual compliance (e.g. Doz and Hamel, 1998; Leiblein and Miller, 2003). Moreover, some organizations have been found to be more experienced in managing joint ventures (e.g. Anand and Khanna, 2000a), more capable of interacting with other companies (Lorenzoni and Lipparini, 1999) or more capable of creating value by means of interorganizational relationships (e.g. Dyer et al., 2001). These organizations have learned, for example, how to gain access to and transfer knowledge across relationships (Lorenzoni and Lipparini, 1999) or they have developed so-called ‘alliance capabilities,

60

Contracts and trust in alliances

relational capabilities or cooperative competencies’ (e.g. Draulans et al., 2003; Dyer and Singh, 1998; Dyer et al., 2001; Heimeriks and Duysters, 2007; Kale et al., 2002; Khanna, 1998; Sarkar et al., 2006; Sivadas and Dwyer, 2000). In their study of 469 make-or-buy decisions involving 117 semiconductor ﬁrms, Leiblein and Miller (2003), for instance, demonstrate that, the greater the number of prior outsourcing relationships with suppliers of a particular technology, the more likely it is that ﬁrms decide to outsource in subsequent make-or-buy decisions. Here, the asymmetric distribution of alliance managerial capabilities, due, among other aspects, to prior experience, encourages some ﬁrms to exploit them as a source of competitive advantage (Dyer et al., 2001). In her analysis of 464 R&D alliances in the telecommunications equipment industry, Sampson (2005) found support for the idea that ﬁrms beneﬁt from alliance experience as well, particularly when alliance activities are uncertain or complex. However, she also observed that only recent collaborative experiences have a positive impact on collaborative returns, suggesting that knowledge from prior experience depreciates over time. Results from other researchers (e.g. Heimeriks and Duysters, 2007; Sarkar et al., 2006) indicate that the impact of alliance experience on performance is partially mediated by the existence of ﬁrmlevel alliance capabilities. These capabilities may enable ﬁrms to capture, share, disseminate and apply knowledge gained in prior relations regarding issues such as partner selection, contracting and alliance restructuring in subsequent alliances.9 In analysing data on the alliance portfolios of 235 ﬁrms, Sarkar et al. (2006: 11), for example, show that alliance experience may enhance portfolio coordination, consisting of the processes by which a ‘focal ﬁrm engages in integrating and synchronizing activities, strategies, and knowledge ﬂows’ across its alliance networks. Next to a more general alliance capability, companies may develop socalled ‘contracting capabilities’ (Argyres and Mayer, 2007; Mayer and Argyres, 2004). These capabilities help to harness and exploit prior contracting experiences in new collaborative relationships (Reuer and Zollo, 2005). They can be created by comparing the contract performance of relationships with various partners, by casting light on diﬀerent contractual relationships with the same partner and by institutionalizing and leveraging this knowledge through learning mechanisms (Heimeriks and Duysters, 2007). In terms of performance eﬀects, these contracting capabilities may create sustained superior exchange performance. More speciﬁcally, the development and exploitation of contract design capabilities may enable ﬁrms to design contracts eﬀectively so as to augment joint value creation (Argyres and Mayer, 2007). Moreover, such a capability may lead to indirect performance beneﬁts, as a focal ﬁrm’s particular competence at

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contractually governing collaborations tends to attract stronger partners (see Sarkar et al., 2006). Mayer and Salomon (2006: 945) claim that contracting capabilities may be reinforced by other, technological capabilities, which help managers of the focal ﬁrm to evaluate a partner’s skills, judge its readiness to perform a task, assess its ability to accept and receive guidance and provide such guidance through technology transfer when necessary. These capabilities raise the ability of organizations to construct better contracts and to clearly deﬁne the roles and responsibilities of each party, specify the knowledge to be exchanged, identify appropriate milestones, stipulate monitoring mechanisms and introduce appropriate pecuniary incentives. In fact, in their analysis of 405 make-or-buy decisions, Mayer and Salomon (2006: 954) ﬁnd that focal ﬁrms were more likely to subcontract a project in the face of high hold-up hazards when it had strong internal capabilities as compared to instances in which those capabilities were not present. This result aligns with the idea that capabilities and transaction costs interact with each other dynamically and that the two considerations have interdependent eﬀects on ﬁrm boundaries (Zenger and Argyres, 2007). It is also consistent with the contention that an integration of control and coordination perspectives represents perhaps the most productive area for further theoretical and empirical development (Carter and Hodgson, 2006; Makadok, 2003). In line with this, Zenger and Argyres (2007) suggests that future research should focus on ‘capability for governing’ in an attempt to understand how ﬁrms learn to govern their internal and external relations over time, and on ‘governing for capability’ in an attempt to understand how governance choices inﬂuence the rate and eﬃciency of capability formation. The ﬁrst concords with the increasing attention that is being paid to alliance and contracting capabilities, whereas the latter connotes the emerging knowledge governance approach, which ‘is taken up with how the deployment of governance mechanisms inﬂuences knowledge processes, such as sharing, retaining and creating knowledge’ (Foss, 2007b: 29, italics added). In particular, the role of governance mechanisms in creating new knowledge has been argued to deserve more attention (Grandori, 2007).10 Critics of the resource-based and dynamic capabilities view have argued that the arguments that have been proposed are tautological, or selfverifying in nature (Priem and Butler, 2001: 31), since competitive advantage as a value-creating strategy is based on resources and capabilities that are, amongst other characteristics, valuable (see Barney, 1991). Others have commented that the resource-based view entails limitations because of its reliance on the competitive equilibrium model (Foss and Ishikawa, 2007), implying that the theory is only concerned with the ability of resources to generate rent in a stable situation (Lippman and Rumelt,

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1982).11 This implies that ‘The issue of how resource and resource applications are discovered (the entrepreneurial process) is bypassed in this approach [. . .]. Such shortcoming may be remedied by drawing more on process notions’ (Foss and Ishikawa, 2007: 750, italics added) and by incorporating entrepreneurship in the resource-based and dynamic capabilities views (Barney, 2001; Lippman and Rumelt, 2003). Concluding, both March and Simon’s behavioural theory and the dynamic capabilities school emphasize the diﬃculties associated with combining resources (Teece et al., 1997). Each of them holds that the need for coordination becomes higher when exchanges become more complex (see Colombo, 2003; Gulati and Singh, 1998; Heiman and Nickerson, 2004). Furthermore, behavioural theory suggests that a larger size of cooperating organizations complicates interorganizational coordination and that the age of cooperating organizations might inﬂuence their inclination to formalize (March and Simon, 1958; Simon, 1947, 1997). Older organizations probably experience a higher degree of institutionalization of procedures for interorganizational cooperation. They may have developed internal coordination capabilities, which can possibly be extended across organizational boundaries (Gittell and Weiss, 2004). Moreover, from a dynamic capabilities point of view, one could argue that the possession of legal expertise and more extensive experience with contracting obtained from earlier interorganizational relationships (see Bagley, 2005; Mayer and Argyres, 2004) may lead to the use of more appropriate contracting mechanisms. Despite their limitations, I believe that both the coordination and the control perspective on formal interorganizational governance have oﬀered us valuable insights. However, I also signal that these perspectives are predicated on the tenets of only a few major paradigms (Gioia and Pitre, 1990), which might lead to illusive explanations and to erroneous prescriptions for practitioners (see Adler, 1993; Huxham and Beech, 2003). A strict focus on these perspectives probably does not do justice to the multifaceted nature of the phenomenon of contracting. Consequently, I am ‘forced to crisscross paradigms’ (Narayandas and Rangan, 2004: 64) and to explore multiple perspectives, instead of an ‘all-encompassing’ theory (see Adler, 1993: 172; Grant and Baden-Fuller, 2004: 62). In the following chapters, I therefore build on the control and coordination perspectives presented here, but I also seek to join them with competing and complementary views. Such a theoretically pluralistic approach is known to have the capability of uncovering rich explanations of complex phenomena (Kumar and Seth, 1998) and to bring ‘ample opportunity for cross-perspective dialogue and learning’ (Oliver and Ebers, 1998: 570). It cherishes the fact that interorganizational relationships are studied from diﬀerent disciplinary approaches, and

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that they oﬀer ‘a precious ground of common interest and potential dialogue among various branches of the social sciences’ (Grandori and Soda, 1995: 183). The pluralistic approach taken towards investigating the research problem in Chapters 3 to 8 should therefore not be viewed as a search for the truth, but more as a search for comprehension in which diﬀerent worldviews are illuminated (Gioia and Pitre, 1990; Lewis and Kelemen, 2002).

CONCLUSION In this chapter, I have discussed how two main streams in research on formal interorganizational governance look upon the role of contracts in collaborative relationships. In Chapters 3 to 8, the phenomenon of contracting will be explored from six alternative, but complementary, angles. This should lead to a more diﬀerentiated and nuanced, but also more coherent and comprehensive, picture of contracting’s role in interorganizational relationships than is currently available in the literature.

NOTES 1. 2.

3.

Although I agree with Reuer and Ariño (2007) that contractual provisions may serve multiple functions, I also suggest that individual contractual provisions may serve more than one function at the same time. Lazzarini et al. (2007: 1) assert that ‘when opportunism creates exchange hazards [. . .], individuals will be reluctant to take full advantage of the gains from switching to more valuable partners [. . .]. Instead of embracing new, valuable exchanges with strangers whose propensity to cooperate is uncertain, individuals may prefer to preserve recurring ties with familiar actors’. Lazzarini et al. (2007) subsequently claim that two mechanisms may encourage movement out of committed relationships in those conditions, being formal contracts and trust in general others as opposed to trust in familiar people (general trust is independent of contractual provisions or controls in an exchange; it is a personal trait that aﬀects an individual’s assessment of the benevolence of others) (Yamagishi and Yamagishi, 1994). In situations where there is high uncertainty about the value of future exchanges with a certain actor – owing to technical or demand factors that induce variation in the value of exchanging with particular partners, such as the expansion of markets and the specialization of activities, which give rise to the emergence of new innovations and trade opportunities outside committed circles – social mobility and movement out of committed relationships becomes necessary, ‘as new, more valuable exchange opportunities with alternative parties are likely to continually emerge over time’ (Lazzarini et al., 2007: 7). I believe that a qualiﬁcation should be made here. Investments in relation-speciﬁc assets entail the potential to create considerable value for both parties within an interorganizational relationship. These returns might be suﬃciently large to discourage opportunistic behaviour by the party that ‘receives’ the investments. To the extent that the specialized assets produce greater than normal returns for the receiver, they may therefore create a self-enforcing contract for the investor (Blois, 1972; Richardson, 1972;

64

4.

5.

6.

7.

8. 9.

10.

11.

Contracts and trust in alliances Rokkan et al., 2003) and render formal governance mechanisms aimed at curbing opportunistic behaviour superﬂuous. The risk of hold-up occurs when partners with malicious intent can use the court to enforce literal contract terms in a manner contrary to the intent of the contract. This is one of the primary economic lessons from the General Motors–Fisher Body Case. In that case, Fisher took advantage of the long-term, cost-plus exclusive dealing contract with GM, as it refused to locate an important body plant next to the GM assembly plant after signing the contract. As a consequence, Fisher produced very costly (but highly proﬁtable) automobile bodies that General Motors was compelled to buy (Klein et al., 1978; Klein, 2000). The General Motors–Fisher Body example illustrates that increased contractual speciﬁcation can make things worse (Klein, 2002). However, as Foss (1999: 3) and Foss and Foss (2005) explain, strictly speaking, it is not true that the transaction cost approach neglects transaction beneﬁts. After all, eﬃcient economic organization ultimately ‘maximizes joint surplus, given sharing rules, path dependencies, information asymmetries and risk preferences’. This causes the separation between exchange and production in the theory of economic organization to be ‘an artiﬁcial one’. Hendry (2002: 101) suggests that, even if actors ‘do know what they will want in any possible situation, it may be so contingently complex as to resists accurate speciﬁcation. And even if they can specify it for themselves, principals may not be able to accurately and unambiguously communicate it to their agents’. Although my inquiries do not explicitly refer to the work of Max Weber, organizational theorists like March and Simon have built on his insights. I therefore brieﬂy outline some of his thoughts here. Weber focuses on the replacement of traditional organizational structures with bureaucratic structures. He points at general administrative policies and speciﬁed procedures, which enable bureaucratic systems to handle complex administrative tasks (Scott, 2003). Weber argues that formal rules contribute considerably to organizational eﬃciency. He explains that formalities restrict organizational members’ room for egoistic manoeuvres and arbitrary decisions, and that rules control organizational processes, increase their predictability, and enable the division of labour (Beck and Kieser, 2003). ‘Bureaucracy is superior, explains Weber, to other historically known forms of administration, because of its stability, reliability, the calculability of results which it permits, and the large scope of its operations’ (Gouldner, 1954: 25). The term ‘dynamic’ refers to a ﬁrm’s capacity to renew these competencies so as to achieve congruence with regard to changes in the collaborative environment, in the relationship and in the partner organizations themselves (Teece et al., 1997). Similar to other research on the management and governance of interorganizational relationships, ‘the emerging literature on alliance capabilities seems to be characterized by an over-emphasis on structure, and a relative disregard of organizational processes’ (Sarkar et al., 2006: 3). In this respect, Grandori (2007: 2) observes that ‘[g]overnance mechanisms have been widely examined and assessed in their capacities of governing knowledge transfer interdependence among diﬀerent nodes (units, ﬁrms, individuals), much less so in their capacity of governing knowledge production interdependence. A re-assessment of governance mechanisms in their capacity of governing innovation as knowledge generation seems therefore to be warranted’. Foss and Ishikawa (2007: 753) note that ‘it is hard to make room for entrepreneurship in an “equilibrium-always” approach, because the essence of entrepreneurship is to either restore or upset equilibrium’ (Kirzner, 1973). They observe that such ‘models do not allow us to understand the phenomenon itself’.

3.

Need versus ability to contract

The less was the measurability of supplier performance, the wider the use of inter-ﬁrm coordination mechanisms. (Delmestri, 1998: 660)

INTRODUCTION In this chapter, I focus on the non-shaded parts of the research framework, as depicted in Figure 3.1. I observe that research on contracting in interorganizational relationships either focuses on the need or on the ability to govern input, outcomes and behaviour (see Gerwin, 2004; Geyskens et al., 2006; Helm and Kloyer, 2004). I reconcile both perspectives by proposing that a higher need to contract is generally accompanied by a lower ability to do so. Managers are expected to cope with this apparent paradox by, amongst other things, investing in information processing and sensemaking activities. I empirically test my hypotheses by means of multiple regression analyses on a sample of 911 buyer–supplier relationships. From the results it accrues that higher levels of asset speciﬁcity and complexity, smaller ﬁrm sizes and an absence of prior experience with the same partner produce gaps between the need and ability to contract, propelling participants in interorganizational relationships to invest, amongst other factors, in information processing and sensemaking activities.

Need to govern

Antecedents Organization level Exchange level Context level

Positive consequences

Ability to govern

Figure 3.1

Performance Value discovery Value creation Value appropriation

Governance Contracting Trust

Negative consequences

Research framework: focus of theme one 65

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The study presented in this chapter allows for the integration of separate views on the relationships between contracting and its antecedents. It not only emphasizes organization and exchange characteristics that cause partners to perceive a higher need to codify and enforce inputs, outcomes, behaviour or processes, but it concurrently draws attention to their ability to do so. TCE, for example, primarily refers to a high need for formal control when considering the eﬀects of investments in relation-speciﬁc assets, environmental uncertainty and the volume and frequency of transactions (Williamson, 1985, 1991). Agency theorists, instead, generally focus on the ability to contract, which they proxy by the measurability of output and the degree to which behaviour can be speciﬁed (Kirsch, 1997; Ouchi, 1979, 1980; Ouchi and Maguire, 1975; Prendergast, 1999).1 Due to the coexistence of these diﬀerent lines of reasoning, arguments on the relationships between antecedents and contracting tend to point in opposite directions. Being unfamiliar with a potential partner, for example, is argued to demand a high degree of formal control (e.g. Gulati, 1995), but it also involves a low ability to codify outcomes and behaviour, because of the lack of knowledge about a partner (e.g. Mayer and Argyres, 2004; Poppo and Zenger, 2002). Similarly, authors focusing on the need to contract have generally put forward that uncertainty, coupled with conﬂicts of interest, tends to favour more stringent governance solutions. However, Grandori (2007) observes that this summary is highly imprecise, since this relation is contingent upon the knowability and observability of behaviour and output.2 The resulting tensions between the need to contract and the ability to contract may explain why researchers have presented inconclusive ﬁndings on the relationships between antecedents and contracting (e.g. see Blumberg, 2001). Stated otherwise, the central problem appears to be that situations that call for high contractual detail, complexity or speciﬁcity, are often simultaneously marked by a low ability to write appropriate contracts (Alchian, 1984; Aulakh and Madhok, 2002). This notion coincides with the idea that ‘contracts may not work when they are needed most’ (Klein Woolthuis et al., 2005: 825), and it resonates with Delmestri’s (1998: 660) ﬁnding on 18 organizations in the German and Italian machine-building industry that ‘the less was the measurability of supplier performance, the wider the use of inter-ﬁrm coordination mechanisms’. These puzzling observations lead to the following research question: to what extent do relationships between antecedents (i.e. characteristics or attributes of organizations, exchanges and the context in which these are embedded) and the ability to contract diﬀer from relationships between these antecedents and the need to contract? Based on a review of the literature, I propose that investments in relationspeciﬁc assets, the complexity of exchanges, the absence of prior cooperation and ﬁrm size all have a positive eﬀect on the need to contract, but also a

Need versus ability to contract

67

negative eﬀect on the ability to contract. I test these hypotheses on a sample of 911 buyer–supplier relationships. The results indicate that a higher need to contract does indeed go hand-in-hand with a lower ability to do so, and vice versa. Further analyses signify that more intense information processing and sensemaking activities during negotiations may constitute one way to solve this paradoxical situation. These ﬁndings contribute to the literature in two ways. First, they integrate previously separate perspectives on the relationships between contracting and its antecedents, encouraging researchers and practitioners to consider both the need to contract and the ability to contract when investigating and deciding on the degree of contracting that is most appropriate for a particular exchange. Second, the results support calls for extending information-processing arguments ‘to broader questions of governance choice’ (Carson et al., 2003: 54). My ﬁndings illuminate how tensions between the need and the ability to contract drive information processing and sensemaking eﬀorts, but they could also provide the basis for other research on extracontractual and intracontractual solutions for coping with the need–ability governance paradox. To accomplish these ends, the chapter is organized as follows. In the next section, I distinguish four antecedents of contracting derived from transaction cost theory (asset speciﬁcity), dynamic capabilities (complexity of the exchange), research on social networks (prior cooperation with the same partner), and the behavioural theory of the ﬁrm (size of the buyer). I then explain that each of these antecedents inhabits opposite relationships with the need and the ability to contract. Subsequently, I maintain that investments in information processing and sensemaking are required to enable coordination and control by means of formal contracts. I then test these hypotheses on a sample of 911 buyer–supplier relationships.

ANTECEDENTS OF CONTRACTING Academic contributions on the relationships between antecedents and formal governance in general have followed two separate lines of reasoning. The ﬁrst category emphasizes the inﬂuence of antecedents on the need to control and coordinate behaviour, processes and outcomes. The second category, sometimes starting from the same antecedents, underscores the impact of these factors on the ability to apply formal governance mechanisms and, in case of contracts, contracting diﬃculties (Mayer and Nickerson, 2005). The arguments that have been advanced in these contributions frequently point in opposite directions, which seems to indicate that situations calling for higher degrees of coordination and control are characterized by lower abilities to do so (see Alchian, 1984; Aulakh and

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Contracts and trust in alliances

Madhok, 2002). Helm and Kloyer (2004: 1110), for example, suggest that, in some situations, ‘a contract is needed but, as a result of uncertainty, a complete regulation [. . ] in the contract is diﬃcult’. Grandori and Furlotti (2007: 1) add that ‘both clear incentives and clear norms and rules are diﬃcult to deﬁne in highly uncertain and relatively unique ventures, where relevant actions and their payoﬀs are not known ex-ante; and even less is known what appropriate behaviours are’ (Grandori, 2006). A remark of a manager of a chemical company having a relationship with a security ﬁrm is illustrative here: ‘All that we had written was that we wanted Securiforce to take over our security from January 1999 and that this would be reviewed at the end of the year. This was a new ballgame to us, also. It was a learning process’ (Marchington and Vincent, 2004: 1048). From these citations, it appears that the ability to contract is typically lower when topics are new and when organizations still have to learn to work together (Mayer and Argyres, 2004). However, in these cases, contractual risks tend to be large, trust may still have to be developed, and interorganizational routines are either inapplicable or unavailable, suggesting a need for formal coordination and control. Moreover, contracting diﬃculties may emerge from measuring and monitoring problems, and from interdependencies among exchanges and technological uncertainties, which make it costly and sometimes even impossible to specify relevant contracts (Mayer and Nickerson, 2005). These problems are reinforced when parties are bilaterally dependent, and when complex tasks and technologies are involved, rendering the proper speciﬁcation of roles and responsibilities a non-trivial matter (Mayer, 2006). Although the need to contract may be apparent, bounded rationality, ambiguity and transaction costs may concurrently diminish the ability to contract (Mukerji, 1998). To assess whether relationships between antecedent variables and the need and the ability to contract assume contradictory values, I investigate the eﬀects of four antecedents of contracting that feature prominently in the literature. In anticipation of the discussion, Figure 3.2 depicts the hypotheses. Investments in Relation-speciﬁc Assets Investments are relation-speciﬁc when they have the highest potential value in a focal relationship; redeployment of these assets outside the relationship diminishes their value or is simply impossible (Dyer and Singh, 1998; Williamson, 1985). A ﬁrst type of relation-speciﬁc investments consists of physical assets, including investments in machinery, information systems, buildings and other physical assets from which little or no value can be recouped outside the relationship (Williamson, 1985, 1991). Another form

69

Need versus ability to contract Antecedents

Contracting

Investments in relation-specific assets

+

Complexity of the exchange

+

Need to contract –

– Paradox – Prior cooperation

Firm size

+

–

Ability to contract

+

Figure 3.2

Antecedents of the need and the ability to contract

of asset speciﬁcity concerns human capital, or even broader, intangibleasset speciﬁcity. Relationship-speciﬁc intangible assets can take the form of operating procedures, which are created and reﬁned over multiple cycles of action in an exchange; skills created through speciﬁc training, learning by doing, and particularistic experience; and knowledge created in the context of the exchange (Jap and Ganesan, 2000; Subramani and Venkatraman, 2003; Zollo et al., 2002). Such relation-speciﬁc investments involve vulnerability, as partners become more dependent on each other. In this respect, Bensaou and Anderson (1999) oﬀer an example of Toyota, which lost a week of production when Aisin, its proportioning valve supplier, suﬀered from a factory ﬁre. No cars could be produced until alternative suppliers were brought up to speed (Nishiguchi and Baudet, 1998), as the speciﬁc investments made by Aisin reduced the range of suppliers that were able to provide valves that were equally suited for Toyota. In general, investments in relation-speciﬁc assets have therefore been proposed to create room for opportunism, particularly in uncertain environments. The greater the speciﬁcity, the more elaborate the governance mechanisms required to constrain this opportunism (Bensaou and Anderson, 1999: 462; Joskow, 1996: 105). In this case, ‘when asset-speciﬁcity is high, ﬁrms are likely to be more

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motivated to protect themselves through contractual means’ (Gainey and Klaas, 2003: 215). Several empirical studies support this line of arguments (Barthélemy and Quélin, 2006; Masten, 1996; Palay, 1996; Rindﬂeisch and Heide, 1997; Shelanski and Klein, 1995). I also contend, however, that high investments in relation-speciﬁc assets are associated with a lower ability to contract. Knowledge concerning such investments is speciﬁc to a particular relationship as well, and thus more diﬃcult to articulate and codify. Formulating agreements on rights and obligations related to such investments is harder than it is for generalpurpose investments, as it becomes imperative to acquire more knowledge of the partner organizations, and as the investments entail risks that are more diﬃcult to foresee by each of the partner organizations, because the investments have never been made before. Unlike more ‘standardized’ investments, comparatively little information might be available regarding the characteristics and speciﬁcities of this type of investment, the risks associated with it and the environmental contingencies that may render such investments less valuable in future. These assertions are congruent with Williamson’s (1985: 211) remark that ‘[I]f measurement problems exist, they are assumed to vary directly with asset-speciﬁcity’. The latter indicates that investments in relation-speciﬁc assets might be of inﬂuence on both the need and the ability to contract. I capture this observation in a ﬁrst set of hypotheses. Hypothesis 3.1 The extent to which parties invest in relation-speciﬁc assets is positively associated with the need to contract. Hypothesis 3.2 The extent to which parties invest in relation-speciﬁc assets is negatively associated with the ability to contract. Complexity of the Exchange Partners in interorganizational relationships may also be confronted with high exchange complexity (Gulati and Singh, 1998). Exchange complexity can relate, amongst others, to the scope of a relationship (Oxley and Sampson, 2004; Reuer and Zollo, 2005; Sampson, 2004a, 2004b), the number of partners involved (Killing, 1988), the need to combine knowledge sets of multiple individuals (Argyres and Mayer, 2007; Nickerson and Zenger, 2004) and the degree of technological and organizational interdependency between partners (Kumar and Van Dissel, 1996; Thompson, 1967). Researchers have argued that complexity entails a higher potential for opportunistic behaviour (Oxley and Sampson, 2004) and that it demands control in the form of contracts, rules, scheduling or plans in

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71

order to cope with uncertainty and equivocality (Barthélemy and Quélin, 2006; Cyert and March, 1963; Leiblein and Miller, 2003; Moldoveanu and Bauer, 2004; Steensma and Corley, 2000; Thompson, 1967). Others have noticed that higher degrees of exchange complexity demand more coordination (Gulati and Singh, 1998; Heiman and Nickerson, 2004) and that it ampliﬁes governance costs and administrative overhead (Contractor, 1990; Doz and Hamel, 1998; Williamson, 1985). Argyres and Mayer (2007), for example, suggest that partners seek to reduce complexity through more explicit descriptions of parties’ roles and responsibilities, communication procedures and contingency planning in contracts. These arguments are consistent with work from Oxley (1997) and Sampson (2004a), who found that interorganizational relationships move towards more hierarchical governance modes for transactions encompassing a wider range of products, technologies and partners. It also conforms to ﬁndings from Barthélemy and Quélin (2006) on 82 outsourcing relationships that greater uncertainty concerning the future needs of outsourcing clients leads to the inclusion of more elaborate clauses dealing with unexpected contingencies in the contracts governing interorganizational exchanges. At the same time, however, high complexity of an exchange tends to reduce parties’ ability to contract. Interorganizational relationships that are complex entail complicated mental processes such as problem solving, applying discretion and using technical knowledge (Van de Ven and Delbecq, 1974), which impose high cognitive demands on participants in the relationship (Campbell, 1988). Occasionally, the number of variables that they have to consider is so large, and the interconnections among these variables are so intricate, that ‘common sense and everyday reasoning no longer provide adequate guides’ (Simon, 1997: 246). In such cases, the cognitive limitations of human beings preclude the comprehensive representation of complex activity systems in formal contracts (Simon, 1997). Moreover, the complexity of exchanges sometimes makes it costly to specify, measure and monitor output, input and behaviour (Mayer and Nickerson, 2005), and to anticipate possible contingencies (Argyres and Mayer, 2007). It becomes more diﬃcult and costly to monitor activities and specify issues in contracts or other formal documents, for instance, when more partners are involved with a relationship and when more products or technologies have to be included in a contract (Gulati, 1995; Oxley, 1997). Even if partners know what they want in any possible situation, things may be ‘so contingently complex as to resist accurate speciﬁcation’, or partners may fail in making correct judgments and interpretations (Hendry, 2002: 101). Oxley and Sampson (2004: 725), for example, indicate that ‘contractual governance of exchanges involving complex, tacit knowledge is particularly problematic as contracts are very diﬃcult to

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Contracts and trust in alliances

specify, monitor and enforce in these circumstances’. Such relationships entail greater uncertainty regarding how to evaluate the behaviour and performance of partners (Luo, 2007). Gainey and Klaas (2003: 215) show that parties therefore ‘must generally avoid speciﬁcity in the development of contracts’ in these cases (see also Bernheim and Whinston, 1998). I capture the relationships between exchange complexity and the need and the ability to contract in a second set of hypotheses. Hypothesis 3.3 The complexity of an interorganizational exchange is positively associated with the need to contract. Hypothesis 3.4 The complexity of an interorganizational exchange is negatively associated with the ability to contract. Prior Cooperation Many interorganizational relationships involve partners that have previously transacted with each other (Kale et al., 2002). Hitherto, however, the literature has remained inconclusive regarding the inﬂuence of prior cooperation on formal governance, describing two opposing eﬀects. The ﬁrst eﬀect that is advanced in the literature consists of a reduced need for formal governance (Gulati, 1995; Johnson et al., 2002; Lui and Ngo, 2004; Saxton, 1997; Zollo et al., 2002). From this perspective, prior relationships can substitute for costly contracts (e.g. Gulati, 1995; Uzzi, 1997). Presuming that prior and future collaboration are interdependent, prior contacts among allying organizations can act as a discipline mechanism, or a self-enforcing sanction (Telser, 1980) as it oﬀers prospects of retaliation in future (Ouchi, 1980; Ryall and Sampson, 2006). Furthermore, common histories and webs of connections reduce uncertainty (Gulati and Gargiulo, 1999; Larson, 1992) and they assist partners in developing deeper knowledge of each other in terms of interests, needs and capabilities (Mayer and Argyres, 2004). Prior relationships thereby may lead to the development of trust in a partner organization (Gulati, 1995; Macaulay, 1963; Saxton, 1997). Consequently, the need to set up contracts diminishes, because parties can make vicarious inferences about likely future behaviour of a partner ‘by extrapolating a past record into the future’ (Parkhe, 1998: 421). In addition, prior collaboration may have led to the development of interorganizational routines, which reduce the need to include contractual provisions in contracts geared to the coordination of relationships (Argyres et al., 2007; Reuer and Ariño, 2007; Zollo et al., 2002). Empirical evidence for such eﬀects of prior cooperation on contracting or other forms of formal governance has been found, amongst others, by Argyres et al.

Need versus ability to contract

73

(2007), Ryall and Sampson (2006), Reuer and Ariño (2007), Gulati (1995), Madhok (1995) and Luo (2002). In contrast, other researchers claim that prior cooperation leads to the proliferation of contracts. As partners come to know more about each other, their ability to codify desired behaviour and outcomes increases (e.g. Mayer and Argyres, 2004; Poppo and Zenger, 2002). Recurring interactions lead to a gradual reﬁnement of knowledge of a partner and it increases the ‘awareness of the rules, routines, and procedures that each needs to follow’ (Gulati et al., 2000: 210). As organizations sustain their business relationships over time, they develop a joint understanding that allows uniquely eﬃcient communication in the form of idiosyncratic interaction routines (Hoang and Rothaermel, 2005; Kotabe et al., 2003; McGinn and Keros, 2002; Zollo et al., 2002). Organizations that are familiar with each other have developed sets ‘of tacit understandings on how to collaborate with each other, how to prevent and remedy misunderstandings, and how to coordinate eﬀectively across organizational boundaries’ (Reuer and Zollo, 2005: 106–7). In other words, previous contacts between organizations presumably entails the development of specialized skills and routines adapted to the partner (Dyer and Singh, 1998; Hoang and Rothaermel, 2005; Kale et al., 2002), and to speciﬁc knowledge about the partner’s structure, operations and competencies (Shenkar and Zeira, 1992). It also increases partners’ ability to understand the kinds of contingencies that could threaten the relationship and the necessary adaptations that may have to be made. Such accumulated knowledge may enable parties to assess and specify roles, responsibilities and contingencies with more accuracy, in more detail and at lower costs (Argyres et al., 2007). Prior interactions also lead to improved monitoring and enforcement of contractual compliance and contracting skills (Leiblein, 2003; Mayer and Argyres, 2004; Reuer et al., 2002). In line with this, Ariño and Reuer (2004: 40) contend that ‘contracts of alliances between partners with prior ties are at least as complex [. . .] as those in which partners have had no previous relationships’. When parties are unfamiliar with each other, instead, relationships are reminiscent of low ‘planability’ (Miller et al., 2004). This is supported by empirical ﬁndings indicating that contracts between familiar organizations are more extensive (Luo, 2002; Mayer and Argyres, 2004; Poppo and Zenger, 2002; Ryall and Sampson, 2006) and systematically diﬀerent from those in de novo pairings (Anand and Khanna, 2000b). Results from the analysis of 386 contracts between a supplier of IT services/hardware and its customers by Argyres et al. (2007), for example, show that repeated exchange between two ﬁrms leads to greater eﬀorts at contingency planning. I capture the presumed links between prior cooperation and the ability and the need to contract in a third set of hypotheses.

74

Contracts and trust in alliances

Hypothesis 3.5 Prior cooperation with the same partner is negatively associated with the need to contract. Hypothesis 3.6 Prior cooperation with the same partner is positively associated with the ability to contract. Size of Buying Organization On an intraorganizational level, the majority of studies on the relationship between organizational size and formalization reveal a positive relation (Davila, 2005; Zeﬀane, 1989). Davila (2005), for example, ascertains that the emergence of management control systems in his sample of 95 young, technology-oriented Silicon Valley ﬁrms is largely driven by ﬁrm size. Studies concerning the inﬂuence of organizational size on governance mechanisms in an interorganizational setting are sparse, however, and most of them exhibit non-signiﬁcant relationships. Reuer and Ariño (2003) and Oxley (1997), for example, ﬁnd that the size of cooperating organizations has no inﬂuence on the use of equity- and non-equity governance forms. Overall, we therefore know little about the relationship between organizational size and the need and ability to contract. Nonetheless, I expect that interorganizational relationships that involve larger buyers exhibit a lower need to contract, as they generally possess more slack resources, which could help them in overcoming problems resulting from the application of insuﬃcient safeguards (March and Simon, 1958). Besides, large buyer organizations are likely to engender higher volumes of future activities, making them more attractive, and reducing their susceptibility to opportunistic behaviour by suppliers. After all, suppliers’ expectations of repeated business with buyer organizations can act as a discipline mechanism, with prospects of retaliation in future periods curbing non-cooperative behaviour in current periods (Ryall and Sampson, 2006; Williamson, 1985). Findings from Palay (1996) on governance choices in 51 transactions between rail freight carriers and their shippers support this assertion. In 19 transactions, Palay found support for the attenuation of opportunistic conduct by parties’ apparent reluctance to exploit short-term advantages to the detriment of long-run relations. Conversely, I claim that large organizations’ ability to contract is higher compared to small organizations. Large organizations possess more resources that they can dedicate to formalizing their relationships (March and Simon, 1958). They are also more likely to possess exhaustive legal expertise and they can probably draw from more prior experience concerning negotiations and contracting practices, which enhances their ability to identify and recognize issues and opportunities, and which promulgates their ability

Need versus ability to contract

75

to capture these in formal documents. Stated diﬀerently, these organizations are more likely to possess contracting capabilities (Mayer and Argyres, 2004). In addition, large and ﬁnancially prosperous buyers generally have a higher relative bargaining power, which increases their ability to include certain clauses in a contract (e.g. see Faems et al., 2007). Furthermore, many large organizations possess alliance departments and formal procedures for establishing, maintaining and governing their relationships (Bagley, 2005; Kale et al., 2002), which should enhance their ability to contract. The connections between size of the buyer organization and the need and ability to contract advanced here are captured in a fourth set of hypotheses. Hypothesis 3.7 contract.

Buyer ﬁrm size is negatively associated with the need to

Hypothesis 3.8 contract.

Buyer ﬁrm size is positively associated with the ability to

Summarizing, a close review of the literature suggests that the ability and the need to contract are inﬂuenced by the same type of antecedents, albeit in opposite directions. Ironically, the very characteristics that propel the need for contracts thus also appear to complicate their development (see Alchian, 1984; Chi, 1994). Information Processing and Sensemaking Factors increasing the need to contract have previously been argued to challenge clear identiﬁcation, deﬁnition, measurement and veriﬁcation, and to raise potential ambiguity in speciﬁcation and measurement (Madhok and Tallman, 1998). I draw on information processing and sensemaking perspectives (e.g. see Daft and Lengel, 1986; Thomas and Trevino, 1993) to propose a solution to close the resulting gap between the need and the ability to contract. I advance that resolution of the paradox may be found by partners instigating and propelling information-processing activities (e.g. acquiring data about products, prices and terms) and sensemaking eﬀorts (e.g. attempts to reduce ambiguity and reconcile perceptions). In situations where key decision makers have no solid understanding of the relationship, lack a common fact base and are unclear about important assumptions (see Kaplan and Beinhocker, 2003) exact stipulations in contracts may need to be postponed until the moment when uncertainty and equivocality have decreased suﬃciently (Helm and Kloyer, 2004). Interorganizational participants do not wait for this to happen, as coordination and control are purposeful, goal-oriented activities (Makhija

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Contracts and trust in alliances

and Ganesh, 1997). Instead, they will seek to ameliorate the quality of the information upon which they base their decisions (Simon, 1997). Analogously to Thomas and Trevino (1993), I therefore presume that they undertake strenuous eﬀorts directed at information processing (e.g. Galbraith, 1973, 1977; Tushman and Nadler, 1978) and sensemaking (e.g. Weick, 1979, 1995, 2001) so as to reduce uncertainty and equivocality, and improve the ability to contract (see also Daft and Lengel, 1986; Pfeﬀer and Salancik, 1978; Ring, 1997). Information processing refers to the acquiring, interpreting and synthesizing of information (Huber, 1991; Tushman and Nadler, 1978). Organizations are reputed to process information in order to reduce uncertainty (Daft and Lengel, 1986; Galbraith, 1973; Tushman and Nadler, 1978) and to enable coordination and control (Galbraith, 1977). Information processing is believed to ameliorate expectations about the future value of resources to an organization (Makadok and Barney, 2001) and to augment the controllability of issues and situations (Kuvaas, 2002; Thomas et al., 1993). Daft and Lengel (1986: 555), for example, suggest that ‘managers try to ﬁnd decision rules, information sources and structural designs that aﬀord adequate understanding to cope with uncertainty’, which is an assertion that can be logically extended to the interorganizational level of analysis (Bensaou and Venkatraman, 1995). Managers experiencing the need to engage in more vigilant and deeper examinations of a situation at hand search for information (Thomas and McDaniel, 1990; Tushman and Nadler, 1978). By acquiring and processing information, they reduce uncertainty (Daft and Lengel, 1986; Galbraith, 1977), which facilitates contracting. Information-processing eﬀorts are therefore a key aspect of well-functioning interorganizational forms (Williamson, 1991). However, managers are not only concerned with deﬁciencies of information, but also with a lack of clarity and with the existence of equivocality (Carson et al., 2006; Daft and Lengel, 1986; Daft and Weick, 1984). The latter implies that multiple and conﬂicting views on an issue exist (Weick, 1979), something which cannot be solved by gathering more information. Diﬀerences in interpretation of information and divergent meanings attached to cues, for instance, can result in participants holding conﬂicting values and developing distinct perspectives on interorganizational issues (Gray, 1985). For consensus and action to occur, interpretations of the information held by cooperating parties must be synthesized and meaning must be communicated (Thomas and Trevino, 1993). Partners consequently attempt to remove equivocality from relationships by investing in sensemaking activities. These activities are reputed to reduce suspicion about partners’ motives and to remove confusion regarding their responsibilities (Gray, 1985; Thomas and Trevino, 1993).

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Sensemaking involves the reciprocal interaction between information seeking, meaning ascription and action (Gioia and Chittipeddi, 1991; Weick, 1979). Eﬀorts directed at sensemaking include, amongst others, asking questions, probing, active detection of information (Daft and Weick, 1984), discussion and debate (Daft and Lengel, 1986) and cross-checking one’s own perceptions and interpretations with those of participants from the other organization. Sensemaking eﬀorts interact with the informationprocessing eﬀorts previously discussed. Managers who have larger amounts of information available, for example, presumably have more raw materials for constructing their interpretations (Daft and Weick, 1984; Kuvaas, 2002). This enables them to develop more accurate perceptions and it allows them to imbue data and information with meaning (Thomas et al., 1993). Sensemaking eﬀorts are particularly manifest during the negotiations preceding transactions. The social–psychological processes of sensemaking that lie behind the formal bargaining processes characterizing negotiations help participants to appreciate the potential for transacting with others and they assist in clarifying the nature of interorganizational relationships (Ariño and Ring, 2004; Ring and Van de Ven, 1989). I therefore propose that information processing and sensemaking eﬀorts are elicited in order to enhance interorganizational performance in cases in which a low ability to contract is accompanied by a high need to do so. In these situations, partners gather data and they attempt to reduce ambiguity before they enter formal commitments in order to reduce the gap between the information required and the information available (Tushman and Nadler, 1978) and to enhance participants’ understanding of their situation. After all, ‘commitments and formalized arrangements are not developed prematurely, when sensemaking and understanding processes are still producing unclear products and the parties are ambivalent as to the beneﬁts of a transaction for themselves or their organizations’ (Ring and Van de Ven, 1989: 183). This leads to the following hypotheses. Hypothesis 3.9 The size of the gap between the ability and the need to contract is positively associated with the eﬀorts that are invested in information processing and sensemaking. Hypothesis 3.10 Eﬀorts invested in information processing and sensemaking are positively associated with the degree of contracting. I test these hypotheses on a sample of 911 transactions involving the exchange of IT solutions among IT suppliers and small- and medium-sized buyers (see Chapter 1 and Appendix A for a more detailed description).

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Appendix B provides an overview of the measures used in the analyses for this and all other quantitative studies included in the book.

RESULTS I ﬁrst calculated correlation statistics (see Table 3.1), which are consistent with earlier research on the same data (Batenburg et al., 2003; Buskens, 2002). Pearson’s correlation coeﬃcient between the ability to contract and the actual degree of contractual complexity is negative and signiﬁcant ( 0.22; p0.01), providing a ﬁrst indication that the need and the ability to contract move in opposite directions. To obtain stronger support, I regress each of the antecedent variables on the ability to contract and on the actual degree of contractual complexity. Table 3.2 displays the results. The ﬁndings conﬁrm hypotheses 3.1 to 3.8 (compare model 1a and model 2). Where asset speciﬁcity and complexity reduce the ability to contract, they raise the degree of contractual complexity, suggesting a higher perceived need to contract. Moreover, relationships between partners that have previously cooperated and relationships involving larger buyers entail a higher ability to contract than relationships between unfamiliar partners, or relationships involving relatively small Table 3.1

Correlation matrix need versus ability to contract † Mean SD

1. Asset-speciﬁcity 8.66 2. Complexity of 5.32 the exchange 3. Prior 0.50 cooperation 4. Size buyer 5.79 5. Size supplier 3.40 6. Financial 2.54 volume 7. Ability to 9.40 contract 8. Contract 10.7 complexity 9. Info-processing 1.23

3.04 2.02

1

2

1.00 0.40

1.00

3

4

5

6

7

8

9

0.50 0.15 0.09 1.00 0.87 1.47 1.46

0.05 0.17 0.37

0.09 0.00 1.00 0.13 0.09 0.27 1.00 0.43 0.06 0.42 0.38 1.00

2.67 0.39 0.30 0.17 0.01 0.07 –0.28

1.00

5.84

0.32

0.35 0.13 0.11 0.35 0.42 0.22 1.00

0.53

0.37

0.37 0.11 0.23 0.20 0.54 0.31 0.39 1.00

& sensemaking †

Correlations with prior cooperation consist of Kendall’s tau-b. Correlations higher than 0.07 are signiﬁcant at the 0.05 level and correlations higher than 0.10 are signiﬁcant at the 0.01 level.

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Need versus ability to contract

buyers, but these factors are also associated with lower degrees of contractual complexity, indicating a lower need to contract. To test hypothesis 3.9, I regress ‘information processing and sensemaking’ on the four antecedent variables. The results of this analysis are presented in model 3 of Table 3.2. Asset speciﬁcity and complexity augment information processing and sensemaking eﬀorts. This is congruent with Tushman and Nadler’s (1978) assertion that complexity or interdependence between organizational units raises information-processing requirements. Prior experience with a partner, instead, reduces information processing and sensemaking eﬀorts. This ﬁnding corroborates Ring’s (1997: 296) remark that it seems probable that in cooperative relationships amongst familiar partners ‘actors will not need to rely heavily on sensemaking or understanding processes’. Interorganizational relationships among parties that have previously cooperated can therefore ‘be expected to evolve more rapidly than when reciprocal sensemaking, understanding or committing processes have not been employed repeatedly between them in the past’ (Ring, 1997: 296). Size of the buyer does not appear to inﬂuence buyers’ information-processing and sensemaking eﬀorts. This suggests that, although smaller ﬁrms experience a higher need to contract and a Table 3.2 Results: multiple regression analysis need versus ability to contract† Model 1a contractual complexity

Constant Asset speciﬁcity Complexity Prior experience Size buyer Size supplier Financial volume Info-processing & sensemaking N F-value R2 – adjusted

Model 1b contractual complexity

Model 2 ability to contract

Model 3 info-processing & sensemaking

Sig.

Sig.

Sig.

Sig.

4.40 0.11 0.17 0.12 0.08 0.25 0.24

*** ** *** *** ** *** ***

3.72 0.080 0.148 0.107 0.087 0.251 0.166 0.170

** * *** *** ** *** *** ***

7.06 0.27 0.12 0.12 0.10 0.02 0.16

*** *** *** *** **

0.64 0.15 0.12 0.07 0.035 0.00 0.42

*** *** *** **

569 38.00 0.28

***

550 34.41 0.30

***

569 24.96 0.20

***

***

† Correlations signiﬁcant at the 0.05-level (**), and the 0.01-level (***).

550 46.85 0.33

***

***

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Contracts and trust in alliances

lower ability to do so compared to larger ﬁrms, they do not put more eﬀorts into information processing and sensemaking so as to reduce uncertainty and equivocality, and to enable formalization. This might be due to the limited resources available in those ﬁrms (Street and Cameron, 2007). To test hypothesis 3.10, I examine whether information processing and sensemaking eﬀorts explain part of the variation in contractual complexity. Model 1b (see Table 3.2) incorporates information processing and sensemaking eﬀorts as an explanatory variable. These eﬀorts appear to account for an additional 2 per cent of the variance in contractual complexity compared to the baseline model (model 1a). The relationship between this variable and contractual complexity assumes a highly signiﬁcant value ( 0.17; p0.01). I therefore conclude that information processing and sensemaking eﬀorts explain a signiﬁcant amount of the variance in contractual complexity.

DISCUSSION In this theme, I investigated how contradictory ﬁndings on the relationships between antecedents and formal governance that prevail in the literature can be reconciled. I argued that, similarly to partner selection (Ahuja, 2000) and learning (Inkpen, 2000), interorganizational governance eﬀorts depend on parties’ needs and their abilities to coordinate and control behaviour and outcomes in their relationships. I capitalized on the observation that the arguments underlying empirically established relationships between antecedents and the use of formal governance mechanisms tend to centre either on the need or on the ability to formalize, but not on both (see Gerwin, 2004; Kirsch, 1997). This evoked the question as to whether antecedents of contracting accommodate contradictory forces. I expected a high need but low ability to contract for interorganizational relationships involving signiﬁcant investments in relation-speciﬁc assets, high exchange complexity, an absence of prior cooperation and small focal organizations. Subsequently, I advanced arguments from information-processing theorists (e.g. Galbraith, 1973, 1977) and authors on sensemaking (e.g. Weick, 1979, 1995, 2001) to explain how participants in interorganizational relationships may resolve the resulting impasse. I proposed that information processing and sensemaking eﬀorts would be higher in relationships in which the ability and the need to contract diverge more strongly. The results corroborated my hypotheses. Collectively, they underscore the idea that antecedents that are commonly associated with formal governance in the literature give rise to multiple, contradictory forces, and that tensions between these forces induce participants in interorganizational relationships to invest in information processing and sensemaking.

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Theoretical and Practical Implications These ﬁndings have numerous ramiﬁcations for researchers and practitioners. On a theoretical level, they indicate that Williamson’s (1979: 239) claim that ‘complex governance structures [would be] reserved for complex relations’ deserves to be qualiﬁed. Instead, contradictory relationships between antecedents and contracting practices may coexist. This may well explain why studies deploying transaction cost explanations remain inconclusive or contain mixed support for the relationship between antecedents, such as uncertainty and the extensiveness of interorganizational governance practices (David and Han, 2004; Geyskens et al., 2006). I therefore recommend researchers to take into account the ability as well as the need to apply formal governance mechanisms in future research. Moreover, as I found that partners may overcome discrepancies between the ability and the need to contract by investing in information processing and sensemaking eﬀorts, researchers should take managers’ tendencies to surmount diﬃculties associated with contracting into account when investigating the role of formalization in interorganizational relationships. Moreover, the ﬁndings imply that, perversely, alliances that are particularly useful also tend to be especially diﬃcult to manage (Accenture, 2003). Hence, it might sometimes be better for practitioners to pursue less complex cooperative ventures, or to design their ventures in a modular way – with a small interface between the cooperating organizations – so that participants in interorganizational relationships are better able to handle the complexity involved with interorganizational cooperation. Of course, this does not mean that they should just initiate external relationships that are easy to govern. Relationships between familiar partners, for example, might render cooperation easier, but these relationships may become overembedded (Lazzarini et al., 2007) and their performance beneﬁts have been argued to be frequently overstated, making careful assessments of alternative partners advisable (Hoang and Rothaermel, 2005). Furthermore, managers should be aware of the fact that more sophisticated relationships require investments in information processing and sensemaking so as to enable the formulation of appropriate contracts. Without these investments, contracting may become inadequate as a means of achieving coordination and control. Limitations and Opportunities for Future Research This study has several limitations, which could be addressed in future research. First, it conformed to a widely held tenet in the literature, by paying only limited attention to the role of managers in the process of

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structuring interorganizational relationships (Pfeﬀer and Salancik, 1978). The focus here lay on exchange characteristics and attributes of the collaborating organizations that inﬂuence structuring activities in interorganizational relationships. Previously, however, it has been remarked that such relationships can only be acted upon if participants are able to sense and interpret the environment (Daft and Weick, 1984; Ring and Van de Ven, 1994). To obtain better insights into the origins and evolution of interorganizational governance (Cardinal et al., 2004; Narayandas and Rangan, 2004), future research could therefore consider how and on what basis managers decide to apply particular degrees of contracting (see also themes three and four). Second, I did not empirically disentangle information processing from sensemaking eﬀorts. Jemison and Sitkin (1986) and Thomas and Trevino (1993), however, already explained that an overemphasis on either information processing or sensemaking could inhibit interorganizational performance. This suggests that inquiries on the interplay between both activities might be worthwhile. Another avenue for future research is to investigate more deeply to what extent purposefully withholding information from negotiation and contracting processes for strategic reasons (e.g. Eggleston et al., 2000), diﬀerences in relative bargaining power between contracting parties (Faems et al., 2007) and broader concerns over value appropriation aﬀect the need–ability paradox. Concerning the latter, Olekalns and Smith (2006: 4) observe: On the one hand, exchanging accurate information helps negotiators to maximize joint outcomes by identifying the needs of both parties. On the other hand, providing accurate information creates the possibility that this information will be used in an exploitative way to beneﬁt the other party. Withholding or misrepresenting information oﬀers the dual beneﬁts of protecting individuals from possible exploitation and increasing a negotiator’s own power.

As information is generally a highly valuable and tradable resource for negotiators, they may thus be tempted to conceal or misrepresent information and to refrain from intense negotiation and contracting processes altogether (Olekalns and Smith, 2006).3 In line with this, concerns over value appropriation deserve to be addressed in future research. A third option for future research concerns other extracontractual alternatives (next to information processing and sensemaking eﬀorts) for dealing with the need–ability paradox, such as restrictions put on the scope of relationships (e.g. see Khanna, 1998; Oxley and Sampson, 2004), or the means that partners have to inﬂuence each others’ beliefs (Foss, 2007a; Langlois, 2005). Further options consist of inquiries into the selection of familiar versus unfamiliar partners (e.g. see Gulati and Gargiulo, 1999; Li

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and Rowley, 2002; Rangan, 2000; Sampson, 2005; Saxton, 1997) and probes into the degree to which managers and engineers are assigned predominant roles in designing contract terms related to roles and responsibilities and exchange-speciﬁc contingency planning (Argyres and Mayer, 2007).4 Furthermore, research could focus on the purposeful introduction of interdependencies among partners (e.g. by exchanging equity or making investment and revenue streams mutually dependent). The latter increases the likelihood that partners act with the other’s interests in mind, without the need to revert to detailed formal contracts. Take, for example, the electronics multinational Philips, which developed the Senseo coﬀee machine in cooperation with Douwe Egberts (DE). The contract between the two parties obliged DE to invest in the development and production of the machines, whereas Philips would receive part of the revenues of the coﬀee pads that would be sold. The relation-speciﬁc investments conducted by DE increased their dependence on Philips, whereas the beneﬁts that would ﬂow from the sales of coﬀee pads increased Philips’ dependence on DE. Both organizations thereby had higher incentives to continue the relationship and refrain from short-term opportunistic behaviour. Preliminary research results by Vlaar and Faems (2007) concerning ﬁve alliance case studies suggest that other ‘extracontractual’ solutions, such as the implementation of a modular project structure so as to reduce unintended knowledge spillovers and interdependencies, the use of an evaluation project to assess a partner’s competencies and the potential for cooperation, and limitations of the scope of relationships may also be appropriate means for dealing with the need–ability paradox (see also Khanna, 1998; Oxley and Sampson, 2004). Finally, I have sought a solution to the need–ability paradox ‘outside the contract’ in terms of heightening information processing and sensemaking activities. Other researchers, such as Grandori and Furlotti (2007: 2) have focused on solutions within the contractual domain instead. They suggest that situations in which potential conﬂicts call for enforceable contracts, but where uncertainty necessitates low levels of articulation and detail, ‘contracts should establish a “society” rather than regulating an exchange’. They should ‘include an “associational contract” – specifying the identity of partners and the fundamental obligations and rights as to resource commitment and outcomes appropriation; and a “constitutional” part specifying the fundamental rules and procedures through which [parties should be] taking decisions – rather than specifying actions and contingencies’. Results of analyses on the governance of 475 inter-ﬁrm projects suggest that formal contracts ‘are “associational” and “constitutional”, i.e. focused on who the partners are, what they contribute (and own), and how they are going to adapt to circumstances (taking decisions and

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eventually separating)’ in situations characterized by uncertainty (Grandori and Furlotti, 2007: 7). Future research could focus on these and other ‘intracontractual’ and ‘extracontractual’ solutions to the need–ability paradox.

NOTES 1. Note that the distinction between the need and the ability to contract follows the fundamental psychology of relations (Heider, 1958), which recognizes that both motivation (need) and capability (ability) are required for action. 2. In line with this, Grandori (2007: 12) advances the view that ‘a frequent over-statement of the virtues of hierarchy in the governance of uncertainty’ has occurred in the context of relationships aimed at innovation, possibly due to the ‘discrete’ or comparative approach to governance and the attraction towards solutions that prevail frequently in practice’ (which do not necessarily have to be the most appropriate). 3. More speciﬁcally, in their simulated two-party negotiations involving 120 undergraduate students, Olekalns and Smith (2006: 14) found that negotiators who were perceived as reliable, predictable, and as having shared goals, triggered less deception by the other party. However, diﬀerent trustworthiness cues predicted diﬀerent forms of deception: whereas unpredictability triggered sins of omission (individuals concealed information), the absence of shared goals triggered sins of commission (active deception in terms of misrepresenting the situation by giving false information). 4. Instead, according to Argyres and Mayer (2007), lawyers should feature more prominently in designing terms related to dispute resolution, assignment of decision and control rights, and generic (non-exchange-speciﬁc) contingency planning.

4.

How trust and contracts coevolve*

While there are numerous examples in the literature where control chases out trust and situations in which trust seems to remove the necessity for control, there are equally as many examples of trust and control being complementary, or going hand in hand. (Bachmann et al., 2001: v)

INTRODUCTION In this chapter, I discuss the evolution of trust, distrust and formal coordination and control in interorganizational relationships. I suggest that the degree to which managers trust and distrust their partners during initial stages of cooperation leaves strong imprints on the development of these relationships in later stages of collaboration. This derives from the impact of trust and distrust on (1) formal coordination and control; (2) interorganizational performance; and (3) the interpretations that managers attribute to the behaviour of their partners. Collectively, my arguments give rise to a conceptual framework, which indicates that there is a high propensity for interorganizational relationships to develop along vicious or virtuous cycles. By integrating and reconciling previous work on the trust–control nexus, and by emphasizing the dynamics associated with it, this chapter contributes to a more comprehensive and reﬁned understanding of the evolution of interorganizational cooperation.

WHAT WE KNOW ABOUT THE INTERPLAY BETWEEN TRUST AND CONTROL Interorganizational governance issues have attracted growing attention from academics and practitioners owing to the increasing number of alliances, outsourcing relationships and other forms of inter-ﬁrm exchange, *

An earlier version of this chapter has been published before. I wish to thank Sage Publications for its permission to reprint this chapter. The original publication appeared under the following title: Vlaar, P.W.L., F.A.J. Van den Bosch and H.W. Volberda (2007a), ‘On the evolution of trust, distrust, and formal coordination and control in interorganizational relationships: towards an integrative framework’, Group & Organization Management, 32 (4), 407–28.

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and the governance issues associated with these relationships (e.g. see Gulati and Singh, 1998; Kale et al., 2002; McEvily et al., 2003a). The corresponding literature distinguishes several governance forms by which cooperating parties may govern these relationships, primarily emphasizing trust and formal control (Bijlsma-Frankema and Koopman, 2004; García-Canal et al., 2003; Luo, 2002; Poppo and Zenger, 2002). In line with these research streams, diﬀerent theoretical perspectives on the signiﬁcance of trust and contracting, and on the interplay between them, have emerged. Particularly, contributions have emphasized (1) that trust and contracts may act as substitutes (e.g. Das and Teng, 2001; Dyer and Singh, 1998; Gulati, 1995; Inkpen and Currall, 2004); (2) that they may function as complements (e.g. Deakin and Wilkinson, 1998; Mayer and Argyres, 2004; Poppo and Zenger, 2002; Sitkin, 1995; Zucker, 1988); (3) that they have a variety of performance eﬀects (e.g. Luo, 2002; Kern, 1998; Mayer and Argyres, 2004; Sydow and Windeler, 2003); and (4) that they may develop along self-reinforcing cycles (e.g. Faems et al., 2007; Ghoshal and Moran, 1996; Inkpen and Curall, 2004; Macaulay, 1963; Zand, 1972). Despite these contributions, the relationships between trust and contracting remains far from clear (Maguire et al., 2001; Sydow and Windeler, 2003), and much theoretical input is still needed to understand how they work as governance mechanisms (Bachmann, 2001). In particular, the role of trust and contracts in the process of relationship development and their evolution during cooperative endeavours deserve more attention (Argyres et al., 2007; Barthélemy and Quélin, 2006; De Wever et al., 2005; Inkpen and Currall, 2004; Reuer and Ariño, 2007). In line with this, calls have been made for more integrative approaches towards theory development and more dynamic representations of the trust–control nexus (Bijlsma-Frankema and Costa, 2005; Bijlsma-Frankema and Koopman, 2004). In this respect, Lazzarini et al. (2007: 36) advance that ‘[u]nderstanding the dynamic relationships between contracts, trust, and social structure is certainly a fertile area for future research’. In this chapter, I undertake a ﬁrst step in this direction by addressing the following research question: how do trust and contracts coevolve in interorganizational relationships? This question pertains to the non-shaded areas in the research framework depicted in Figure 4.1. To investigate this question, I distinguish trust from distrust, and formal coordination from formal control. I then introduce a conceptual framework in which I incorporate two other variables, these being interorganizational performance and managers’ interpretations of partner behaviour. This framework contributes to the literature in two ways. First, it transcends prior work on interorganizational governance through the systematic integration of a range of contributions on the roles of trust and contractual governance in interorganizational relationships and on the

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Positive consequences

Need to govern

Antecedents Organization level Exchange level Context level

Ability to govern

Figure 4.1

Performance Value discovery Value creation Value appropriation

Governance Contracting Trust

Negative consequences

Research framework: focus of theme two

interrelationships between them (as advocated by Bachmann, 2004; Bachmann et al., 2001; Bijlsma-Frankema and Koopman, 2004; McEvily et al., 2003a). Second, by reconciling apparently inconsistent arguments and empirical evidence on the trust–control nexus (Bachmann et al., 2001; Bijlsma-Frankema and Costa, 2005), I describe how interorganizational governance may evolve, something which has received little attention in the literature thus far (Inkpen and Currall, 2004; Klein Woolthuis et al., 2005). More speciﬁcally, I explain why trust and distrust at initial stages of cooperation leave strong imprints on the development of collaborative relationships in later stages of development by elucidating their impact on formal coordination and control, interorganizational performance and the interpretations that managers attribute to the behaviour of their partners.

DISTINGUISHING TRUST FROM DISTRUST AND FORMAL COORDINATION FROM FORMAL CONTROL Although trust and distrust are sometimes viewed as two ends of a continuum, several scholars acknowledge that they are separate, but related, constructs (Hardin, 2004; Lewicki et al., 1998; Sitkin and Roth, 1993). Following Lewicki et al. (1998: 439), I contend that trust and distrust coexist and therefore conceptually distinguish distrust from trust, deﬁning it as involving ‘conﬁdent negative expectations regarding another’s conduct’ that manifest themselves in fear, vigilance or suspicion (Sitkin and Roth, 1993). Distrust thus derives from the negative hypothetical possibility regarding a partner’s behaviour and actions (Bachmann, 2001). It arises when partners have an interest in behaving opportunistically (Williamson, 1985). Partners

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can trust each other in one respect and distrust each other regarding other issues (Lewicki et al., 1998; Mesquita, 2007). Moreover, partners may cultivate trust and distrust at the same time so as to reap the beneﬁts from both and to compensate for the weaknesses associated with each of them. Trust, for example, always remains a fragile mechanism (Dodgson, 1993), which prompts Langfred (2004: 391) to state that ‘a little skepticism never hurt anyone’. This indicates that combinations of trust and distrust may be most beneﬁcial to interorganizational cooperation. To conclude, I thus embrace the idea that trust and distrust coexist (see Miles and Creed, 1995). Where trust and distrust involve the expectations of managers concerning their partners, contracting involves actual interference in collaborative endeavours. As indicated in previous chapters, it involves the codiﬁcation and enforcement of inputs and outcomes, or processes and behaviour (Bijlsma-Frankema and Costa, 2005; Das and Teng, 2001). As suggested earlier, contracts and negotiation and contracting practices fulﬁl both a control function and a coordination function, something which is gradually receiving more systematic attention in the literature (e.g. Carson et al., 2006; Foss, 1999; Foss and Foss, 2005; Gulati and Singh, 1998; Klein Woolthuis et al., 2005; Madhok, 2002; Mayer and Argyres, 2004; Reuer and Ariño, 2007). Whereas control problems are primarily rooted in diﬀerences in motivation and interest between partners, coordination problems generally arise from the cognitive limitations of individuals. These problems may persist even though partner interests may be aligned (Foss and Foss, 2005; Gulati et al., 2005). I therefore distinguish formal control from formal coordination. Since I will argue that trust, distrust and formal coordination and formal control aﬀect interorganizational performance and the interpretation that managers give to their partners’ behaviour, I also brieﬂy touch upon the meaning of these last two constructs here. Interorganizational performance both concerns ‘the degree of accomplishment of the partners’ goals [. . .], and the extent to which their pattern of interactions is acceptable to the partners’ (Ariño, 2003: 23). When I discuss interorganizational performance, I therefore consider the outcomes achieved in a relationship, as well as the relational quality underlying these outcomes (Ariño, 2003). Finally, in the context of this chapter, interpretation is deﬁned as the meaning that is attributed to a partner’s behaviour. Now that I have deﬁned the main constructs in this study, I elucidate how trust, distrust and formal coordination and control may evolve in interorganizational relationships. I do so by explaining the research framework depicted in Figure 4.2. The general thrust of my argument is that managers’ expectations during initial stages of cooperation, in terms of the levels of trust and distrust that they hold towards their partners, have a major impact on the development of these relationships in later stages (see also

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Contracting • Coordination • Control P4.3

P4.1 P4.8 P4.6 P4.4

Trust & distrust

Performance

Positive or negative expectations about a partner

P4.2

• Relational quality • Outcomes

P4.5 P4.9

P4.10

P4.7

Interpretation of a partner’s behaviour

Figure 4.2 Evolution of trust, distrust and contracting in interorganizational relationships Doz, 1996; Ferrin et al., 2005; Klein Woolthuis et al., 2005). This stems from their inﬂuence on formal coordination and control, interorganizational performance and the favourability with which managers interpret the behaviour of their partners. These eﬀects increase the likelihood that existing expectations are reinforced and that trust and distrust develop along vicious or virtuous cycles.

TRUST AND DISTRUST AFFECTING FORMAL COORDINATION AND CONTROL A large body of literature proposes that trust may act as a substitute for formal control, as higher degrees of trust reduce the need to control (e.g. Das and Teng, 2001; Dyer and Singh, 1998; Gulati, 1995; Inkpen and Currall, 2004). From this perspective, trust and formal control consist of

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‘functionally equivalent strategies for absorbing uncertainty and dealing with the freedom and indeterminacy of other agents’ (Knights et al., 2001: 329; see also Reed, 2001; Zucker, 1988). Both forms of governance increase the perceived predictability of social actors’ future behaviours (Luhmann, 1979; Nooteboom, 2002). This implies that, if managers lose trust in their partner, more resources have to be invested in formal control (Dyer and Chu, 2003), while increments in trust reduce the need to do so (Inkpen and Currall, 2004; Zaheer et al., 1998). This substitution eﬀect between trust and formal control is conditional upon the existence of a certain degree of distrust. After all, if managers do not have any reason to distrust their partner (e.g. the perceived opportunities and payoﬀs for opportunistic behaviour by a partner are low), a lack of trust does not have to be compensated by an increase in formal control. This leads to a ﬁrst proposition (see also Figure 4.2). Proposition 4.1a In the presence of distrust, increases in trust reduce the need for formal control, while decreases in trust augment the need for formal control. Trust also exhibits a positive relationship with formal control, in that higher degrees of trust enable higher levels of formal coordination and control (Dekker, 2004; Mellewigt et al., 2007; Poppo and Zenger, 2002). Trust facilitates open communication and negotiations on the details of contracts, ‘including the thorny sensitive clauses like relationship termination’ (Klein Woolthuis et al., 2005: 831). Furthermore, by facilitating information sharing (Dyer and Chu, 2003; Dyer and Singh, 1998) and by functioning as a ‘lubricant of economic exchange’ (Knights et al., 2001: 312), trust enables parties to record aspects of their relationships in formal contracts and documents. Distrust, instead, entails low degrees of information exchange, and limited opportunities to observe and learn from partners (Maguire et al., 2001), which reduce possibilities to formalize the relationship. I contend that the enabling character of trust and the restricting nature of distrust pertain both to contracting’s coordination function and its control function. After all, communication and information exchange are conducive to codiﬁcation and enforcement in general. Moreover, as the coordination and control functions of formalization are strongly intertwined, an enabling or restricting inﬂuence on one of them will generally aﬀect the other function as well (Foss and Foss, 2005; Madhok, 2002). This leads to the following proposition (see also Figure 4.2). Proposition 4.1b Decreasing levels of distrust and increasing levels of trust augment the ability of managers to establish formal means of coordination and control.

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According to Mayer and Argyres (2004), this relationship also holds the other way around. More speciﬁcally, the managers interviewed for their study emphasized that contracts that are more detailed actually enhanced, rather than diminished, trust between managers of the focal ﬁrm and its contractual partner over time. The managers explained that, by clarifying each partner’s expectations regarding the other’s behaviour in various circumstances, they could place greater trust in one another.

PERFORMANCE EFFECTS OF TRUST, DISTRUST AND FORMAL COORDINATION AND CONTROL In this section, I discuss the performance eﬀects of trust, distrust and formal coordination and control that feature most prominently in the literature. First, basic levels of trust function as a prerequisite for interorganizational cooperation, because they help to generate and maintain interaction and social order (Bachmann et al., 2001; Inkpen and Curall, 2004; Luhmann, 1979; Reed, 2001). In particular, ‘[I]n the face of unknown conditions, unintended consequences, existing zones of uncertainty, and the prevailing dialectic of control, social interaction always requires some trust’ (Sydow and Windeler, 2003: 79). Otherwise, interorganizational relationships would be pervaded by very high levels of uncertainty, causing managers to continually question the motives and competences of their partners (Das and Teng, 2001; McEvily et al., 2003a). In such cases, they become less willing to take risks, and they refrain from sharing perspectives and knowledge (Bijlsma-Frankema, 2004; March and Olsen, 1975). Similarly, I contend that excessively high levels of distrust prohibit beneﬁcial cooperation as well, as potential partners may become reluctant to initiate relationships, or because their relationships are pervaded by so much suspicion that they are not able to capitalize on joint opportunities for value creation. High distrust, for example, may increase a focal party’s concerns about the use of particular information by the other party, thereby eliciting self-protective action in the form of the concealment or misrepresentation of preferences (see Olekalns and Smith, 2006). I capture this in proposition 4.2 and reﬂect it in Figures 4.2 and 4.3. Proposition 4.2 Low levels of trust and high levels of distrust have a negative eﬀect on interorganizational performance. Analogously to trust, basic levels of formal coordination and control form a precondition for people to engage in transactions with external partners as well (Bachmann, 2001; Dasgupta, 1988; Johnson et al., 2002; Malhotra and

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High

Contracts and trust in alliances

Intermediate levels

Low

Suspicion Low High

Trust Distrust

High Low

Trust, distrust and interorganizational performance

Low

Interorganizational performance

High

Figure 4.3

Naïveté

Intermediate levels

Chaos

Low

Figure 4.4

Rigidity

Formal coordination & Formal control

High

Formal contracts and interorganizational performance

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Murnighan, 2002). Irrespective of the level of trust, certain levels of coordination and control are necessary to endow participants in interorganizational relationships with a fair degree of certainty, stability and guidance (Langfred, 2004; Weick, 2001). Without it chaos is likely to reign (Luo, 2002; Mintzberg, 1994; Volberda, 1998). In this respect, Dyer and Chu (2003: 64) note that ‘it seems that even for high-trusting relationships, it is necessary to spend some eﬀort up-front to make sure that the responsibilities of each party are clearly spelled out’. Support for this contention is provided by Hoecht’s (2004) study of collaborative research projects, in which he found that legal instruments such as detailed contracts were considered normal rules of the game, which were not even relaxed if parties had long cooperative histories. Very high levels of formal coordination and control can be detrimental to interorganizational performance as well, because they may entail ‘cumbersome, overregulated, and impersonal processes that individuals are forced to adhere to’ (Beck and Kieser, 2003: 794). Excessive contracting leads to conﬂict and disagreement among parties (Ring and Van de Ven, 1994). It also has a retarding eﬀect on creativity, entrepreneurship and innovation (Foss et al., 2007), and it inhibits the ﬂexibility that is needed for coping with complex, ambiguous and unstable task environments (Mintzberg, 1994; Nooteboom, 1999; Volberda, 1998). High levels of contracting may further stiﬂe desirable mutual accommodations (Ireland et al., 2002; Nooteboom, 1999) and it can easily degenerate into formalism (Balogun and Johnson, 2004; Mintzberg, 1994; Starbuck, 1983). Moreover, the existence of strong formal controls may inhibit the development of trust, because it leaves few situations where there is any remaining perceived risk, so that trustworthy actions will be attributed to the existence of the control system rather than to the trustee (Schoorman et al., 2007; Strickland, 1958). Finally, high degrees of formal coordination and control may result in areas of unilateral dependence (Lusch and Brown, 1996; Macneil, 1980), hold-up problems (Klein et al., 1978) and other transaction costs (Williamson, 1985). I therefore contend that, all else remaining equal, very low and very high levels of formal coordination and control have a negative eﬀect on interorganizational performance. I capture this in a third proposition (see also Figures 4.2 and 4.4). Proposition 4.3 Low and high levels of formal coordination and control have a negative eﬀect on interorganizational performance.

COMBINATIONS OF GOVERNANCE FORMS Hitherto, I have described several individual eﬀects of trust, distrust and formal coordination and control on interorganizational performance.

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However, I also advance that combinations of these governance forms may aﬀect interorganizational performance. As I cannot discuss all of them in this chapter, I focus on one particularly dangerous combination here, consisting of a high level of trust joined with low levels of distrust and formal control. In this situation, the danger lurks around the corner, that a ﬁrm becomes an easy target for exploitation by greedy partners (Wicks et al., 1999; Zeng and Chen, 2003). This threat arises from the fact that trust may be based on systematic biases (Jeﬀries and Reed, 2000; McEvily et al., 2003b) and from the notion that ﬁrms can never completely rule out that partners see it as advantageous to cheat (Lane and Bachmann, 1997). It is reinforced by the fact that even trustworthy partners can be relied upon to be untrustworthy if the incentives are great enough (Dasgupta, 1988). Anderson and Jap (2005: 78) therefore advance that ‘while cozy relationships sound good in theory, such relationships also provide an opportunity for covert activities designed to systematically cheat a partner’. Similarly, Langfred (2004) argues that, under certain conditions, trust can be harmful, as it encourages actors to suspend judgment of others. This could manifest itself in the initial denial of problems, in giving others the beneﬁt of the doubt and in giving second chances more frequently (Hoetker, 2005). Managers asking themselves ‘Our partners are so trustworthy; how could they be exploiting us?’ may be reminiscent of such cases (Anderson and Jap, 2005: 76). In fact, trust may go as far that ‘one takes the relation for granted and does not continuously think about opportunities to gain extra advantage from it, nor does one consider the other to do so’ (Klein Woolthuis et al., 2005: 816). An example consists of a relationship between an automaker and one of its suppliers, as described by Anderson and Jap (2005). The automaker invested heavily in this relationship, which eventuated in a high level of mutual trust. However, the automaker’s trust was abused by the supplier, which ‘cut corners in a calculating manner’ (Anderson and Jap, 2005: 77). Such examples show that trust sometimes ‘binds and blinds, making economic actors insuﬃciently vigilant and excessively vulnerable’ (McEvily et al., 2003b: 98), and that trust can lead to naïveté and a take-itfor-granted mind-set in which relationships are put on ‘cruise control’ (Anderson and Jap, 2005; Carson et al., 2006; Mesquita, 2007). More speciﬁcally, when a focal actor trusts its partner, the tendency to screen the information provided by the other for accuracy decreases, and the inclination to accept the information at face value increases (McEvily et al., 2003b; Uzzi, 1997). Moreover, excessive levels of trust in a familiar partner may reduce the willingness of actors to move into new, potentially more valuable, relationships (Lazzarini et al., 2007). This connotes the idea that, although ‘a widely held opinion in organization studies is that

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formalization causes rigidity [. . .] this is too crude a generalization. Social norms and social control [e.g. trust] can be as much and even more rigid (prescriptive, unconditioned, enforced through sanctions)’ (Grandori, 2006: 128). If trust is not accompanied by certain degrees of healthy suspicion, vigilance and/or formal controls, an organization thus risks being cheated or missing out on major opportunities. In this respect, Mesquita (2007: 85) notes that ‘the often naïve and blind managerial encouragement for ﬁrms to trust one another to attain the beneﬁts of cooperation’ should be avoided. These assertions conform to the observation of Reuer and Ariño (2007) that relational governance may substitute for coordination provisions in contracts, but not for the more stringent contractual provisions that are designed for severe and costly breaches of collaborative agreements. Jointly, they shed light on the ‘intriguing issue of when and how social ties are detrimental’ (Poppo et al., 2008: 28) and they lead to a fourth proposition (see also Figure 4.2). Proposition 4.4 Relationships in which high levels of trust are accompanied by low levels of distrust and/or formal control entail higher performance risks than relationships in which high levels of trust are accompanied by higher levels of distrust and/or formal control. As the framework in Figure 4.2 shows, interorganizational governance is not a static phenomenon. During a relationship, managers may update their expectations and wish to bring about changes in the formal coordination and control mechanisms that they adopt (Bijlsma-Frankema and Costa, 2005; Wicks et al., 1999). I argue that such changes become more likely when interorganizational performance (in terms of relational quality and the outcomes achieved in early stages of cooperation) is considered weak or worse than expected.

EXPECTANCY DISCONFIRMATION When interorganizational performance is relatively weak, managers may come to perceive their partners as being less trustworthy than they originally thought them to be. This assertion derives from work on expectancy disconﬁrmation theory, which concurs that managers’ perceptions of performance trigger a comparison of actual behaviour and outcomes against their expectations (Oliver et al., 1994). When positive disconﬁrmation prevails, trust in a partner is reinvigorated. In case of negative disconﬁrmation, managers may blame their partners for discrepancies between actual and expected performance. Accordingly, they may perceive that their partner is

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less trustworthy (March and Olsen, 1975). In a similar vein, negative disconﬁrmation may cause managers to experience a relatively high propensity to act, in order to reduce deviations between the actual performance of the relationship and their expectations. This urge to act, or feeling that something has to be done, may translate itself into a heightened level of formal coordination and control (Sitkin and Bies, 1993). This became evident in an R&D alliance between an imaging company (GRAPH) and an inkjet technology ﬁrm (JET) aimed at the development of a generic printhead that could be integrated into printing systems of diﬀerent original equipment manufacturing (OEM) partners (Faems et al., 2007). When the ﬁrst printheads delivered by JET were perceived to be non-compliant with the performance standards agreed in the contract, GRAPH’s engineers started to question the technological capabilities of JET’s engineering team. Because of GRAPH’s lower expectations and heightened suspicions about the intentions of JET, ‘GRAPH’s management started to even push harder for the milestones that were negotiated in the contract’, something which resulted in a negative spiral (Faems et al., 2007: 22).1 Accordingly, I propose that levels of interorganizational performance achieved in early stages of cooperation aﬀect the development of trust and formal coordination and control in subsequent stages through the (dis)conﬁrmation of expectations (see Figure 4.2). Proposition 4.5 The lower the level of interorganizational performance in early stages of cooperation, the larger the decline in trust and growth of distrust in subsequent stages of development. Proposition 4.6 The lower the level of interorganizational performance in early stages of cooperation, the more managers perceive the need to increase formal coordination and control.

INTERPRETING THE BEHAVIOUR OF PARTNERS Changes in trust and distrust also stem from the interpretation that managers attribute to the behaviour of their partners. These interpretations, in turn, depend on the performance that has been achieved in relationships during earlier stages of cooperation, the degrees of formal coordination and control that have been adopted, and the expectations of managers concerning their partners (trust and distrust). Trusting partners, for instance, ‘are more likely to interpret each other’s equivocal actions in a manner conducive to the stability of [their] relationship’ (Krishnan et al., 2006: 895). More broadly speaking, by assigning good faith to the intent and reliability

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of a partner, trust allows actors to engage in constructive interpretation of each other’s actions (Zaheer et al., 1998). Concerning performance, I believe that managers become more inclined to interpret the behaviour of their partners negatively when the quality of a relationship is low or when the outcomes of a relationship are unfavourable. In contrast, when performance is high, there is no need to blame the partner, and its behaviour is therefore likely to be interpreted in a more favourable way. This is captured in the following proposition (see Figure 4.2). Proposition 4.7 The higher the level of interorganizational performance in prior stages of cooperation, the more positive are managers’ interpretations of the behaviour of their partner. Considering formal coordination and control, I propose that higher levels of contracting make it easier for managers to interpret the behaviour of their partners. Negotiating and formulating contracts assists them in creating shared expectations and it helps them to deﬁne and agree on the coordination and control of activities and outcomes (Mayer and Argyres, 2004). Contracts are then used as referents against which others’ actions are assessed (Carson et al., 2006). This was the case, for example, in the R&D alliance between an imaging company (GRAPH) and an inkjet technology ﬁrm (JET) described by Faems et al. (2007: 26). In this alliance, interviewees referred to the contractual structure to explain intensive information sharing in case problems occurred: JET engineers were contractually obliged to provide information about ongoing technological activities. One JET interviewee, for instance, mentioned that ‘now we had to tell them what was going on’. Second, GRAPH engineers emphasized that JET’s ongoing eﬀorts were now closely monitored by checking the status of JET’s contractually deﬁned activities.

In this case, the presence of a broad contractual interface structure positively inﬂuenced the quality and amount of joint sensemaking between engineers. This enabled joint problem deﬁnition and joint problem solving. It also reduced uncertainty about the partners’ intentions and competences, decreasing suspicion and introducing positive trust dynamics at the managerial level (Faems et al., 2007). In contrast, when formal coordination and control are low, much more room is left for widely diﬀerent perceptions and frames against which meaning is made. Such a situation occurred, for example, in an alliance between Ciba Geigy and Alza, where the absence of reasonably detailed contractual agreements led to ‘growing suspicions and tensions as each partner was searching for clues in the behaviour of the other’ (Doz, 1996: 68). In

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these and similar cases, it becomes much harder for managers to interpret the behaviour of their partners. The clarity of deﬁnitions and expectations that results from contracting thus facilitates assessments by managers of their partners’ behaviour (Carson et al., 2006; Malhotra and Murnighan, 2002). This leads us to the following proposition (see also Figure 4.2). Proposition 4.8 The higher the levels of formal coordination and control, the easier it becomes for managers to interpret the behaviour of their partners in subsequent stages of development. Finally, as managers make sense in ways that minimize the discrepancies between their expectations and their observations (Kahneman and Tversky, 1973), the behaviour of partners is generally interpreted so that it reinforces existing preconceptions of trust and distrust (March and Olsen, 1975; Weick, 1995). Consequently, initial levels of trust and distrust strongly inﬂuence whether behaviour by a partner results in spirals of distrust, defensive behaviour, conﬂict and increased emphasis on monitoring and control (Ghoshal and Moran, 1996) or in increased levels of commitment and trust (Klein Woolthuis et al., 2005). High levels of trust, for instance, have been shown to lead to less rigid forms of contract application, which may introduce positive self-reinforcing trust dynamics (Faems et al., 2007). High levels of distrust, instead, lead managers to interpret their partner’s behaviour in a less favourable light (Kramer, 1994). In this case, they will hesitate to reveal information, reject inﬂuence and evade control, which complicates trust building and reinforces distrust, potentially causing partners to fall into spirals of suspicion (Anderson and Jap, 2005; Zand, 1972). Acts by partners that are intended to restore trust may even increase suspicion and alienate partners further from each other (Avadikyan et al., 2001; Hoecht, 2004; Liebeskind and Oliver, 1998; Sitkin and Stickel, 1996). An implicit cost of contracting is then that it may damage the quality of relationships (Lazzarini et al., 2007). The development of contracts may be perceived as evidence that a ﬁrm’s goodwill or competence is thrown into doubt, rendering it a signal of distrust (Das and Teng, 1998, 2001; Ghoshal and Moran, 1996; Jap and Ganesan, 2000; Poppo and Zenger, 2002; Sitkin and Roth, 1993). This conforms to Macaulay’s (1963: 64) statement that ‘detailed negotiated contracts can get in the way of creating good exchange relationships’. It also coincides with Sitkin and Roth’s (1993: 376) observation that ‘legalistic remedies can erode the interpersonal foundations of a relationship they are intended to bolster because they replace reliance on an individual’s “good will” with objective formal requirements’. Indirectly, it supports the assertion of Chaserant (2003: 163) that ‘the acceptance of

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contractual incompleteness by the parties is a positive signal, which favours cooperation’. But matters may become even worse, since the use of formal contracts may signal that no reciprocity is expected, as it frames the relationship according to a strictly economic orientation (Lazzarini et al., 2007). The incentives, rewards and punishments included in the contract may drive out intrinsic motivation, focusing participants’ attention on fulﬁlling what is in the contract and reducing their inclination to go beyond the agreement (Fehr and Falk, 2002; Kreps, 1997; Lazzarini et al., 2007).2 Contracting does not contribute to coordination and control here, rather it becomes destructive, undermining the development of trust (e.g. Lewicki et al., 1998; Sitkin and Roth, 1993). It discourages partner contributions to a relationship, provokes human ﬁghts and aversions to change (Bijlsma-Frankema, 2004) and gives rise to a low trust atmosphere, which is frequently reciprocated with even more formal constraints, possibly eventuating in ‘inﬂationary spirals’ of increasingly formalized relationships (Sitkin and Roth, 1993: 367) and in relationships that are locked up in formalities (Nooteboom, 1999; Parkhe, 1993a). Van Marrewijk (2004) oﬀers an example of such a spiral in his description of Unisource, an alliance of Swedish Telia, Dutch KPN Telecom, Swiss Telecom and Spanish Telefónica. He clariﬁes that, as trust did not develop, the partners turned to more formal controls. This slowed down decision making processes and diminished the competitiveness of the alliance, so that trust and commitment deteriorated even more. Conversely, when participants in interorganizational relationships initially experience high levels of trust, attempts by their partner to establish higher levels of formal coordination and control may be regarded as symbols of the sharing of values and the articulation of communal norms and customs (Zucker, 1988). Participants then presume that the other party is acting in good faith and they will interpret partner behaviour more positively (Adobor, 2005; Uzzi, 1997). In these situations, a partner’s willingness to contract becomes a signal of commitment (Klein Woolthuis et al., 2005), indicating that it cares about the relationship and that it intends to put eﬀorts into achieving the objectives that were set (Serva et al., 2005). Higher levels of trust ensue, which enable partners to capture other aspects of the relationship in formal documents as well (Mayer and Argyres, 2004; Poppo and Zenger, 2002). I capture this in a ﬁnal set of propositions. Proposition 4.9 The higher the level of distrust and the lower the level of trust that managers have in their partners, the more negative is their interpretation of the behaviour of their partner.

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Proposition 4.10 The more positive managers’ interpretations of the behaviour of their partners, the lower the level of distrust and the higher the level of trust is during subsequent stages of cooperation. Collectively, the arguments and framework that I present here support Doz’s (1996: 77) idea that initial conditions characterizing interorganizational cooperation have ‘disproportionate’ eﬀects on the development of interorganizational relationships (see also Das and Teng, 2002). Low levels of trust and high levels of distrust in early stages of cooperation, for example, entail a high need for formal control, and a low ability to install contractual means of coordination and control (P4.1). The resulting combination of trust, distrust and formal contracting has a negative impact on interorganizational performance (P4.2, P4.3, P4.4), which subsequently diminishes trust and increases distrust (P4.5). In addition, low levels of interorganizational performance lead to increases in formal coordination and control (P4.6), and they entail negative interpretations of partner behaviour (P4.7). As these interpretations are also shaped by the degrees of formal coordination and control (P4.8), and by initial degrees of trust and distrust (P4.9), trust is likely to diminish even more and distrust tends to increase further (P4.10). The framework thus shows that starting conditions, in the form of trust and distrust, may trigger vicious and virtuous cycles of behaviour and expectations (Adobor, 2005; Das and Teng, 2002; Gambetta, 1988; Macaulay, 1963; McEvily et al., 2003b). This observation is congruent with Zand’s (1972) spiral reinforcement model and with ﬁndings from Anderson and Jap (2005), indicating that a signiﬁcant portion of the more than 200 industrial partnerships that they studied exhibited the formation of dysfunctional spirals of distrust.

DISCUSSION In this chapter, I have developed a conceptual framework on the evolution of trust, distrust and formal contracting in interorganizational relationships. Building on the work of other researchers (Doz, 1996; Ferrin et al., 2005; Klein Woolthuis et al., 2005), I argued that starting conditions – consisting of initial levels of trust and distrust – leave strong imprints on the development of cooperative relationships. Starting conditions do not only inﬂuence the degrees of formal coordination and control and the levels of performance achieved in early stages of cooperation, but they also aﬀect how managers interpret the behaviour of their partners. As a result, trust, distrust and formal contracting tend to develop along self-reinforcing paths (see also Faems et al., 2007). These assertions are captured in an integrative

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conceptual framework, which reconciles hitherto fragmented views on the evolution of trust, distrust and formal contracting in interorganizational relationships. Theoretical and Practical Implications The model and arguments advanced in this chapter have signiﬁcant implications for both research and practice. They show how apparently inconsistent arguments and empirical evidence on the trust–control nexus can be reconciled, and they describe how governance mechanisms may evolve in interorganizational relationships. More speciﬁcally, they suggest that monocausal explanations for observations on these mechanisms provide incomplete accounts of reality (see also Bachmann, 1998; Möllering, 2005) and that an integrative approach to theory development has to be taken to fully understand their evolution in interorganizational relationships (see also Faems et al., 2007). Moreover, my arguments indicate that neither trust nor formal contracting should become ends in themselves, as this could lead to naïveté or rigidity, respectively. Inquiries into interorganizational governance should therefore be accompanied by performance assessments, preventing trust and formal coordination and control from becoming ﬁnal aims (see Suen, 2005). Furthermore, the model indicates that managers should consider refraining from cooperation at all when starting conditions are unfavourable. They might also think of breaking oﬀ relationships that are characterized by negative self-reinforcement in early stages of cooperation. Although this may seem obvious, I emphasize it here, because many relationships persist although prospects are bad (Inkpen and Ross, 2001). I suggest that this may partly derive from managers being unaware of the signiﬁcance of starting conditions and self-reinforcing eﬀects. Future Research Several avenues for further research can be identiﬁed. A ﬁrst and promising research direction could be to investigate the extent to which the relationships in the framework are contingent upon the nature of economic exchanges and the cultural and legal regimes in which cooperation takes place. These factors may explain a relatively large share of the variance in trust and control (Bijlsma-Frankema and Costa, 2005; Schoorman et al., 2007). Sitkin and Stickel (1996), for example, have indicated that the degree of formalization should match the nature of the task performed to prevent escalating cycles of trust deterioration from developing. Williamson (1985) adds that relationships that are embedded in uncertain environments and for which parties have to make investments in relation-speciﬁc assets

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demand more formal control than relationships for which these investments are not required. Others have argued that formal control is problematic in exploration contexts (Oxley, 1997), as the scope of relationships cannot be clearly deﬁned in advance, behaviours cannot be observed and performance tends to be ambiguous (Carson et al., 2006; Das and Teng, 2001; Dirks, 2000; Hoecht, 2004; Sitkin and Roth, 1993; Sitkin and Stickel, 1996; Wicks et al., 1999). Although the trust-based mode of governance is probably risky here (Carson et al., 2006), it may be the only option for leveraging the resources that are critical to competitive advantage (BijlsmaFrankema, 2004; Bijlsma-Frankema and Koopman, 2004; McEvily et al., 2003b). In an empirical assessment of 125 interorganizational relationships involving R&D for new product development, Carson et al. (2006) examine such concerns and ﬁnd that relational contracting (e.g. reputations, expectations of continuity and trust) is robust to volatility but not to ambiguity, whereas formal contracting is robust to ambiguity but not to volatility. In a similar vein, Krishnan et al. (2006) have shown that trust matters more to interorganizational performance under conditions of behavioural uncertainty (i.e. situations of high interdependency and potential competition in which the scope for tensions, misunderstandings and misinterpretations is higher) and less under conditions of environmental uncertainty. Their analysis of 126 international alliances shows that trust may mitigate uncertainties about partner behaviour, but it also revealed that trust might simultaneously limit partners’ cognitive eﬀorts when considering their broader environment. More speciﬁcally, Krishnan et al. (2006) observe that overconﬁdence in the information provided by partners, limited alertness and excessively high levels of cognitive comfort associated with trust might restrain the vigilance with which actors scan their environments and they may reduce the likelihood that constructive discussions lead to the crossfertilization of diﬀerent views among partners. These drawbacks of trust are particularly detrimental to interorganizational performance under conditions of high environmental uncertainty, since such situations require accelerated scanning and search, as well as the confrontation of alternative views and diverse information to stimulate creativity and constructive criticism (Krishnan et al., 2006). Diﬀerent cultural and institutional environments may also give rise to distinct relationships between trust and formal contracting (Deakin and Wilkinson, 1998; Rus and Iglicˇ, 2005). Contractual agreements in the UK, for example, are frequently the result of exhaustive negotiations in which each party attempts to impose conditions upon the other. Contracts then easily become a signal of low trust. In Germany, instead, contracts are used to reassure partners of the common, or shared, legal principles to which they wish to adhere, something fostering trust (Bachmann, 2001). These

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examples indicate that the relationships depicted in framework 4.2 are contingent upon the nature of economic exchanges and on the cultural and legal regimes in which these take place, something clearly deserving more attention in future research (Bijlsma-Frankema and Costa, 2005; Schoorman et al., 2007). A second option for future research concerns the ambiguity that surrounds the intentions of partners and their ability to communicate these intentions (see also Carson et al., 2006; Klein Woolthuis et al., 2005; Serva et al., 2005). This is important, as interpretation processes can be fraught with missteps and errors as well as systematic biases (March and Olsen, 1975). This renders the development of trust contingent upon the ability of trading partners to ‘read each other’ and on their ability to ‘signal trustworthiness’ (Carson et al., 2003; Chaserant, 2003). Third, and in line with calls of Schoorman et al. (2007) and research by Ferrin et al. (2005) and Serva et al. (2005), the framework may be reﬁned by distinguishing the actions and reactions from diﬀerent parties. This would oﬀer a better reﬂection of the reciprocal nature of trust building between partners. Fourth, more attention could be paid to the negative consequences or dysfunctions of trust, and the positive aspects or functions of contracting, so that a more balanced perspective on these governance forms arises. The positive sentiments surrounding most research on trust (Dirks and Ferrin, 2001) and the negative connotation that many people have regarding formal contracting (Beck and Kieser, 2003) may be replaced by images of both concepts that are closer to reality. Fifth, the topic of trust violation and repair ‘warrants more research’ (Schoorman et al., 2007: 349). As Schoorman et al. (2007) observe, such research may start from a better conception of how trust is damaged in the ﬁrst place, since diﬀerent means of damaging trust are likely to require diﬀerent reparative responses. A nice example is provided by Mesquita (2007: 73) here, who shows that third parties may ‘help create momentary opportunities for trust to resurface and shift ﬁrms out of their noncollaborative inertia’. They do so, amongst other things, by taking ‘advantage of the multiplex nature of relationships’ and by leveraging their reputation and trust-facilitation abilities (i.e. their entrepreneurial leadership mediation/arbitration abilities) to ‘demarcate separate relationship domains within which trust and cooperation [may] emerge’ (Mesquita, 2007: 75). Finally, research eﬀorts could focus on the interventions that managers undertake to make sure that trust and formal contracting do not degrade or escalate beyond certain levels. Insights into some of the ways in which self-reinforcing cycles can be broken could further advance our understanding of the evolution of trust and contracting in interorganizational relationships.

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Concluding, I have developed a conceptual framework which shows that trust and distrust during initial stages of cooperation leave strong imprints on the development of collaborative relationships in later stages of development. This stems from their impact on formal coordination and control, interorganizational performance and the interpretations that managers attribute to the behaviour of their partners. The framework presented in this chapter reconciles hitherto fragmented views on the evolution of trust, distrust and formal contracting in collaborative relationships, thereby oﬀering a fertile basis for further theorizing in this ﬁeld.

NOTES 1. In contrast, a much less rigid mode of contract application was present in a subsequent alliance between the same parties, allegedly due to the presence of more positive goodwill trust dynamics (Faems et al., 2007). 2. Concerning intrinsic motivation, Gottschalg and Zollo (2007) distinguish hedonic from normative intrinsic motivation, with the ﬁrst implying that people are driven by the goal of being engaged in enjoyable, self-determined and competence-enhancing behaviour and the second implying that people are driven by the goal of engaging in behaviour that is compliant with norms and values. In this book, I focus primarily on extrinsic motivation, where people receive rewards such as money, recognition, power and so forth.

5. Functions of negotiation and contracting* the focus in much of organizational theorizing is to homogenize what is essentially a pluralistic world. On balance, organizational theorists have tended to emphasize the unifying principles that lend cohesion, focus, legitimacy, and identity; the result has been to problematize (or often overlook) the variety embedded in pluralism. (Glynn et al., 2000: 726) The formal process of negotiating enables, perhaps even forces, the parties to engage in sensemaking. (Ring and Van de Ven, 1989: 185)

INTRODUCTION Research on interorganizational governance focuses primarily on problems of coordination, control and, to a lesser extent, legitimacy. In this chapter, I develop a complementary perspective, proposing that contracting enables interorganizational participants to give, make, demand and break sense. I further contend that these sociocognitive processes contribute to value creation not only by helping participants in interorganizational relationships to cope with problems of understanding, but also because they facilitate the transfer of pre-existing understandings and the co-creation of novel understandings. This chapter thus emphasizes an alternative theoretical perspective on the functions, beneﬁts or positive consequences of contracting practices and formalization in general, departing from mainstream research (see the non-shaded areas in Figure 5.1). By doing this, I attempt to ‘provide more creative, innovative, and insightful ideas, facilitating new theory generation and enhancing the level of disciplinary maturity’ (Robson et al., 2002: 392) in the interorganizational governance ﬁeld. I also answer calls from, among others, Glynn et al. (2000) to use pluralism and paradigmatic eclecticism more explicitly in organizational theorizing. *

An earlier version of this chapter has been published before. I wish to thank Sage Publications for its permission to reprint this chapter. The original publication appeared under the following title: Vlaar, P.W.L., F.A.J. Van den Bosch and H.W. Volberda (2006), ‘Coping with problems of understanding in interorganizational relationships: using formalization as a means to make sense’, Organization Studies, 27, 1617–38.

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Need to govern

Antecedents Organization level Exchange level Context level

Performance Value discovery Value creation Value appropriation

Governance Contracting Trust

Ability to govern

Figure 5.1

Positive consequences

Negative consequences

Research framework: focus of theme three

I start the discussion with Randolph Marcy (1859), a US army captain who wrote The prairie traveler: a handbook for overland expeditions, which stipulates some examples (Bamford et al., 2003). Marcy argued that formal governance endorsed collaboration between colonists and other prairie travellers when they were travelling from the East to the West of the United States during the 19th century (see Textbox 5.1).

TEXTBOX 5.1

FORMAL GOVERNANCE AMONG PRAIRIE TRAVELLERS

‘An obligation should be drawn up and signed by all the members of the association, wherein each one should bind himself to abide in all cases by the orders and decisions of the captain, and to aid him by every means in his power in the execution of his duties; and they should also obligate themselves to aid each other, so as to make the individual interest of each member the common concern of the whole company’ (Marcy, 1859: 23). ‘In case of failure on the part of any one to comply with the obligations imposed by the articles of agreement after they have been duly executed, the company should of course have the power to punish the delinquent member, and, if necessary, to exclude him from all the benefits of the association’ (Marcy, 1859: 24). ‘Unless a systematic organization be adopted it is impossible for a party of any magnitude to travel in company for any great length of time, and for all the members to agree upon the same arrangements in marching, camping, etc. I have several times observed, where this has been attempted, that discords and dissensions sooner or later arose which invariably resulted in breaking up and separating the company’ (Marcy, 1859: 25).

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‘Besides, prairie travelers needed plans and budgets to know not just the requisite food to bring, but also the amount of water, clothing, bedding, and, of course, arms. Travelers needed a clear resource budget – from 150 pounds of flour all the way down to four pairs of socks and a bit of beeswax, as overloading was a real danger. Poor up-front planning left many pioneers dead on the prairie – starved, frozen, or, more likely, unable to recover from minor sickness or injury. It also made them face exorbitant prices at outposts such as Ford Dodge or Council Grove’ (Bamford et al., 2003: 315).‘Other formalities that are required when traversing the prairies with a group of people include agreements on telegraphic signals, and smoke signals’ (Marcy, 1859: 227–8). Marcy notes that these signals, when well understood and enforced, tend to greatly facilitate the communication of intelligence throughout the camp, and contribute much to its security. To avoid mistakes, the signals should be written down and copies furnished the commander of each party. Source:

Bamford et al. (2003) and Marcy (1859).

Although Marcy points at beneﬁts of coordination and control, the functions of contracting appear to be more diverse than surfacing in his story. Table 5.1 provides an overview of the major characteristics of the coordination, control, legitimacy and sense-perspectives on the role of formal governance in interorganizational relationships. The ubiquity of research on the coordination and control functions of formal governance stems from a historical preponderance of theoretical perspectives in which rationality, computation, anticipation and decision making have prevailed. It is embedded in a rich tradition of cross-sectional governance research (see Barley, 1986) and seems to be the result of a manner of thinking in which the costs of processes such as contracting are justiﬁed only by its outputs and ‘not by the learning beneﬁts of the codiﬁcation process itself’ (Zollo and Winter, 2002: 349). More speciﬁcally, most arguments deriving from these perspectives refer to the functions of contracts, rules and procedures, but not to the beneﬁts associated with the process from which these formalities originate (for notable exceptions, see Ariño and Ring, 2004; Kaghan and Lounsbury, 2006; Ring and Rands, 1989; Ring and Van de Ven, 1989, 1994; Sampson, 2003; Zollo and Singh, 2004). The customary approach has been to focus on the structure of exchange, rather than the speciﬁcs of the processes of exchange (Contractor, 2005; McGinn and Keros, 2002; Salk, 2005), possibly resulting from a tendency to investigate interorganizational relationships that already exists for a while (Ring, 2000).

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March and Simon’s theory of organizational behaviour & dynamic capabilities school

Analytical focus on ‘friction in production’

Procedural

Organizations formalize their interorganizational activities to coordinate activities with a partner organization and to make sure that they jointly ‘create a larger pie’

Deviation from neoclassical theory

Focus

Major arguments

Coordination perspective

Organizations formalize their interorganizational activities to control their partner, and to make sure that they can appropriate a large part of the pie’

Procedural

Analytical focus on ‘friction in exchange’

Transaction cost theory & agency theory

Control perspective

Organizations formalize their interorganizational activities to legitimize them, and to make sure that they obtain ‘support from stakeholders to create a pie with their partner’

Procedural & substantive

Analytical focus on ‘friction in comfort with external initiatives’

Institutional theory

Legitimacy perspective

Overview of diﬀerent perspectives on formal interorganizational governance

Foundations

Table 5.1

Organizations formalize their interorganizational activities to reach better understanding. Formalization helps to ‘envision the pie and the processes by which it can be created’

Substantive

Analytical focus on ‘friction in understanding/cognition’

Weick’s theory of sensemaking & emerging cognitive views on organizations and governance activities

Sense perspective

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Representative contributions

Colombo, 2003; Gulati and Singh, 1998; Madhok, 2002; March and Simon, 1958; Mayer and Argyres, 2004; Simon, 1947, 1997; Sobrero and Schrader, 1998; Zajac and Olsen, 1993

Klein et al., 1978; Lassar and Kerr, 1996; Masten, 1996; Oxley, 1997; Shane, 1996; Williamson, 1985, 1991

Kale et al., 2001; Meyer and Rowan, 1977; Sitkin and Bies, 1993; Walsh and Dewar, 1987

Ariño and Ring, 2004; Avadikyan et al., 2001; Foss, 1999; Jap, 2001; Lindenberg, 2003; Meindl et al., 1996; Ring and Rands, 1989; Ring and Van de Ven, 1989, 1994; Simons, 1990, 1995; Weick, 1969, 1995, 2001; Witt, 1998, 2000; Zolloand Singh, 2004

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As is depicted in Table 5.1, research focusing on formal governance as a means to coordinate primarily builds on March and Simon’s theory of organizational behaviour, and the more recent dynamic capabilities school (see Colombo, 2003; Gulati and Singh, 1998; Madhok, 2002). Proponents of these schools point to formal governance’s role in the adjustment and adaptation of partner activities, resources and expected outputs. Authors emphasizing the control function of formal governance draw support from, amongst others, transaction cost economics and agency theory (Lassar and Kerr, 1996; Shane, 1996; Williamson, 1985, 1991). They presume that gaining partial control over a partner organization is fundamental to interorganizational cooperation, as interests of partners rarely coincide (Blumberg, 2001; Buskens et al., 2003a), and as each of them may exhibit opportunistic behaviour (Williamson, 1985, 1991). Whereas theories focusing on the coordination function of formal governance deviate from neoclassical theory by their analytical focus on ‘friction in production’, theories on control stress ‘friction in exchange’ (Langlois and Foss, 1999; Madhok, 2002). In addition to the coordination and control perspectives on formal governance, a third perspective has developed, focusing on legitimacy. Although formal governance as a means of gaining legitimacy has received relatively less attention in interorganizational governance research, it assumes an important role in collaborative relationships. Grounded in institutional theory (Dacin et al., 2007; Meyer and Rowan, 1977; Sitkin and Bies, 1993; Walsh and Dewar, 1987), it conveys that the use of certain governance mechanisms may bestow legitimacy on collaborative activities as they allow for the development of ‘a generalized perception or assumption that [these activities] are desirable, proper, or appropriate within some socially constructed system of norms, values, beliefs, and deﬁnitions’ (Suchman, 1995: 574). In contrast, interorganizational relationships that omit such mechanisms lack legitimate accounts of their activities, and they become vulnerable to claims that they are ‘negligent, irrational, or unnecessary’ (Meyer and Rowan, 1977: 350). The legitimacy function of formal governance is therefore primarily preoccupied with ‘friction in comfort with external activities’. In this chapter, I conjecture that the coordination, control and legitimacy perspectives on formal interorganizational governance do not tell the entire story. I start by noting that although ‘formal organizations are generally understood to be systems of coordinated and controlled activities’ (Meyer and Rowan, 1977: 340), for which information processing is crucial, they are increasingly regarded as systems of meaning (Meindl et al., 1996). This implies that research on interorganizational relationships can not only focus on interest- and information-asymmetry problems any more (Hendry, 2002; Langlois, 2005), but that it also has to consider issues relating to ‘the meeting of minds’, sensemaking and the ways in which

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participants in interorganizational relationships reduce ambiguity and equivocality (e.g. see Carson et al., 2006; Hendry, 2002; Ring, 2000). In building my argument, I focus on formalization, both in terms of contracting and in terms of the development and application of rules and procedures. I advance that formalization functions as a means to give, make, demand and break sense. This ‘sense perspective’ on formalization is grounded in Weick’s theory of sensemaking and in emerging cognitive views on organizations and governance activities (for some key references, see Table 5.1). It deviates from neoclassical theory by its analytical focus on ‘friction in understanding and cognition’ between participants in interorganizational relationships, which may arise from, amongst others, diﬀerences in the cognitive representations of phenomena from person to person (Porac et al., 2002) and from the risky, uncertain settings and non-standard business objectives that generally pose partners for diﬃculties in assessing and comparing each other’s contributions, gains and competencies (Jap, 2001). Although prior studies suggest that contracting can be conducive to sensemaking and to solving problems of understanding (e.g. Blomqvist et al., 2005; Kaghan and Lounsbury, 2006; Mayer, 2006), a systematic overview of the mechanisms through which this occurs has hitherto remained absent in the literature. In this chapter, I therefore address the following research question: how do negotiation and contracting practices inﬂuence acts and processes of sensegiving, sensemaking, sensedemanding and sensebreaking, and how do they eventually inﬂuence the development of understanding and the creation of value in interorganizational relationships? I further investigate this research question by building upon Karl Weick’s work on sensemaking and organizing (Weick, 1969, 1979, 1995, 2001; Weick et al., 2005) and by critically examining research on interorganizational structuring practices (e.g. Ariño and Ring, 2004; Ring and Rands, 1989; Ring and Van de Ven, 1989, 1994). In doing so, I focus on the relationships between contracting, understanding and the mechanisms through which contracting facilitates sensegiving, sensemaking, sensedemanding and sensebreaking, including (1) focusing attention; (2) forcing articulation, deliberation and reﬂection; (3) instigating and maintaining interaction; and (4) reducing judgment errors and individual biases, and diminishing incompleteness and inconsistency of cognitive representations (see Figure 5.2). I argue that problems of understanding propel the need for negotiation and contracting, which subsequently inﬂuence acts and processes of sensegiving, sensemaking, sensedemanding and sensebreaking through the four mechanisms distinguished before. I contend that these processes eventually amplify value creation, as they enable participants in interorganizational relationships to cope with problems of understanding, transfer and develop pre-existing understandings, and co-create novel understandings.

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Figure 5.2

• The contexts in which these relationships are embedded

• Interorganizational relationships

• Their partners

The ability of participants in collaborative relationships to make sense of:

Sensemaking

• Contract terms and clauses

• As a process of codification and enforcement, which is inextricably linked with outcomes, such as

Contracts and negotiation and contracting processes:

Relationships between contracting, sensemaking and understanding

Diminishes problems of understanding

• Discontinuity and uncertainty and ambiguity in early stages of collaboration

• Differences in culture, experience, size, background, structure, industry, et cetera

Issues of understanding in interorganizational relationships emanating from:

Understanding

Propels the need for contracting

Contracting

Interaction

Articulation, deliberation and reflection

Focus of attention

Four mechanisms

Influence sensemaking

Biases, judgment errors, completeness and consistency

Affects four mechanisms

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By doing so, I illuminate the socio psychological processes through which participants in interorganizational relationships socially construct or ‘enact’ their realities and cope with frictions in understanding and cognition (Vaara, 2003; Weick, 1995) and I depict formalization as a process of ‘constructive clariﬁcation’ (Cardinal et al., 2004: 422) This results in three contributions to the literature. First, the chapter elucidates that interorganizational relationships not only entail issues of coordination, control and legitimacy, but also problems of understanding, originating from the diﬀerences between cooperating parties, and from the ambiguity and uncertainty that tend to prevail in the early stages of interorganizational cooperation. This description of cooperative endeavours conforms with Karl Weick’s accounts of complex, ambiguous events, and it complements more conventional perspectives on interorganizational governance prevailing in the literature (e.g. see Kale et al., 2001; Madhok, 2002). More speciﬁcally, it shows that the management of meaning and understanding is critical for interorganizational collaboration (for a more general argument on the signiﬁcance of understanding, see Maitlis (2005) and Sandberg and Targama (2007)) by challenging the assumption that participants in these relationships have clear images of their partners, the relationships in which they are engaged and the contexts in which these are embedded (see Jap, 2001). Second, the chapter carries Karl Weick’s (1969, 1979, 1995, 2001; see also Weick et al., 2005) work on the relationship between organizing and sensemaking forward in the context of interorganizational relationships. I capitalize on Weick’s contributions in this area to develop a richer and more comprehensive notion of the relationship between contracting, sensemaking and problems of understanding than has hitherto been available in the literature on interorganizational relationships. In particular, I present a systematic overview of the mechanisms through which contracting contributes to sensemaking, oﬀering researchers a fertile basis for further theorizing in this area and helping practitioners to address problems of understanding in their collaborative endeavours. Third, the chapter answers calls for research on sharedness: how it arises, how it aﬀects outcomes, and how much of it is necessary (Gibson and Earley, 2007: 452–3), by clearly deﬁning what is meant with understanding and by distinguishing congruent from shared, common or mutual understandings. In the remainder of this chapter, I will develop a theory of why, how and when formalization functions as a means to give, make, demand and break sense. A useful starting point for developing such a theory lies in describing the origins of acts and processes of sensegiving, sensemaking, sensedemanding and sensebreaking in interorganizational relationships. I will therefore turn to the issue of understanding now.

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ISSUES OF UNDERSTANDING People increasingly act not only according to ‘their understanding of the rules and routines governing their work’, but also according to their understanding of ‘tasks and the reality in which they act’ (Sandberg and Targama, 2007: 9). Understanding and communication thus progressively serve as a basis for coordinated and collective action (Cronin and Weingart, 2007; Rathe and Witt, 2001; Rico et al., 2008; Vlaar et al., 2006; Witt, 1998, 2000). This may explain ‘the impression that many of us have [. . .] that there must be something else driving the coordinated performance [among participants] beyond the members’ explicit eﬀorts to communicate or plan the activity’ (Rico et al., 2008: 30). Developing understandings in interorganizational relationships, however, may be problematic. Interorganizational modes of organization bring together people from disparate backgrounds with diﬀerent experiences that are likely to interpret things in diﬀerent ways (see Vaara, 2003). These diﬀerences may arise, amongst others, because people are accustomed to diﬀerent structures, cultures, functional capabilities (Barkema and Vermeulen, 1997; Doz, 1996), cognitive frames (Nooteboom, 1992), terminologies (Kaghan and Lounsbury, 2006) and management styles and philosophies (Lane and Lubatkin, 1998). They may be aggravated by the fact that cooperating parties work in diﬀerent industries, with dissimilar belief systems (Sutcliﬀe and Huber, 1998). Consequently, participants may not fully comprehend each other’s competencies, strengths and weaknesses, and they may ﬁnd it hard to envision the projected outcomes of relationships (Jap, 2001; Jap and Ganesan, 2000). In addition, parties may experience diﬃculties in appreciating the potential for transacting with each other (Ariño and Ring, 2004) due to an absence of unity in purpose and expectations (Mjoen and Tallman, 1997). Moreover, especially in early stages of cooperation, interorganizational relationships are frequently characterized by relatively high levels of ambiguity and uncertainty (Carson et al., 2006). Discontinuities in structures, contexts, routines, expectations and perceptual frameworks (Hoang and Rothaermel, 2005; Rouleau, 2005; Weick, 1995; Zollo et al., 2002) cause problems of understanding. They lead participants to interpret and understand the same phenomena diﬀerently (Porac et al., 2002; Sutcliﬀe and Huber, 1998; Vaara, 2003) and increase the likelihood that misinterpretations and misunderstandings occur (Shankarmahesh et al., 2004). Problems of understanding also tend to prevail when collaborative relationships are embedded. In these cases, ambiguity and uncertainty become fundamental concerns (Carson et al., 2006). Such problems are especially pertinent in relationships between unfamiliar partners (Ring and Van de

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Ven, 1994; Reuer and Ariño, 2007; Sutcliﬀe and McNamara, 2001) and in complex, cross-sector collaborations involving non-standard business objectives, where ‘the nature of the pie, its size, and an assessment of its ingredients may be ambiguous’ (Jap, 2001: 86; McGinn and Keros, 2002). In these cases, cooperation brings into tension ‘extraordinarily complex ways of framing problems, as well as divergent knowledge and truth claims based on competing disciplinary paradigms’ (Couchman and Fulop, 2002: 43). Interorganizational relationships resemble new organizations in the making (Thatcher, 2004). Moreover, especially when partners have not cooperated with each other before, they lack institutionalized structures and routines (Dyer and Singh, 1998; Hoang and Rothaermel, 2005; Zollo et al., 2002). In these cases, they might have trouble in evaluating and conceptualizing relationships, their underlying logics, contributions of partner organizations and the new contexts in which they have to act (Meindl et al., 1996; Ring, 2000; Ring and Van de Ven, 1989, 1994). In such a world, where participants may not share the same conceptual categories or interpret information in the same way, impediments to exchange become largely cognitive and informational (Langlois, 2005) and recourse to experience will only aid participants in creating meaning to a limited extent (Balogun and Johnson, 2004). In line with this, Hendry (2002: 107) claims that ‘the essence of agency relationships lies not in the individual motivations or competence of the partners involved [. . .] but in the delegation of authority from principal to agent, as a result of which responsibility for the conceptualization, interpretation and expression of objectives is divided between two or more people’. Consequently, developing more congruent and advanced understandings becomes imperative for cooperation and joint value creation (Balogun and Johnson, 2004; Weick, 2001; White and Lui, 2005). The notion of understanding implies that individuals use their cognitive capability to think about an issue in their task environment (Spender, 1996) and to focus their attention on a particular phenomenon, while investing mental eﬀorts so as to develop more meaningful and elaborate thoughts (Weick et al., 2005). Researchers have developed at least 20 labels to describe understandings that are in some sense similar, shared, overlapping, compatible, distributed or complementary (Cannon-Bowers and Salas, 2001). Following Cronin and Weingart (2007), Rico et al. (2008), and Sandberg and Targama (2007), I focus on understandings1 that are at least congruent with each other, so that diﬀerent parties envision comparable behaviours and outcomes. Taking this position is warranted by the fact that individual understandings usually diﬀer (Bechky, 2003; Donnellon et al., 1986; Gibson, 2001; Maitlis, 2005). People understand, interpret and attend to situations diﬀerently (Baba et al., 2004; Cronin and Weingart,

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2007) because of lasting diﬀerences in prior experience (Balogun and Johnson, 2004), bounded rationality (Simon, 1997) and discrepancies in interests and objectives among stakeholders (Vlaar et al., 2006). Moreover, by focusing on congruent and actionable instead of shared, mutual or common understandings, I avoid becoming ‘trapped’ in recommending practitioners to engage in costly and time-consuming activities such as education and training to equalize their knowledge and experience. The latter may cause beneﬁts from specialization to dissipate and it potentially interferes with creativity and innovation by homogenizing diverse perspectives (Cannon-Bowers and Salas, 2001; Cronin and Weingart, 2007; Levina and Vaast, 2005). It also neglects the fact that inconsistency and disagreement regarding certain domains of understanding may ‘provide important seeds to grow subsequent commitment for action by stimulating [participants] to question and integrate their diverse perspectives, increasing learning and innovation’ (Gibson and Earley, 2007: 453). I thus recognize that the goal should not be to reduce diversity in perspectives, but rather to capitalize on distinct views in order to co-create understandings that are suﬃciently congruent and actionable to achieve purposeful collective action. I now proceed by exploring in more detail the adjectives ‘congruent’ and ‘actionable’. The term ‘congruence’ indicates that understandings have to be ‘consistent’ or ‘compatible’. It qualiﬁes the relationship between the expectations held and the actions and outcomes produced by diﬀerent individuals (Weick, 2006; Weick et al., 2005). Particularly, congruence refers to the extent to which person A and person B’s understandings of a certain task interrelate in a fashion that is perceived as being consistent or compatible (e.g. see Gaehde and Hartmann, 2006; Gibson, 2001). The reason for adding ‘actionability’ is that, even though understandings may be congruent, individuals could still be unable to act upon these understandings, owing to a lack of information and resources, or because of organizational and contextual constraints (Cramton, 2001; Johns, 2006). Actionability thus refers to the capability of members to conﬁgure and execute action patterns in a manner coherently tied to someone else’s expectations. To be congruent and actionable, understandings then need to have the same behavioural implications or lead to the same outcomes (Cronin and Weingart, 2007; Donnellon et al., 1986).

SENSEGIVING, SENSEMAKING, SENSEDEMANDING AND SENSEBREAKING The diﬀerences among participants that I have described before and the uncertainty and ambiguity characterizing many interorganizational

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relationships may require cognitive reorientations and revisions of existing patterns of beliefs and assumptions (Fiss and Zajac, 2006; Gioia and Chittipeddi, 1991). Collective action in these relationships frequently demands that new and more coherent understandings are being created (Maitlis, 2005; Weick, 1993). Participants therefore attempt to ameliorate their understandings by making sense of their partner, the relationships in which they are engaged and the contexts in which these are embedded (Kirsch, 2004; Lindenberg, 2003; McGinn and Keros, 2002; Ring, 2000). As sensemaking processes form ‘the primary site where meanings materialize that inform and constrain’ action (Weick et al., 2005: 409, citing Mills, 2003: 35) and, as they permit parties with ‘diﬀerent views of the purposes and expectations of a relationship to achieve congruency’ (Ring and Van de Ven, 1994: 99), they assume a central role in collaborative initiatives. Sensemaking is a concept that has been central to the work of Karl Weick (e.g. 1969, 1979, 1995, 2001). It refers to the reciprocal interaction of information seeking, meaning ascription and action (Thomas et al., 1993). In the context of this chapter, it concerns the interactive processes by which participants in interorganizational relationships construct accounts that allow them to comprehend the world and act collectively (Maitlis, 2005; Rouleau, 2005; Weick and Roberts, 1993). It derives from the needs of individuals to have a sense of self-identity in relation to others and to construct a common factual order regarding their social relationships (Turner, 1987). Sensemaking not only concerns identifying, assimilating and utilizing information, but also removing its equivocality (Weick, 1995) and diminishing participants’ cognitive disorder by foreclosing alternative interpretations and understandings of phenomena (McKinley and Scherer, 2000), so that the world appears more stable and enduring (Weick, 1995). Such attempts at sensemaking are generally undertaken in concert with acts of sensegiving, sensedemanding and sensebreaking (e.g. see Vlaar et al., 2008). These acts inﬂuence the sensemaking and meaning construction of others towards new deﬁnitions of reality (Gioia and Chittipeddi, 1991; Maitlis, 2005; Maitlis and Lawrence, 2007; Rouleau, 2005; Weick, 1995). Acts of sensegiving, sensedemanding and sensebreaking by some participants give rise to sensemaking eﬀorts by others, rendering them interactional complements (Gioia and Chittipeddi, 1991; Rouleau, 2005). And, although sensemaking is essentially a cognitive concept, and sensegiving, sensedemanding and sensebreaking primarily refer to communicative acts (Shankarmahesh et al., 2004), all of them are associated with continuous processes of organizing (Weick et al., 2005). Sensegiving consists of acts by which individuals attempt to alter and inﬂuence others’ way of thinking and acting (Maitlis, 2005; Weick, 1995). It concerns the socially constructed activities (Gioia and Chittipeddi, 1991) by

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which stakeholders frame and disseminate their visions and beliefs (Fiss and Zajac, 2006). Sensegiving may include acts such as oﬀering descriptions and explanations, providing signals (Lin et al., 2005), constructing credible and consistent narratives, and projecting images through stories, metaphors and artefacts (Ravasi and Schultz, 2006). It may also entail translation of one’s understandings and accounts of reality in a diﬀerent language so that they become comprehensible to others (e.g. see also Carlile, 2004) and using standard templates and methods for conveying information (Orlikowski, 2002). Finally, it may concern acts such as providing explanations, arguments, backgrounds and rationales behind requests, conﬁrming and correcting the viewpoints of others, and using examples, analogies and metaphors (Bechky, 2003; Majchrzak et al., 2005; Malhotra et al., 2001; Vlaar et al., 2008). Sensedemanding stems from the fact that most individuals are unlikely to wait for others to clarify their situation (Ramirez et al., 2002). Instead, they will seek to ameliorate the quality of information upon which they base their decisions, undertaking strenuous eﬀorts to acquire and process information so as to establish ‘a workable level of uncertainty’ and equivocality (Weick, 1969: 40). They thus actively seek out such information (Cramton, 2001: 368), for example, by cross-checking one’s own perceptions and interpretations with those of participants from another organization (Maitlis and Lawrence, 2007) and by performing inquiries, or asking questions (Ashford et al., 2003). In their study of creative collectives (i.e. consulting ﬁrms) Hargadon and Bechky (2006: 490) claimed that individuals actively sought the assistance of others when they recognized or experienced an ambiguous situation. Because individuals fear being blamed for ignorance and failure (Ashford et al., 2003), sensedemanding surfaces in a myriad of subtle forms. Team members may attempt to gauge, for example, what is going on by asking indirect questions. Sensedemanding may also assume the form of participants asking their counterparts for clariﬁcation, requesting conﬁrmation and demanding additional information (Vlaar et al., 2008). Finally, sensebreaking is used to call into question existing understandings of others, causing them to experience their views of reality as incoherent and insensible (Lawrence and Maitlis, 2007). Acts of sensebreaking involve the reframing of previously held conceptions, and redirecting other team members’ attention and search for solutions. Sensebreaking makes new aspects of tasks and environments salient to other team members, prompting them to view things in a new light (Hargadon and Bechky, 2006). A focal person engages in acts of sensebreaking when he or she believes that others hold incongruent, undesirable or incorrect views of reality, and when she believes that someone else’s’ line of thinking leads to adverse and disjointed action. In line with this, Lawrence and Maitlis (2007: 15) argue that sensebreaking is motivated by the need to have others ‘question the bases on

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which they have been acting’ and interrupt any undesirable courses of action they have taken. Whereas sensemaking, sensegiving and sensedemanding entail the creation of meaning (Weick, 1995), sensebreaking involves the disruption of others’ understandings (Lawrence and Maitlis, 2007), the break-up of an epistemic stalemate (Foss, 2001) and creating ‘a meaning void that must be ﬁlled’ (Pratt, 2000: 464). Successful sensebreaking practices should lead to discontentment and a drive to ﬁnd meaning (Pratt, 2000). This means that parties use acts of sensebreaking to unsettle existing understandings and lines of thinking of others, by providing them with contradictory evidence or highly negative evaluations of their work, oﬀering an ‘overall’ or ‘big’ picture, presenting alternative views that are radically diﬀerent from the ones that were held before, and openly questioning assumptions (Vlaar et al., 2008). Jointly the acts of sensegiving, sensedemanding and sensebreaking as well as the processes of sensemaking constitute a continuing and dynamic process with a fundamentally social character (see also Maitlis, 2005; Pratt, 2000) intended to advance understandings.

CONTRACTING AND SENSEMAKING Although acts and processes of sensegiving, sensemaking, sensedemanding and sensebreaking may develop through story telling and other informal means of communication (Balogun and Johnson, 2005; Kirsch, 2004; Rouleau, 2005), in the context of interorganizational relationships they have been shown to be intricately related to formal processes of negotiating and contracting (see Ariño and Ring, 2004; Ring and Rands, 1989; Ring and Van de Ven, 1989, 1994). Objects of negotiation and contracting, for example, have been argued often to entail ambiguous features and wide ranges of options, requiring participants in collaborative relationships to frame and make sense of their relationship as it evolves (McGinn and Keros, 2002). Other authors have argued that interorganizational participants engage in social-psychological processes such as sensemaking that lie behind the more formal aspects of negotiation and contracting processes to come to appreciate the potential for transacting with others (Ariño and Ring, 2004).2 However, contracts are not only the social product or sediment of sensemaking (Kaghan and Lounsbury, 2006; Klein Woolthuis et al., 2005; Mayer and Argyres, 2004; Putnam and Cooren, 2004). Instead, contracting practices also enable parties to engage in acts of sensegiving, sensedemanding and sensebreaking, allowing them to make sense of their partners, the relationships in which they are engaged and the collaborative contexts in which

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these are embedded. This hints at the existence of a reciprocal relationship between contracting and sense-processes (Ring and Van de Ven, 1989, 1994). Preliminary empirical support for such a contention has been provided by Blomqvist et al. (2005: 497), stating that ‘the contracting process may be used purposefully to increase mutual understanding’, and by Kaghan and Lounsbury (2006: 260), who argue that formal written contracts provide a structure ‘within which on-going relationships can proceed sensibly over time’. Blomqvist et al. (2005: 502), for example, found that a global machine and equipment supplier and a small metal engineering company ‘got to know each other through the lengthy contracting process’, indicating that this process enabled them to make sense of their partner. Moreover, a description of three alliances in the Norwegian retailing industry by Ness (2002: 31) suggested that formal aspects to a large extent anchor, inform, inﬂuence and add to the informal and implicit understanding of cooperating parties, and that they assist parties in deﬁning and redeﬁning ‘the terms of their interdependence’ (Walton and McKersie, 1965: 35, as cited in Putnam, 2003). Mayer (2006: 81) inferred that ‘additional [contractual] detail may actually help [. . .] parties develop a better relationship by creating the foundation for a common understanding’, particularly in complex exchanges involving the creation of new knowledge. He argued that it could thereby help ‘parties realize the potential from their interaction’ (Mayer, 2006: 80). Correspondingly, Hill (2001a) has argued that a signiﬁcant function of negotiation and contracting is to help parties ﬁnd out what they want from the transaction and from one another. In this sense, formalization can be understood as a means to reconcile parties’ expectations, future actions and consequent valuations to increase the size of the aggregate pie. Whereas metaphorical expressions for the coordination, control and legitimacy functions of formalization respectively focus on the creation of a large pie, appropriation of a considerable piece of that pie, and legitimizing the creation of the pie, formalization as a means to give, make, demand and break sense is therefore best portrayed as assisting potential collaborators in envisioning or discovering a pie and the parties and processes by which it can be created. In order to further develop the argument, I build on Ring and Van de Ven’s (1994: 97) ‘process framework of the development of IOR’s’ (see Figure 5.3). Ring and Van de Ven (1989, 1994) suggest that cooperating organizations move through three formal stages of cooperation, which correspond with informal processes of sensemaking, understanding and committing. They presume that the development and evolution of interorganizational relationships comprises a repetitive sequence of negotiation, commitment and execution stages. Each of these stages is assessed,

Functions of negotiation and contracting

NEGOTIATIONS of joint expectations

121

COMMITMENTS for future action through

formal bargaining

formal legal contract

sensemaking

psychological contract

ASSESSMENTS based on: efficiency equity

EXECUTIONS of commitments through role interactions personal interactions

Source: Ring and Van de Ven (1994: 97).

Figure 5.3

Ring and Van de Ven’s process framework

not only on the eﬃciency of economic exchange, but also on the equity or ‘fairness’ of the interaction and outcomes in relationships (Husted and Folger, 2004; Tekleab et al., 2005). In light of my argument, the most signiﬁcant contribution of Ring and Van de Ven’s model (1989, 1994) is that formalization seems to allow participants in interorganizational relationships to develop mutual expectations about their motivations, possible investments and perceived uncertainties regarding a business deal that they are jointly exploring. During these enactment processes participants create shared understandings by lifting equivocal knowledge out of the tacit, private, complex, random and past to make it explicit, public, simpler, ordered and relevant to the situation at hand (Obstfeld, 2004). They ‘come to appreciate the nature and

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purpose of a transaction with others’, and they become able to ‘assess uncertainty associated with the deal, the nature of each other’s role, the other’s trustworthiness [. . .], their rights and duties in the transaction being considered, and possible eﬃciency and equity of the transaction as it relates to all parties’ (Ring and Van de Ven, 1994: 98). When considering the link between formalization and processes of sensemaking further, Ring and Van de Ven (1989: 185) contend that ‘[T]he formal process of negotiating enables, perhaps even forces, the parties to engage in sensemaking’. In this light, the negotiation of contracts can be seen as ‘a process of getting to know and understand each other’ (Klein Woolthuis et al., 2005: 835). A comment from Ring and Rands (1989: 350) serves as an illustration here: ‘[The] work involved in drafting and revising the memorandum of understanding that was done [. . .] may be viewed as evidence that understanding and committing processes between the organizations had been fruitful’. I also illuminate Weick’s position on the relationship between sensemaking and organizing. Although Weick (1995: 229) contends that ‘a little order can go a long way’, he also acknowledges that some kind of structure needs to be present to guide action, and to direct attention to particular aspects of a situation (Weick, 1995). He further posits that ‘sensemaking and organization constitute one another’ and that sensemaking involves the ‘continued redrafting of an emerging story so that it becomes more comprehensive, incorporates more of the observed data, and is more resilient in the face of criticism’ (Weick et al., 2005: 410–11). This conforms to descriptions of negotiation and contracting processes in interorganizational relationships (e.g. see Mayer and Argyres, 2004). Weick (2001: 116) also asserts that ‘a framework of roles, rules, procedures, conﬁgured activities and authority relations’ can both reﬂect and facilitate meanings, and that organizing may help to establish a workable level of uncertainty and ambiguity (Weick, 1969, 1979), which corresponds to images of contracting as a means to reduce and absorb complexity and ambiguity (Carson et al., 2006). Weick thus seems to acknowledge that organizing processes, such as contracting, may be conducive to sensemaking. Building on this insight, I further develop the idea that contracting enables, or even forces, collaborating parties to engage in sensegiving, sensemaking, sensedemanding and sensebreaking, helping them to create common ground and achieve mutual understandings (Blomqvist et al., 2005; McGinn and Keros, 2002; Ring and Van de Ven, 1989, 1994). Although several examples suggest that contracting inﬂuences sensemaking, sensegiving, sensedemanding and sensebreaking, and eventually the creation of generic understandings that form the basis for interorganizational exchange (Ariño and Ring, 2004; McGinn and Keros, 2002; Sivadas and Dwyer, 2000), a systematic overview of the mechanisms through which this may occur is still lacking in the literature.

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In this chapter, I develop such an overview (see Figure 5.2) by discussing four mechanisms that feature prominently in Karl Weick’s work on sensemaking and in literature on contracting and formalization. To ensure conciseness of the argument, I will focus on the sociocognitive process of sensemaking, although recognizing that these are generally accompanied by acts of sensegiving, sensedemanding and sensebreaking. Focusing Attention A ﬁrst mechanism through which contracting enables sensemaking is labelled ‘focusing attention’. Participants in interorganizational relationships generally display a joint focus or co-orientation on formal documents and processes, which renders contracting a focusing device (Avadikyan et al., 2001; Nooteboom, 1992; Sutcliﬀe and McNamara, 2001; Taylor and Robichaud, 2004; Yu et al., 2005). Formal documents and processes serve as focal points for diﬀerent streams of ongoing activity, providing them with meaning and direction (Weick, 2001; Yakura, 2002). They focus attention by clarifying whether there are decisions that need to be made and what those decisions might consist of (Weick, 2001), and by demarcating what is allowed, expected, acceptable and possible, and what is not (Carson et al., 2006; Lui and Ngo, 2004; Nellore, 2001). Formalization helps to highlight selectively some issues and marginalize or omit others (Brown, 2000; Fiss and Zajac, 2006), and it prevents participants from being distracted by issues of secondary importance (Delmar and Shane, 2003). Formal items on agenda meetings, for example, enable partners to open up discussions on speciﬁc issues, and close oﬀ discussion on other topics (Putnam, 2003) so that participants can focus on a small number of concerns and expend their cognitive eﬀorts on restricted problem areas, reducing the cognitive complexity they experience (Boisot and Child, 1999; Campbell, 1988). Mayer and Argyres (2004: 400) oﬀer an example of formalization’s role in focusing attention in their description of a relationship between a Silicon Valley Software ﬁrm and a Japanese electronics producer. They note that formal statements of work ‘forced the parties to determine mutually agreeable delivery dates early in the coding process, before managerial attention on scheduling was lost’. Similarly, Avadikyan et al. (2001: 1453) describe how a contract for the development of a fuel cell-powered electric car inﬂuenced ‘the methodological orientations’ of participants. These examples show that contracts provide the ‘general direction as to how the parties to a contract should orient their mutual interaction so as to achieve a common purpose’ (Kaghan and Lounsbury, 2006: 267). The resulting focus in attention may not only reduce the complexity perceived by partners (Boisot and Child, 1999), but it may also enable the absorption of complexity during

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relationships, provided that participants remain open and willing to revise formal documents continuously (Ring, 2000), maintain contingencies and preserve ﬂexibility. In such cases, contracting becomes a process by which reality is constructed and reconstructed, instead of a means by which reality is ﬁxed at one point in time. It restricts the extent to which participants intrude on their environment, and acquire and perceive cues and connections around which they cohere and structure their beliefs. It also conditions sensemaking by limiting the information and cues on which participants focus their attention (Daft and Weick, 1984). The resulting conceptions of reality subsequently represent the interpretive frameworks which furnish actors with a general orientation and a general associative basis for deriving and assessing information (Witt, 1998: 166). Summarizing, I argue that contracting entails a focus of attention, thereby inﬂuencing sensemaking (see Figure 5.2). Proposition 5.1 Contracting helps participants in interorganizational relationships to focus their attention, thereby aﬀecting their ability to make sense of their partners, the relationships in which they are engaged and the collaborative contexts in which these are embedded. Forcing Articulation, Deliberation and Reﬂection A second mechanism through which contracting facilitates sensemaking concerns articulation, deliberation and reﬂection. Contracting forces parties ‘to articulate their individual and mutual goals explicitly during the contracting process’ (Blomqvist et al., 2005: 501). It thereby helps participants to lift equivocal knowledge out of the tacit, private, complex, random and past to make it explicit, simpler, ordered and relevant to the situation at hand (Obstfeld, 2004). By doing so, contracting generates more ‘raw material’ from which cooperating parties can make sense (Daft and Weick, 1984; Thomas and Trevino, 1993). It also assists in clarifying their identity, positions and payoﬀs, and the behaviour and interaction that they prefer, so that interpretable responses by other participants are elicited (Hill and Levenhagen, 1995; Shankarmahesh et al., 2004). Contracting thus ensures ‘that the structural foundations of a deal [are] well articulated’ (Kaghan and Lounsbury, 2006: 274). On an individual level, such articulation is associated with synthesizing issues on paper, forcing people to reﬂect, cogitate and think more deeply (Weick, 1995; Zollo and Winter, 2002; Zollo and Singh, 2004). It stimulates participants to deliberate beyond general understandings, and to be clear about the variables and parameters that need to be considered, the sequence or priority with which diﬀerent criteria of decision making are to be invoked,

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and the process of inference by which decisions are to be made (Katz and Kahn, 1966). This is reinforced by the fact that participants wish to avoid unnecessary grievances and mistakes. They therefore give contracts, rules and procedures generally ‘more deliberation than orders’ and try to make sure that they are ‘carefully expressed’ (Gouldner, 1954: 162; see also Putnam, 2003). An example of contracting’s role in provoking articulation, deliberation and reﬂection concerns the negotiation and contracting eﬀorts in an alliance between Xerox and Fuji Xerox. The Xerox executive for this alliance claimed that the negotiating teams ‘left no stone unturned’. He mentioned that ‘a lot of bright people argued down all the alleys looking for potential future problems’ and that they spent their time ‘going through all the “what if ” questions’. They continuously ‘took the agreement apart and put it back together’ (Gomes-Casseres, 1996: 27). Another example consists of a relationship between a Silicon Valley Software ﬁrm and a Japanese electronics producer in which a ‘risk and concern’ section was inserted in formal statements of work in order to ‘force the participants to think through the project’ (Mayer and Argyres, 2004: 400). In contrast, a lack of contracting may inhibit deliberation and reﬂection, something which was evident in the relationship between Coca-Cola and Nestlé. When negotiating this deal, ‘too little attention was paid to the alliance business plan. Market pressures were such that executives rushed into the collaborative agreement [. . .]. The contract was signed in one weekend’ (Ariño and Reuer, 2004: 45). In this case, a lack of contracting eﬀorts resulted in low degrees of deliberation and reﬂection and the relationship was dissolved after three years, despite a stipulated contract horizon of one hundred years. Through inducing articulation, deliberation and reﬂection, contracting practices turn circumstances into words and salient categories that form a basis for sensemaking (Weick et al., 2005). Moreover, it renders sensemaking processes more active and animated, and it imbues them with social energy (see Maitlis, 2005). Participants become more heedful (see Weick, 1993), question current assumptions, beliefs and understandings, and actively construct their new reality. To recapitulate, I argue that negotiation and contracting processes facilitate articulation, deliberation and reﬂection, and thereby inﬂuence sensemaking (see Figure 5.2). Proposition 5.2 Contracting helps participants in interorganizational relationships to articulate, deliberate and reﬂect upon issues, thereby aﬀecting their ability to make sense of their partners, the relationships in which they are engaged and the collaborative contexts in which these are embedded.

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Instigating and Maintaining Interaction A third mechanism through which contracting facilitates sensemaking revolves around its role in instigating and maintaining interaction (Avadikyan, 2001; Balogun and Johnson, 2005; Simons, 1995). Interaction between participants in interorganizational relationships ﬂows through ‘series of formal processes’ and outcomes (Ring, 2000: 154), which serve as frameworks, mediums, or triggers for interaction (Ness, 2002; Putnam, 2003). Formalization is used to spin new stories, set actions in motion, announce beginnings, milestones, and ends and trigger changes of course (Avadikyan, 2001; Eccles and Nohria, 1992; Weick, 1995). It entails the exchange of proposals between parties, which mediate conversations and dialogues (Nellore, 2001; Putnam, 2003) and enable parties to discuss tasks not yet executed and outcomes that still have to be created (Yakura, 2002). Formalization further involves processes of arguing, listening and working to reconcile diﬀerences (see Weick, 2004; Weick and Roberts, 1993), enabling individuals to ‘express their opinions and beliefs, engage in constructive confrontations, and challenge each other’s viewpoints’ (Zollo and Winter, 2002: 341). In this way, participants in collaborative relationships come to share and synthesize knowledge sets, implicit assumptions and mental models (Kotabe et al., 2003). An example of formalization’s role in instigating and maintaining interaction concerns a geographically and organizationally dispersed group of artiﬁcial intelligence language designers, which treated each release of a formal manual ‘as an event initiating discussion of perceived gaps or problems and further proposals and agreements, which in turn led to the next draft’ (Orlikowski and Yates, 2002: 692). Another example concerns two partnerships involving original-equipment manufacturers in the auto and aircraft industries, where contracts provided a setting for discussion, allowing partners to ‘understand the speciﬁcations, each other’s capabilities, and the resources needed to do the job’ (Nellore, 2001: 502). These examples indicate that contracting entails representations of reality through which participants in interorganizational relationships interrelate and make sense of their new situation. Summarizing, I contend that contracting helps to instigate and maintain interaction among participants in interorganizational relationships, thereby oﬀering fertile ground for sensemaking (see Figure 5.2). Proposition 5.3 Contracting instigates and maintains interaction among participants in interorganizational relationships, and thereby aﬀects their ability to make sense of their partners, the relationships in which they are engaged and the collaborative contexts in which these are embedded.

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Reducing Biases, Judgment Errors, Incompleteness and Inconsistency Finally, I advance the view that negotiation and contracting practices facilitate sensemaking by reducing the impact of individual biases and judgment errors, and by augmenting the completeness and consistency of the cognitive representations that participants develop of their partners, the relationships in which they are engaged and the contexts in which these are embedded. Contracting reduces inﬂuences of individual biases and judgment errors on collaboration, as it is sensitive to the ideas and interests of several persons. It compensates for deﬁciencies in individual thought processes, such as global and undiﬀerentiated thinking, cognitive nearsightedness and oversimpliﬁed notions of causation (Katz and Kahn, 1966; Ketokivi and Catañer, 2004). It therefore tends to result in more nuanced, consummate and consistent pictures of reality (Katz and Kahn, 1966), increasing the reliability and predictability of decision making processes and outcomes (Sutcliﬀe and McNamara, 2001). This is reinforced by the fact that contracting requires parties to adopt relatively unambiguous proxies for desired behaviour and outcomes so that deviations are clearly veriﬁable (Carson et al., 2006). Contracting also raises the likelihood that relevant information is considered and treated properly, and that inconsistencies are uncovered and eliminated (Avadikyan et al., 2001; Sutcliﬀe and McNamara, 2001). An example stems from an alliance between L’Oréal and Esthétique, in which additions to the contractual framework ‘reduced “noise” in the interaction on all levels, as typically small and recurring conﬂicts were dealt with once and for all’ (Ness, 2002: 25). Doz (1996) oﬀers an example of a contrasting situation. In his description of an alliance between Ciba Geigy and Alza aimed at the development of controlled oral pills and transdermal patches, he indicates ‘that the initial agreement left room for [. . .] widely diﬀerent perceptions and broad frames [which] led to growing suspicions and tensions as each party was searching for clues in the behaviour of the other’ (Doz, 1996: 68). These examples indicate that contracting may enable participants in interorganizational relationships to make sense of their new situation by reducing the impact of biases and judgment errors, and by increasing the consistency and completeness of their cognitive representations. I capture this in a fourth proposition (see Figure 5.2). Proposition 5.4 Contracting reduces the impact of individual biases and judgment errors, and it diminishes incompleteness and inconsistencies among the cognitive representations held by participants in interorganizational relationships, thereby aﬀecting their ability to make sense of their partners, the relationships in which they are engaged and the collaborative contexts in which these are embedded.

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Contracting appears to be a way of organizing by which people make sense of equivocal inputs, which they enact back into their world to make it more orderly (see Weick et al., 2005). This may eventuate in more reﬁned understandings of partners’ cultures, management systems, capabilities and weaknesses, and it may oﬀer participants more clarity about the context in which relationships are embedded (Zollo et al., 2002). Contracting may aﬀect sensemaking in such a way that participants in interorganizational relationships create ‘a solid understanding of the business, share a common fact base, and agree on important assumptions’ (Kaplan and Beinhocker, 2003: 72). It helps them to gradually come to understand the nature of the pie that could be created in their relationship, the size of that pie, and the processes and resources that could help create it (Jap, 2001). Moreover, it can improve their understanding of each other’s intentions and behaviour (Aulakh and Madhok, 2002). The resulting collective consciousness (Clegg et al., 2002a; Hill, 2001b), common reality or shared understandings (Brown, 2004; Hardy et al., 2005; Putnam and Cooren, 2004) oﬀer participants in interorganizational relationships a unitary basis for action (Maitlis, 2005; Weick and Roberts, 1993). This does not imply that partners need to have the same point of view, or understand each other completely. Plurivocal interpretations and understandings will always persist among organizational actors owing, among other reasons, to lasting diﬀerences in prior experience (see Balogun and Johnson, 2004; Brown, 2000, 2004), and diﬀerences in interests and objectives. Various stakeholders may, for example, ‘have diﬀerent views as to what is valuable because of unique knowledge, goals, and context conditions that aﬀect how the novelty and appropriateness of the new value will be evaluated’ and because ‘they may have competing interests and viewpoints on what is valuable’ (Lepak et al., 2007: 185). However, contracting’s eﬀects on sensemaking at least increase the likelihood that participants in interorganizational relationships develop mutual and congruent understandings next to their private understandings. This permits coordinated action, while preserving the complexity of multiple individual cognitive structures (Barr and Huﬀ, 1997; Elsbach et al., 2005; Weick, 1995; Weick and Roberts, 1993).

CREATING AND DISCOVERING VALUE The ultimate outcome of advanced understandings should be measured in terms of value creation (Sandberg and Targama, 2007), which is at the heart of any organizational activity and a central concept in the management and organization literature. Nonetheless, there is little consensus on

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what value creation is (Lepak et al., 2007). In general, it has to do with the quality of a job, task, product or service as perceived by users or clients in relation to their needs (Bowman and Ambrosini, 2000). When value is being created, customers or clients are willing to pay more for an organizational eﬀort or outcome than the costs that were made to produce it (Kang et al., 2007; Priem, 2007; Sirmon et al., 2007). By facilitating sensegiving, sensemaking, sensedemanding and sensebreaking in interorganizational relationships, contracting practices advance understandings, which promises to augment value creation in multiple ways. First, contracting may help to solve problems of understanding among interorganizational participants. By increasing the congruency and actionability of understanding contracting limits inappropriate information processing, it reduces failures to interpret new cues and data, and it diminishes misunderstanding that lie at the basis of friction and conﬂict (Cronin and Weingart, 2007). I therefore suggest that contracting has the potential to reduce problems of understanding among participants in interorganizational relationships (see Figure 5.2). Proposition 5.5 Contracting enhances value creation by reducing the degree to which participants in interorganizational relationships experience problems of understanding. Moreover, incongruent and inactionable understandings may render coordination precarious, increasing the likelihood that workers’ actions contradict each other and that they produce outcomes that are inconsistent with others’ expectations (Cronin and Weingart, 2007). They diminish managers’ ability to devise an eﬀective division of labour consisting of ‘revenuegenerating and organized actions’ (Witt, 2000: 740). After all, labour can only be divided when parties have conceived, at least vaguely, which activities should be undertaken and what the results of those activities should be (Rathe and Witt, 2001: 344). In brief, incongruent and inactionable understandings may diminish value creation by reducing unity of intention and action (Baba et al., 2004). Because individuals frequently hold diﬀerent and sometimes competing viewpoints on what is valuable, it therefore becomes necessary to recognize and reconcile incompatibilities in understandings (Cronin and Weingart, 2007; Lepak et al., 2007). Acts of sensegiving, sensedemanding and sensebreaking associated with contracting may oﬀer interorganizational participants new representations, accounts or conceptions of their partners, the relationships in which they are engaged and the collaborative contexts in which these are embedded, allowing them to act in line with each other’s expectations. Interoranizational participants use these acts to shape each other’s sensemaking processes (Maitlis and

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Lawrence, 2007) so as to make sure that part of their own understandings becomes shared by the other party. This enhances value creation, not only by diminishing problems of understanding, but also by enabling coordinated and controlled forms of collective action. The advanced understandings emanating from the contracting process enable specialization and the division of labor. They increase the likelihood that dispersed knowledge and individual endeavour can be coordinated most eﬀectively (Witt, 2000). Witt (2000: 739) asserts that ‘each venture that is undertaken [. . .] is informed by some notions of what business to do, how to do it, under what constraints, and how to work on those constraints over time’. These reﬂect the subjective ‘imaginings of the way the venture might be carried through [. . .] and of what could be achieved with it’ (Witt, 2000: 739). He proceeds by stating that such business conceptions guide the concrete steps undertaken towards organizing the division of labour ‘in order to create competitive, revenue-generating and organized actions’ (Witt, 2000: 740). The existence of more congruent understandings of reality among members of diﬀerent organizations not only helps to organize ‘otherwise meaningless or ambiguous information into signiﬁcant agendas and action plans’ (Witt, 1998: 162), but it may also attenuate incentive problems. When presiding over more congruent and actionalble understandings, participants may perceive their task in terms of contributing to a common goal (Witt, 2000) and they become more likely to identify themselves with the relationship, possibly increasing their motivation. In addition, focal actors may attempt to inﬂuence others’ accounts, conceptions or understandings of reality in such a way that their interests are served better. In this respect, Barnard (1948: 141, as cited in Foss, 2001: 363) already stated that ‘an organization can secure the eﬀorts necessary to its existence . . . either by the objective inducements it provides or by changing states of mind’. From a cognitive point of view, this possibility of concerting individual motivation and dispersed knowledge based on a socially shared cognitive frame is attractive in that it may substitute for more costly forms of governance. Foss (2007a: 251), for example, has shown that, in situations that may be characterized as presenting a coordination problem to agents, managing beliefs can be an eﬀective means of overcoming these problems and assisting other actors in coordinating on a preferred outcome. By changing other actors’ conceptions of reality (e.g. through signalling or inﬂuence tactics), a focal actor may eﬀectively alter their behaviour in line with its own preferences and in such a way that collective action becomes possible. If actors are successfully induced to pursue a particular conception as their own, ‘they may be less likely to engage in ﬁguring out opportunities for opportunistic choices. The simple reason is that their

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attention tends to be diverted away from such a line of thought’ (Witt, 1998: 173). Furthermore, the existence of congruent understandings may increase others’ ability to predict and anticipate actions, needs and reactions of others during collective undertakings, which promotes eﬀective monitoring (Rico et al., 2008). In contrast, if there are rivalling business conceptions, individual knowledge and eﬀorts are generally not well concerted (Rathe and Witt, 2001: 345). Consistent with the observation by Foss (2007a: 250–51),3 that the ability to inﬂuence beliefs will be increasingly important in managing cooperation and creating wealth, and based on the arguments exposed here, I conclude the following: Proposition 5.6 Contracting enhances value creation as it allows for the development of more congruent and actionable understandings, which serve as the basis for the coordination and control of collective action. Finally, contracting augments value creation by helping interorganizational participants to conceive of what has to be developed and how this has to be done (Witt, 2000). More speciﬁcally, it constitutes a potential sources of value creation, because it allows ‘parties to discover the opportunities that they otherwise may not have discovered, both with respect to exploiting the possibilities of combining their existing resources and with respect to exploiting new possibilities for resource combination’ (Foss, 1999: 15). By engaging in the sociocognitive, acts and processes associated with negotiating and contracting, interorganizational participants may come to experience ‘imaginary moments’ (Gergen et al., 2001: 697) from which new and valuable ideas emerge, which enable them to enhance value propositions (also see Levina and Ross, 2003). Moreover, these acts help them to relentlessly uncover latent ‘strategic problems’ that need to be solved, whether embedded with customers (or potential customers), with suppliers or within their own ﬁrms’ (Nickerson et al., 2007: 212).4 More speciﬁcally, I conjecture that ideas and opportunities for imagining and discovering value generally reside in interactions where existing knowledge and perspectives of diﬀerent parties are made explicit and where existing accounts of reality are recombined. Value creation then rests on the ability of interorganizational participants to bring together their perspectives and experiences through social interactions, possibly changing how they deﬁne and think about concerns and situations (Baba et al., 2004; Hargadon and Bechky, 2006). By having access to others’ knowledge, experience and perspectives, these particpants can gain insights and ‘discover higher-order themes, generalizations, and ideas’ that move beyond individual deductions (Weick and Roberts, 1993: 358). The communicative acts

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associated with contracting allow them to explore knowledge of diﬀerent parties (Kang et al., 2007) and to actively reframe situations, problems and possible solutions (Hargadon and Bechky, 2006). This may lead to new images, conceptions or accounts of what to do, how to do it, and under what constraints to do it (Witt, 2000), possibly uncovering previously hidden opportunities for value creation (Gergen et al., 2001; Sandberg and Targama, 2007). This suggests that participants in interorganizational relationships not only engage in acts of sensegiving, sensedemanding and sensebreaking to circumvent or alleviate problems of understanding or to communicate preexisting understandings (transferring or transforming the understandings held by members of one partner). They also undertake these acts to co-create novel accounts or conceptions of their partner, the relationships in which they are engaged and the contexts in which these are embedded (i.e. understandings that are new for members of both teams). Such understandings enable both parties to see their world in a new light (Bechky, 2003, 2006; Gergen et al., 2001; Hargadon and Bechky, 2006). Following Hargadon and Bechky (2006), I therefore propose that contracting involves micro-level interactions of a transient nature by which participants in interorganizational relationships may arrive at novel ‘conceptions’ (Witt, 1998) or ‘accounts’ (Lawrence and Maitlis, 2007) of requirements and the processes by which software has to be developed. As interorganizational relationships initiatives increasingly include innovative and complex activities (see Lewin and Peeters, 2006), the sociocognitive acts constituting those interactions tend to become more signiﬁcant (e.g. see Priem, 2007). In this case, parties engage in contracting to jointly conceive, imagine and discover where value resides (Witt, 1998, 2000), something which is reﬂected in proposition 5.7. Proposition 5.7 Contracting enhances value creation as it allows participants in interorganizational relationships to co-create novel understandings (new for both parties). Coping with problems of understanding and discovering opportunities both relate to value creation and they tend to be strongly related (Hsieh et al., 2007). Shane (2003: 47) explains, for example, that ‘[d]iscovery of opportunities is often like solving puzzles because a new piece of information is often the missing element necessary to see that an opportunity is present’. He adds that the discovery of opportunities may require the development of new means–ends frameworks involving problem-solving activities such as identifying, deﬁning and structuring solutions to openended problems (Shane, 2003). Nickerson et al. (2007: 214), however, note

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that there is also a signiﬁcant diﬀerence between problem-solving and opportunity-discovery activities. ‘Searching for an unknown solution to a formulated problem provides at least a benchmark against which various solution attempts can be evaluated. In contrast, when searching for a problem and its formulation there exists no analogues benchmark against which to evaluate alternative problem formulations.’ In this respect, Nickerson et al. (2007) refer to Einstein and Infeld (1938: 92) who claimed that ‘The formulation of a problem is often more essential than its solution [. . .]. To raise new questions, new possibilities, to regard old questions from a new angle, requires creative imagination and marks real advance [in science].’

TOWARDS A BALANCED VIEW In previous paragraphs, I argued that contracting facilitates sensegiving, sensemaking, sensedemanding and sensebreaking through four mechanisms, possibly turning ambiguous or equivocal circumstances into a situation that is ‘comprehended explicitly in words and that serves as a springboard into action’ (Weick et al., 2005: 409, citing Taylor and Van Every, 2000: 40). Moreover, I have suggested that negotiation and contracting processes may assist partners in interorganizational relationships in coping with problems of understanding, transferring pre-existing understandings, co-creating novel understandings and facilitating coordination and control. In concrete terms, contracting may for example assist participants in testing and establishing expectations as to how roles and responsibilities are divided, how partners are doing, and how they will react to what one says and does (Hill and King, 2004; Klein Woolthuis et al., 2005; Narayandas and Rangan, 2004; Sivadas and Dwyer, 2000; Weick and Roberts, 1993). It may also enable them to assess and appreciate the nature and purpose of relationships (Ring and Van de Ven, 1994) and to discover the amount of agreement they have on cause–eﬀect linkages and on priorities and preferences for outcomes, which coincides with a description of sensemaking in early stages by Weick and McDaniel (1989). More generally speaking, contracting may help participants to make sense of their partners, the relationships in which they are engaged and the contexts in which these are embedded, by oﬀering them ‘a collaborative framework in which the potential for joint action is both signiﬁcant and beneﬁcial’ (Hardy et al., 2005: 63). However, we should recognize that contracting may also have negative eﬀects on sensemaking, as it may make events seem more comprehensible and controllable than they really are (Brown, 2004), fuelling the illusion

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that ‘management’ or ‘control’ are in place (Brown, 2000; Yakura, 2002). Furthermore, high degrees of formalization may result in psychic imprisonment (Snell, 2002), so that subsequent sensemaking activities proceed within overly narrow analytical and decision-making boundaries (Ring, 2000). In such cases, contracting leads to a focus in attention that is too rigid or inappropriate, which may lead managers to ignore or overlook critical factors, and which may render their understandings too parsimonious, myopic, or otherwise incongruent with reality (Hill and Levenhagen, 1995; Sutcliﬀe and McNamara, 2001). In this respect, Weick (2001: 460) mentions that ‘once a sense of the situation begins to develop, that sense can be terribly seductive and can resist updating and revision.’ It may also lead managers to lose ‘sight of the forest’ while picking away ‘at the branches and leaves of the trees’ (Putnam, 2003: 48). This was evident in Doz’s (1996: 68) description of an alliance between Ciba Geigy and Alza, where sensemaking led to cognitive understandings that ‘made the behavioural learning agenda look taller and taller’. Contracting has other disadvantages in that it can easily turn into formalism (Mintzberg, 1994), cause rigidity and a loss of creativity and ﬂexibility (Volberda, 1998) and diminish trust (Klein Woolthuis et al., 2005). Moreover, formal attempts to articulate, deliberate and reﬂect upon issues may entail high costs and eﬀorts, and they can even hamper interaction if their beneﬁts are unclear to participants in collaborative endeavours. Furthermore, contracting may not only diminish but also introduce biases and errors, if it reﬂects desired outcomes and behaviours inappropriately. In addition, partners are not always likely to seek clariﬁcation during negotiation and contracting processes, because it is likely to raise new issues that may hamper the negotiation outcomes (Fréchet, 2007). In a similar vein, they may not wish to give or break sense to participants of the partner, as this may reveal their true intentions or weaken their negotiation position (Eggleston et al., 2000). Finally, contracting eﬀorts aimed at decreasing problems of understanding, increasing the congruence of understandings and co-creating novel understandings involve what Langlois (1992) has called ‘dynamic transaction costs’, or the costs of teaching and persuading others (Langlois, 2005). I thus acknowledge the fact that contracting has a dark side, and that it can generate undesired and unanticipated outcomes (Balogun and Johnson, 2005; Yu et al., 2005). In the words of Henry Mintzberg (1994: 386) ‘formalization is a double-edged sword, easily reaching the point where help becomes hindrance’. I therefore conclude that the relationship between contracting and sensemaking is likely to be a curvilinear one, in which contracting contributes to sensemaking up to a certain point, through each of the four mechanisms that I distinguished previously, after which it diminishes participants’ capacity for sensemaking (see Figure 5.2).

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Proposition 5.8 The extent to which contracting enables participants to (1) focus their attention; (2) articulate, deliberate and reﬂect; (3) interact; and (4) reduce judgment errors, biases and incompleteness and inconsistency of their cognitive representations has an (inverted) curvilinear relationship with their ability to make sense of their partners, the relationships in which they are engaged and the contexts in which these are embedded.

MODERATING EFFECTS OF CONTEXT AND TIME The relationships that have been previously proposed are likely to be more pronounced in certain contexts and at certain stages of interorganizational cooperation than in others. I therefore distinguish between relationships focused on exploration and exploitation and on early versus later stages of collaboration (Koza and Lewin, 1998; March, 1991; Rothaermel and Deeds, 2004). These moderators are discussed simultaneously here, as interorganizational activities tend to shift from exploration towards exploitation over time (Rothaermel and Deeds, 2004). Innovations and new initiatives, for example, eventually require commercialization. Furthermore, learning tends to take place, which raises the eﬃciency with which partners jointly deploy their resources (Dyer and Singh, 1998; Zollo et al., 2002). Having presumed this, I argue that the need for acts and processes of sensegiving, sensemaking, sensedemanding and sensebreaking diﬀers for exploration and exploitation contexts, and for early and later stages of cooperation. To construct my argument further, I have to clarify what is meant by exploration and exploitation. Exploration involves innovation, risk taking, building new capabilities, learning and entering new lines of business (Koza and Lewin, 1998). Exploitation, on the other hand, is associated with enlarging the productivity of capital and assets by improving and reﬁning existing capabilities and technologies, standardization, routinization and systematic cost reduction (Koza and Lewin, 1998; March, 1991; Rothaermel and Deeds, 2004). Challenges of understanding tend to be particularly pronounced during initial stages of collaboration, as members from diﬀerent organizations tend to hold diﬀerent accounts (see Lawrence and Maitlis, 2007) or conceptions of reality (see Witt, 1998, 2000). The representational gaps they experience may not only cause challenges of understanding, such as distrust, conﬂict and misinterpretation (Cronin and Weingart, 2007; Vlaar et al., 2006), but also complicate the transfer and transformation of preexisting understandings and the co-creation of novel understandings (see Baba et al., 2004; Bechky, 2006; Gergen et al., 2001; Hargadon and Bechky, 2006). This ultimately restricts opportunities for innovation and

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value creation (Lepak et al., 2007; Sandberg and Targama, 2007; Witt, 1998, 2000). In early stages of collaboration, employees need ‘slack’ to discover, innovate, discuss and experiment (e.g. March, 1991). Partners are primarily assessing each other’s competencies and the value of interaction (Jap and Ganesan, 2000), and they try to develop understandings of their new situation (Ring, 2000). In these circumstances, the need for sensegiving, sensemaking, sensedemanding and sensebreaking is most salient, as expectations of prospective partners might be incompatible (Mjoen and Tallman, 1997) and diﬀerences in background, experience and culture can lead to ambiguity, equivocality and conﬂict (see Jemison and Sitkin, 1986). Moreover, partners still have to achieve a certain degree of coherence and unity of purpose (Flyvbjerg, 1998), and participants in these relationships still have to come to appreciate the potential for transacting with each other (Ariño and Ring, 2004). Organizations are therefore ‘testing the goal compatibility, integrity, and performance of the other, as well as potential obligations, beneﬁts, and burdens involved with working together on a long-term basis’ (Jap and Ganesan, 2000: 244). Findings from Fryxell et al. (2002) indicating that formal controls have a more positive relationship with international joint venture performance in younger rather than in older relationship provide support for the fact that the sense function of formalization is particularly relevant in early stages of cooperation. As partners get to know each other better and information asymmetries are being reduced, the need for signalling and sensemaking diminishes (Heide, 2003). Similarly, exploratory relationships, such as cross-sector collaborations, often ‘bring into tension and conﬂict extraordinarily complex ways of framing problems, as well as divergent knowledge and truth claims based on competing disciplinary paradigms. . . .’ (Couchman and Fulop, 2002: 43). This eﬀect is particularly pronounced for organizations with little common history to rely on (see Weick, 2001). Creating more coherent understandings that enable collective action has been argued to be particularly important and challenging for this type of situation (Maitlis, 2005; Weick, 1993). Conversely, in relationships dedicated to exploitation, issues are generally clear-cut (see Koza and Lewin, 1998; Rothaermel and Deeds, 2004). Parties to the relationship are likely to have a reasonable picture of the business proposal underlying their collaboration, and they have developed joint understandings that allow for uniquely eﬃcient communication in the form of idiosyncratic interaction routines (Dyer and Singh, 1998; Hoang and Rothaermel, 2005; Kotabe et al., 2003; Zollo et al., 2002). They have also come to know more about each other’s structure, operations and competencies (Shenkar and Zeira, 1992), which enhances their ability to

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formalize the relationship (e.g. see Mayer and Argyres, 2004; Poppo and Zenger, 2002). In this respect, Zollo et al. (2002: 703) note that a ‘key body of knowledge accumulated during alliance activity concerns the partnering organizations themselves’ reducing the need for sensegiving and sensemaking in exploitation contexts and stages. This can be illustrated with Ring’s (1997) description of collaborations between 3M, NASA and a ﬁrm called Beta Trading, in which early stages of negotiation and commitment had resulted in trust, a free ﬂow of information, speaking the same language, and mechanisms for private ordering. He concluded that, as a result, ‘the need for extensive sensemaking, understanding, and committing processes during administrative phases was [. . .] reduced’ (Ring, 1997: 298). In general, Ring notes that, once the details of a cooperative interorganizational relationship are established in the transactional phases, ‘sensemaking and understanding processes, although ongoing, will be less intense than those that occur during transactional phases, at least until problems arise’ (Ring, 1997: 299). In line with this, Krishnan et al. (2006: 902) state that ‘partners in longlasting alliances have had enough time to develop mutual understanding’. The preceding arguments imply that the need to engage acts of sensegiving, sensemaking, sensedemanding and sensebreaking is most pressing in early stages of collaboration and in exploratory relationships. In these situations, participants still have to form themselves cognitive representations and formal attempts to coordinate and control behaviour and outcomes may not be very beneﬁcial, because expected returns and activities might be highly variable and very unclear (Cardinal, 2001; March, 1991; Rothaermel and Deeds, 2004) and because these attempts may discourage the development of creative ideas and innovative developments. This assertion coincides with Oxley’s (1997) observation that, if the purpose of a contract or alliance is the creation rather than exploitation of technology, adequate speciﬁcation of rights will inevitably be problematic. It also aligns with Child’s (1975:13) observation that ‘in conditions of high variability in the environment, successful performance is likely to depend on [. . .] avoidance of heavily formalized systems of organization, in so far as these are built upon standard procedures and red tape which tend to shape activities on precedence rather than on new changing requirements’. In these situations, interorganizational partners might feel the need for coordination and control, but they simply lack the ability to design appropriate formalities (Gerwin, 2004; Helm and Kloyer, 2004). Relationships aimed at exploitation and relationships that ﬁnd themselves in later stages of development, instead, are frequently associated with the transformation and utilization of existing knowledge, something which is

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facilitated by formalization (Jansen et al., 2005). The exploitation of existing knowledge demands predictability, control, and high degrees of conformity, so that interorganizational partners become more inclined to use formal mechanisms in order to attain coordination and control. Concluding, I propose that the sense function of contracting (i.e. its use as a means to give, make, demand and break sense) is more pronounced in relationships that are still in the early stages of cooperative development and in relationships directed at exploration than in those aiming at exploitation. This is formally captured in propositions 5.9 and 5.10. Proposition 5.9 Contracting’s function as a means to give, make, demand and break sense is more pronounced in early stages of collaboration than in later stages of collaboration. Proposition 5.10 Contracting’s function as a means to give, make, demand and break sense is more pronounced in relationships aimed at exploration than in relationships directed at exploitation. Finally, it is noteworthy to mention that trust, which has frequently been argued to substitute for the control function of contracting (e.g. Das and Teng, 2001; Dyer and Singh, 1998; Gulati, 1995; Inkpen and Currall, 2004), may actually diminish the cognitive eﬀorts that partners invest in considering their broader environment (Krishnan et al., 2006). More broadly speaking, high levels of trust may diminish the extent to which collaborating parties engage in acts of sensegiving, sensedemanding and sensebreaking so as to make sense of their partner, the relationships in which they are engaged and the collaborative contexts in which these are embedded. More speciﬁcally, the perception that information obtained from a partner is reliable and the cognitive comfort associated with trust may limit variety of thought and action, attentiveness to detail and alertness (Langfred, 2004). Krishnan et al. (2006: 897) add that ‘Because trust accustoms partners to rely on each other without doubt, each partner tends to rely more extensively on the other’s knowledge of the environment when scanning the opportunities and threats faced by the alliance [or another type of relationship], while paying less attention to the completeness and veracity of the information thus obtained.’ Krishnan et al. (2006) conclude that trust functions as a simplifying heuristic that constrains cognitive eﬀort, which may translate itself as ‘strategic blindness’ or outright insensitivity to environmental changes (McEvily et al., 2003b). It tends to bias partners’ eﬀorts in search, scanning and processing information, while also attenuating and colouring their attempts to make sense of their environments (Krishnan et al., 2006). Krishnan et al. (2006: 898) therefore state

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‘Overall, interorganizational trust stands to result in inadequate response to the challenges posed by an uncertain environment because it limits cognitive eﬀorts or even causes strategic blindness. Notwithstanding good intentions, trust may thus lead partners into making slow and suboptimal decisions [. . .] or even no decisions at all.’

DISCUSSION This theme was born out of the observation that understanding ‘why economic agents use contracts [. . .] is crucial to understanding the organization and eﬃciency of economic exchange’ (Masten and Saussier, 2002: 273). It was denominated ‘functions of negotiation and contracting’, because it concerned the underlying reasons or rationales for instituting formal interorganizational structures and practices. In this chapter, I have taken issue with the observation that existing studies tend to focus on formal governance either as a means to coordinate, a means to control or a means to legitimize (see, for instance, Dacin et al., 2007; Gulati and Singh, 1998; Madhok, 2002; Meyer and Rowan, 1977; Salbu, 1997; Kale et al., 2002). They generally pass over the fact that formal governance might have other functions (e.g. for notable exceptions see, for example, Ariño and Ring, 2004; Lindenberg, 2003; Zollo and Singh, 2004). Closer inspection of the functions of negotiation and contracting appeared necessary, as several authors suggest that there is a need for alternative explanations and novel understandings of formal structures and practices (Hatch, 1999; Meyer and Rowan, 1977; Simons, 1990, 1995). I have therefore exempliﬁed that contracting entails socio psychological processes through which participants socially construct or ‘enact’ their realities (Ariño and Ring, 2004; Vaara, 2003; Weick, 1995) and by which they reduce the cognitive disorder, ambiguity and uncertainty that they experience (Carson et al., 2006; McKinley and Scherer, 2000; Weick, 1979, 1995, 2001, 2004). Collectively, my arguments depict contracting as a process of ‘constructive clariﬁcation’ (Cardinal et al., 2004: 422) by which particular versions of reality are created, clariﬁed, sustained and modiﬁed (Brown, 2004), and as a form of structuring that generates and recreates meanings (Ranson et al., 1980). My description accommodates several distinguishing features of sensemaking such as ‘its genesis in disruptive ambiguity [e.g. the initiation of a new relationship], its beginnings in acts of noticing and bracketing [e.g. codiﬁcation], its mixture of retrospect and prospect [e.g. diﬀerent experiences of partners combined with converging understandings], [and] its culmination in articulation that shades into acting’ [contracting as a basis for action]’ (Weick et al., 2005: 413). Moreover, it

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suggests that contracting processes strongly resembles the notion of sensemaking as a ‘guided and controlled’ process, which results in the creation of more unitary and rich accounts of reality, that provide ‘common foundations for action’ and enable ‘the emergence of series of actions with a consistent focus’ (Maitlis, 2005: 28). Jointly, the sociocognitive acts associated with negotiation and contracting constitute processes that may assume both an analytical and a synthetic character. They involve analysis, disassembly and decomposition, as well as active combination and integration of knowledge so as to arrive at novel, or catalytic, questions and new deﬁnitions of problems, opportunities and solutions (Nickerson et al., 2007: 218).5 My depiction of negotiation and contracting processes as means to create understanding aligns with work by Argyres et al. (2007) suggesting that cross-provisional learning occurs among the persons involved in discussing and drafting a contract. It supports the notion that learning about contingency planning, for example, may spill over in learning about task description in contracts. Argyres et al. (2007: 7) describe this accordingly: The design of a complex contract tends to parallel the planning and design of the broader transaction more generally [. . .]. As more eﬀort is expended in identifying and providing for additional contingencies in the contract, opportunities for clarifying the task description to avoid these contingencies are revealed, thereby reducing the marginal cost of developing terms in that category. Conversely, as greater eﬀort is made to clarify the parties’ roles and responsibilities in the project, potentially problematic contingencies are more likely to be identiﬁed, and therefore the marginal cost of including them in the contract falls. That is, opportunities for clearer and more detailed task description are often important by-products of the contingency planning activity, while opportunities for additional contingency planning are important by-products of eﬀorts at task description.

Theoretical and Practical Implications This chapter advances prior research on the sensemaking function of formalization (Ring and Van de Ven, 1989, 1994) by discerning the mechanisms through which contracting facilitates the creation of more congruent understandings among participants in interorganizational relationships. It indicates that research on contracting in interorganizational relationships may beneﬁt from embracing the inherent qualities of the process of formalization itself, and from changing its focus on contracts, rules and procedures to an emphasis on the processes from which these formalities originate (see also Langley, 1988; Mintzberg, 1994). This is congruent with pleas by Weick and other researchers for more research into structuring processes (see Ariño and De la Torre, 1998; Carson et al., 2006; De Rond

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and Bouchikhi, 2004; Narayandas and Rangan, 2004; Ring and Van de Ven, 1994; Weick, 2001; Weick et al., 2005). Moreover, this conceptualization of contracting implies that researchers should regard formalization as a means to achieve coordination, control and legitimacy, but also as a means to cope with issues of understanding in interorganizational relationships. This implies that researchers may have to redirect their attention from coercive towards enabling types of contracting (see Adler and Borys, 1996; Zollo and Winter, 2002) in which higher levels of understanding (Zollo and Singh, 2004) and the constitution of meaning (Giddens, 1984) assume a more central position. The arguments advanced in this chapter also imply that contracting has to be regarded as ambivalent, in the sense that it is a vehicle of several functions (Avadikyan et al., 2001; Foss, 1999; Madhok, 2002), something which renders either–or discussions on its role in interorganizational relationships unproductive (Klein Woolthuis et al., 2005). In contrast to prior work (Reuer and Ariño, 2007), I further suggest that individual contractual provisions and the processes from which they emerge may serve multiple functions at the same time (see also Foss, 1999; Foss and Foss, 2005; Klein Woolthuis et al., 2005; Madhok, 2002). The coexistence of each of the four functions of contracting and their interrelationships indicate that researchers and practitioners should not let one perspective on formalization rule their thinking. Take, for example, clauses that put restrictions on the use of proprietary information. Negotiating and writing such clauses may fuel parties’ understandings, but they may also induce partners not to expropriate certain information and to coordinate the relationship in such a way that the other ﬁrm is confronted with this type of information to the minimum possible. Consequently, more research attention could be directed to the intentions underlying managers’ decisions to formalize inputs, behaviour or outcomes in interorganizational relationships, and to the interpretations that partners give to each other’s actions. Chalos and O’Connor (2004) show that such research is promising. In their study on control mechanisms in US–Chinese joint ventures, US partners viewed particular controls as being useful for the selective transmission and protection of their knowledge, while Chinese partners viewed the same controls as a means to protect their relationspeciﬁc investments. This implies that researchers and practitioners should not let one perspective on contracting rule their thinking. Furthermore, my conceptualization of negotiation and contracting practices rejects common beliefs that the degree of formalization necessarily has to be low in uncertain situations for which measurability is low (Galbraith, 1973; Lassar and Kerr, 1996; Ouchi, 1979; Poppo and Zenger, 2002; Shane, 1996; Williamson, 1985). Although I acknowledge that this

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might hold for negotiation and contracting practices primarily directed at coordination and control, I suggest it does not apply to practices aimed at advancing understandings (see also theme one). I even argue that the latter functions of negotiation and contracting practices is probably more salient in ambiguous and exploratory contexts. In fact, I have shown that contracting may be highly valuable in such circumstances, since it is likely to enhance partners’ understandings. It may, for example ‘enable the identiﬁcation and selection of problems that ultimately reveal value creating solutions’ (Nickerson et al., 2007: 215). This is important, as economizing on the costs related to the creation of such understandings may explain important aspects of economic organization in general and interﬁrm relations in particular (Foss, 1999: 16). Practitioners could use the insights generated in this chapter to establish more congruent understandings among themselves and other participants in the relationships in which they are involved. This promises to be particularly useful when such relationships are characterized by large interpartner diﬀerences and high degrees of ambiguity and uncertainty. In such cases, simply exchanging more information may not solve their problems, and eﬀorts have to be put into shaping interpretations and understandings (Sutcliﬀe and Weber, 2003; Thomas and Trevino, 1993). This chapter has shown that contracting may be an important means for doing so. More speciﬁcally, the chapter oﬀers practitioners insights into the way formalization facilitates sensegiving, sensemaking, sensedemanding and sensebreaking and how it helps to develop more congruent understandings in collaborative relationships. Limitations and Future Research As much as this chapter may help advance the literature on interorganizational governance, it also leaves several areas unattended. Most signiﬁcantly, the implicit assumption has been that parties jointly develop the contract and that they are both involved in the negotiation and contracting process (i.e. the contract is not imposed on one of them). Fréchet (2007) has shown that this may not always be the case. From observing the contract and relationship between Vision3D (a company that was proﬁcient at digitally converting objects in 3D and reproducing them with the help of a robot sculptor) and another ﬁrm, he concluded that ‘as the contract had been entirely drafted by the other party, the top manager had not been involved in a clariﬁcation process that could have revealed the discrepancies between the formal contract and his psychological contract’ (Fréchet, 2007: 17). In another relationship aimed at the launch of a simple money converter, Fréchet (2007: 18–19) found that managers of the

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technology ﬁrm involved did not have experience in contract negotiation and that they had not really participated in the contract-drafting process as well. Instead, they were presented with a pre-formulated contract by their partner, which they had not discussed in great detail. In this case, ‘the poor experience in contact drafting, in parallel with the absence of participation in the drafting processes explain[ed] the poor role that the contract played in the entrepreneurs’ representations’ and the relationship deteriorated quickly. In both examples, the one-sided nature of the contract-drafting process and limited involvement and participation of the other party reduced the likelihood that advanced understandings would arise from sociocognitive processes of sensegiving, sensemaking, sensedemanding and sensebreaking, something obviously demarcating the boundaries within which the theoretical framework that I presented in this chapter is valid. Other opportunities for future research are abundant. First, researchers could investigate how power, politics, and resource and information asymmetries aﬀect acts of sensegiving, sensedemanding and sensebreaking in collaborative relationships. After all, the development of understandings is not free of power issues, diﬀerences in preferences and self-interested behaviour (Brown, 2000, 2004). Such factors provide diﬀerent people with unequal positions from which they inﬂuence the social construction of reality (Mills, 2003). They aﬀect, among other aspects, the extent to which parties have control over cues, communicate with each other and support or constrain each other’s actions and behaviour (Weick et al., 2005). Moreover, when resource and information asymmetry exists between partners, participants are likely to perceive diﬀerent cues and attribute diﬀerent meanings to similar observations, as they interpret cues in light of their expectations and knowledge (Weick, 1995). Besides, participants in interorganizational relationships will attempt to inﬂuence and shape each other’s beliefs in the direction that they prefer (see Foss, 2007a). Moreover, they may choose not to give other parties particular information for strategic reasons, or use their power to make sure that issues are (not) captured in formal documents (see Eggleston et al., 2000). An example of such a situation is provided by Faems et al. (2007) who described the realization of a contract in an R&D alliance between an imaging company (GRAPH) and an inkjet technology ﬁrm (JET) aimed at the development of a generic printhead that could be integrated into printing systems of diﬀerent original equipment manufacturing (OEM) partners. One of the managers of the imaging company stated: ‘Jet’s CEO came to us and said “We propose this kind of collaboration and this is the contractual framework in which this collaboration should ﬁt. You only need to sign it . . .” ’ The reason provided by one of the engineers of the inkjet

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company ran as follows: ‘JET had only one body of intellectual property. So the fear was that if we engaged GRAPH at a detailed technical level, our intellectual property would rapidly ﬂow out of this building towards GRAPH.’ In addition, JET interviewees mentioned that, ‘if GRAPH were to become actively involved in the design and development of printheads, they would be able to inﬂuence the original design speciﬁcations in order to improve the applicability of the printhead for the particular printing systems that GRAPH envisioned. Such changes, however, would hamper the generic applicability of the printhead, making it much more diﬃcult for JET to sell the printhead to other EOM partners’ (Faems et al., 2007: 18–19). This and other examples show that power, politics, and resource and information asymmetries may exert fundamental inﬂuences over acts of sensegiving, sensedemanding and sensebreaking, rendering them an important area for future research. A second option for future research concerns inquiries into organization, context and task characteristics that determine how the need for sensemaking evolves. I have presumed that the sense function of contracting is particularly valuable for interorganizational relationships between partners possessing divergent skills, backgrounds and organizational structures, and for organizations based in disparate cultures or industries, as these diﬀerences can lead to misunderstandings and conﬂicts (Child and Rodrigues, 2003). Moreover, I have stated that, as partners get to know each other better and information asymmetries are being reduced, issues become more clear-cut (see Koza and Lewin, 1998; Rothaermel and Deeds, 2004) and the need for sensemaking diminishes (Heide, 2003). Parties may have developed joint understandings that allow for uniquely eﬃcient communication in the form of idiosyncratic interaction routines (Hoang and Rothaermel, 2005; Kotabe et al., 2003; Zollo et al., 2002) and they may have come to know more about each other’s structures, operations and competencies (Shenkar and Zeira, 1992). However, researchers could examine variation on other contingency dimensions as well. Here, a fertile option seems to exist in inquiring into the structural, aﬀective and cognitive dimensions of social relations among participants in interorganizational relationships (Kang et al., 2007).6 Variation on these dimensions seems to aﬀect the likelihood that parties are able to mitigate problems of understanding, transfer pre-existing understandings and co-create novel understandings by acts of sensegiving, sensedemanding and sensebreaking. Does the use of common information systems, artefacts and standardized languages, for example, propel the creation of congruent and actionable understandings? Moreover, researchers could examine to what extent the language that is being used in these interactions shapes the understanding that is being created (e.g. see Gergen

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et al., 2001), as language is arguably ‘one of the most basic and critical, but also creative, acts of human beings, providing a “window to the mind” ’ (Felin and Hesterly, 2007: 202). A third avenue for future research pertains to investigating other means facilitating acts and processes of sensegiving, sensemaking, sensedemanding and sensebreaking, such as informal processes of interaction (Balogun and Johnson, 2005) and examining the factors that inﬂuence managers’ preferences for each of them. An example of such a factor could be the likelihood that relationships experience negative eﬀects of employee turnover (Ring and Van de Ven, 1994). The departure of two founding fathers in a joint venture in the consumer products industry between a NorthAmerican and a French company illustrates my point. Ariño and De la Torre (1998: 321) explain that ‘agreements and understandings that may have been implicit in their thinking, or that could have been articulated in an informal telephone call, [were] now easily misinterpreted by those not involved in the original design and negotiations’. In this case, contracting could have prevented knowledge dissipation and facilitated continued sensemaking and learning. As this example indicates, formal and informal approaches to sensegiving, sensedemanding and sensebreaking may be preferred for diﬀerent reasons and in diﬀerent situations. Finally, researchers could inquire into the relationship between contracting, understanding and other activities needed to achieve collaborative performance. In this chapter, I have focused on the sociocognitive acts that are used to create the understandings that underlie value creation (Sandberg and Targama, 2007; Witt, 1998, 2000). After such understandings have been established, more familiar management processes, such as structuring, bundling and leveraging of resources, may be deployed in order to actually realize this value (Sirmon et al., 2007). In fact, researchers (e.g. Vlaar et al., 2008) have noted that understanding progressively serves as a basis for coordinated and collective action (Cronin and Weingart, 2007; Rathe and Witt, 2001; Vlaar et al., 2006; Witt, 1998, 2000). After all, people increasingly act not only according to ‘their understanding of the rules and routines governing their work’, but also according to their understanding of ‘tasks and the reality in which they act’ (Sandberg and Targama, 2007: 9). Hitherto, it has remained unclear, however, to what extent and how better understandings of partners in interorganizational relationships aﬀect other processes required for value creation, such as coordination and control (e.g. see Sirmon et al., 2007) and vice versa. In this respect, Makadok (2003: 1046) advances that ‘Having managers who are motivated to do the right thing [. . .] is not much help if those managers don’t know what the right thing to do is.’ Kaplan and Henderson (2005) add that new

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initiatives involve both a cognitive (how things are done) and motivational (what gets rewarded) dimension. More speciﬁcally, Kaplan and Henderson (2005: 513) state that novel activities ‘require not only new cognitive frames, but also new incentives – and building a new incentive regime may be particularly diﬃcult in the face of deeply embedded cognitive frames’. Their argument implies that coordination and control mechanisms are always deﬁned in relation to the understandings that actors have of their partners, the alliances in which they are engaged and the contexts in which these are embedded. This suggests that coordination and control may become diﬃcult when the conceptions or accounts of reality held by collaborating parties are incongruent and strongly ingrained (i.e. when actors exhibit cognitive rigidity). On top of this, several indications exist that coordination and control presuppose a particular degree of understanding. We know, for example, that sensemaking processes contribute to envisioning how value can be created (Ariño and Ring, 2004), and that they assist in removing misunderstandings, information asymmetry, and opportunities for moral hazard and opportunistic behaviour (Foss, 1999). We also know that these processes could lead to more accurate appreciations of the risks involved in a transaction. This should result in the design of more appropriate governance structures (Ring and Rands, 1989; Ring and Van de Ven, 1989, 1994) and enable parties to develop a solid basis for their relationships, while tempering hubris and faddishness (Sampson, 2003). In a similar vein, a better understanding of the dilemma between cooperation and competition in particular alliances has been argued to increase the likelihood of cooperation (Zeng and Chen, 2003), thereby reducing strains on the relationship and diminishing the eﬀorts needed to steer relationships in the right direction. Likewise, the argument has been made that completing an extensive contracting process results in parties being better prepared to interpret their environment and their partner’s behaviour ex post. Since partners know that they are dealing with better prepared ﬁrms and because those ﬁrms are indeed actually better prepared, the understanding function of contracting may substitute for its control function (see Carson et al., 2006). In contrast, the prevalence of inappropriate or incongruent understandings and expectations may lead to the inﬂexible application of existing structures and routines (Howard-Grenville, 2005). Feldman (2003), for example, found that changes in routines requested by supervisors fail to take hold when these changes contradict employees’ understandings of the organization. In this case, existing coordination and control structures tend to be reproduced. Moreover, Kaplan and Henderson (2005) vividly argue that, in case of high situational uncertainty, limited understandings may impede the development of new incentive regimes, since actors may be

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unclear about their interests and about the behaviours that are likely to be eﬀective. Moreover, existing incentive schemes may shape actors’ understandings in such a way that change becomes diﬃcult. These points suggest that cognition, coordination and control are ‘intimately linked at the most granular level’ (Kaplan and Henderson, 2005: 510). Despite these insights, a systematic overview of the interactions between contracting, the development of understanding and functions such as coordination, control and legitimacy is not yet available. Future research should focus on these interstices (Kaplan and Henderson, 2005). Here, one of the more speciﬁc questions deserving further attention is whether and to what extent implicit coordination (concerted action based on expectations, understandings, anticipation and predictions) and explicit coordination act as substitutes or complements. Another issue that requires to be explored concerns the extent to which understandings have to be shared to enable implicit coordination (e.g. see Rico et al., 2008; Sandberg and Targama, 2007).7 Starting from a diﬀerent angle, research could also further examine to what extent early decisions regarding coordination and control aﬀect the likelihood that novel understandings are co-created. Contractual limitations regarding the scope of relationships, for example, may constrain the development of such understandings. To conclude, the chapter complements perspectives on contracting focusing on its coordination, control and legitimacy functions, with a view that regards contracting as a means to give, make, demand and break sense. This augments value creation by diminishing problems of understanding, enhancing the congruence and actionability of understandings so that understandings come to serve as a basis for coordinated and controlled action, and facilitating the co-creation of novel understanding. It has thereby opened up a new way of thinking about the meaning of formalization for the management of interorganizational relationships.

NOTES 1. I deliberately use the plural noun in discussing congruent and actionable understandings, rejecting the notion that multiple individuals may hold a single thought and form a single brain (Bigley and Roberts, 2001; Cronin and Weingart, 2007; Donnellon et al., 1986; Weick and Roberts, 1993). 2. In line with this, Hill (2001a) has argued that a signiﬁcant function of contract negotiation pertains to parties trying to ﬁnd out what they want from the transaction and from one another. In this vein, contracting can be understood as a means to reconcile parties’ expectations, future actions and consequent valuations to increase the size of the aggregate pie. 3. Foss (2007a: 250) notes that ‘beliefs are arguably underresearched in strategic organization’, possibly owing to the ‘introverted nature of our dominant theories of strategic organization’.

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4. Concerning this point, the key questions that ﬁrms face is not so much ‘how can managers organize an eﬃcient search for high-value solutions to an identiﬁed problem?’ but ‘how can managers organize a search to identify and select a problem whose resolution can be expected to generate signiﬁcant value?’ (Nickerson et al., 2007: 213). Stated diﬀerently, managers should ask themselves not ‘how to organize to exploit [govern, and transfer] already developed knowledge or capability, but rather how to organize to eﬃciently generate knowledge and capability’ (Nickerson and Zenger, 2004: 617). 5. Nickerson et al. (2007: 218) note that one may ‘diﬀerentiate synthetic from analytical processes by suggesting that the former seeks out interesting and catalytic questions where analytic processes generate questions through deviations generated by repeated activities’. 6. Kang et al. (2007) respectively discuss the structural, aﬀective and cognitive dimensions by pointing at weak/non-redundant networks versus strong/dense networks, resilient dyadic trust versus generalized trust, and common component knowledge versus common architectural knowledge. 7. According to Rico et al. (2008: 4), implicit coordination takes place ‘when team members anticipate the actions and needs of their colleagues and task demands, and dynamically adjust their own behaviour accordingly, without the need to communicate directly with each other or to plan the activity’. Behavioural exponents of implicit coordination involve (1) providing task-relevant information, knowledge or feedback without previous request, (2) proactively sharing workload or helping others, (3) monitoring the progress of activities and the performance of others, and (4) adapting behaviour to the expected actions of others (Rico et al., 2008).

6.

Duality and dialectic tensions*

From a dialectical perspective, then, speciﬁc theories are not in any simple sense to be set aside. Rather they are to be superseded in a more encompassing framework. (Benson, 1977: 17)

INTRODUCTION The mainstream literature on contracts, rules and procedures presumes that formalization is directed at coordination and control, and that its inﬂuence on performance is contingent upon ﬁrm, transaction and contextual characteristics. In response to recent calls for inquiries into dialectics in interorganizational relationships, and in an eﬀort to provide managerial choice with a more prominent position in research on interorganizational governance, a complementary perspective is being developed here. I propose a framework in which formalization is presented as a duality, involving tradeoﬀs between its functions and dysfunctions, and eventuating in dialectic tensions with which managers have to cope. In line with this, I argue that researchers should be preoccupied not only with assessing the ‘rightness’ of governance solutions, but also with the trade-oﬀs and tensions associated with them. The framework is illustrated by a case study of an alliance between a major European ﬁnancial services ﬁrm and one of the world’s leading retailers. The alliance managers in this particular relationship attempted to reduce or capitalize on the tensions associated with formalization by (1) adopting a semi-structure, in which outcomes were formalized, but behaviour was not; (2) justifying formalization through referring to factors that were beyond their control, and (3) alternating their emphasis on diﬀerent requirements by each of the partner ﬁrms. The chapter shows that a dialectic perspective on formalization in interorganizational relationships oﬀers a promising complement to the mainstream literature. *

An earlier version of this chapter has been published before. I wish to thank Sage Publications for its permission to reprint this chapter. The original publication appeared under the following title: Vlaar, P.W.L., F.A.J. Van den Bosch and H.W. Volberda (2007b), ‘Towards a dialectic perspective on formalization in interorganizational relationships: how alliance managers capitalize on the duality inherent in contracts, rules, and procedures’, Organization Studies, 28(4), 437–66.

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I start by observing that researchers in the ﬁeld of interorganizational management have become increasingly interested in the concept of formalization and its many manifestations, such as contracts, rules and procedures (e.g. Grandori, 1997; Sampson, 2003). Hitherto, however, the majority of their studies have exhibited a rather deterministic character. Transaction cost economics, agency theory and contract theories, for example, all presuppose that the degree of formalization has to be aligned with organization, exchange or contextual characteristics to achieve appropriate levels of coordination, control and, eventually, interorganizational performance (Foss and Foss, 2005; Gulati and Singh, 1998; Madhok, 2002). As is shown in Figure 1.3, contributions based on these theories focus either on the relationship between governance mechanisms and their antecedents, or on their relationship with interorganizational performance (Anderson and Dekker 2005; Sobrero and Schrader 1998). In such relatively ‘deterministic’ approaches, management’s role is conﬁned to making the ‘right’ choices, choices that render optimal alignment. Nonetheless, the literature is infested with examples in which managers make sub-optimal decisions regarding formal governance (e.g. Anderson and Dekker, 2005; Mayer and Nickerson, 2005; Sampson, 2004a), and in which they attempt to attenuate the tensions emanating from formalization, instead of simply accepting them (see Blau, 1955; Cardinal et al., 2004). This raises the question as to how our understanding of formalization in interorganizational relationships would change if more attention were granted to managerial choice. Consistent with conceptualizations of formalization as being aﬀected by trade-oﬀs (Galbraith, 1977) and managerial choice (see Child, 1997), and in response to recent calls for dialectic perspectives on interorganizational cooperation (e.g. Das and Teng, 2000; De Rond, 2003; De Rond and Bouchikhi, 2004; Vieira da Cunha et al., 2002), I therefore develop a complementary view on formalization. In contrast to the mainstream literature, this perspective emphasizes the role of the alliance manager in coping with and capitalizing on the tensions emanating from organizational design choices. In doing so, I touch upon the non-shaded areas in Figure 6.1. The chapter’s contributions to the literature are twofold. First, and congruent with Hatch (1999) and Vieira da Cunha et al. (2002), I reintroduce managerial adaptation in this research ﬁeld, and elucidate how it complements the relatively deterministic viewpoints on formalization currently prevailing in the literature. I thereby add a theoretical layer to existing conceptualizations of interorganizational structuring eﬀorts. Second, I move beyond the current emphasis in the literature on formalization’s coordination, control and legitimacy functions (e.g. Foss and Foss, 2005; Gulati and Singh, 1998; Madhok, 2002). By illuminating its linkages with cognition and learning, for example, I elucidate that formalization has partly

Duality and dialectic tensions

Need to govern

Antecedents Organization level Exchange level Context level

Figure 6.1

Positive consequences

Performance Value discovery Value creation Value appropriation

Governance Contracting Trust

Ability to govern

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Negative consequences

Research framework: focus of theme four

assumed new meanings, which may explain why it is still a relevant concept in today’s business environment. By doing so, I attempt to allow others to see both the existing literature on interorganizational governance and daily collaborative practices in a diﬀerent way (consistent with Siggelkow, 2007). The chapter is organized accordingly. First, I introduce a conceptual framework by which I explain how a dialectic perspective on formalization in interorganizational relationships complements more ‘traditional’ views prevailing in the literature. Subsequently, I provide an overview of formalization’s functions and dysfunctions, which stand at the basis of such a dialectic perspective. I then illustrate the framework with a case study of an alliance between a major European ﬁnancial services ﬁrm and one of the world’s largest retailers. Finally, I elaborate on the insights provided by the study, its theoretical and practical implications, some of its limitations and avenues for future research.

TRADITIONAL VERSUS DIALECTIC PERSPECTIVES ON FORMALIZATION Researchers adhering to ‘traditional’ views on formalization, as depicted in Figure 1.3, generally strive to determine single best governance solutions, depending upon given organization, exchange and contextual characteristics (Eisenhardt, 1989a; Ghoshal and Moran, 1996; Cardinal et al., 2004). By using diﬀerentiation models, they polarize costs and beneﬁts, or functions and dysfunctions of various governance options, in an eﬀort to ascertain the ‘right’ choice or decision (see Peng and Nisbett, 1999). Transaction costs economists, for example, explain the degree of formalization in interorganizational relationships by referring to transaction

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characteristics, such as the levels of uncertainty and asset-speciﬁcity, and the frequency with which goods or services are exchanged (Klein et al., 1978; Williamson, 1985). Agency theory, constituting another example, claims that the degree of formalization should be aligned with the measurability of transactions, and with partners’ abilities to specify tasks (Eisenhardt, 1989a). Such perspectives ﬁt well with our natural inclination to assume irreconcilability of apparent inconsistencies, implying that a particular degree of formalization is either appropriate or inappropriate. However, they fail to sustain the tensions inherent in most managerial problems (Das and Teng, 2000; Volberda, 1998). While focusing on the origins of structuring choices, these perspectives neglect the consequences of selecting certain governance solutions, and they reduce the role of managers to making ‘right’ decisions (Blau, 1955; Merton, 1957). This chapter complements these views by introducing a dialectic perspective on formalization, in which interorganizational relationships are regarded as a unity of opposites, and in which managers are confronted with contradictory values that compete with each other (Das and Teng, 2000; Van de Ven, 1992). I thus replace either–or conceptions of interorganizational governance with both–and constructions, and I explicitly recognize the tensions accruing from the simultaneous existence of formalization’s functions and dysfunctions, something that conforms to descriptions of apparent inconsistencies by other authors (see Eisenhardt, 2000; Lewis, 2000; Van de Ven and Poole, 1995). In developing such a perspective, I observe the principles of simultaneity, locality, minimality and generality (Benson, 1977; Vieira da Cunha et al., 2002). This implies (1) that a dialectic perspective on formalization is grounded in the interplay between its functions and dysfunctions; (2) that managers have to cope with the tensions arising from formalization in their daily activities, and that these cannot be completely solved or forestalled by clever organizational design; (3) that extreme levels of formalization are less desirable than intermediate levels (see also Foss et al., 2007; Luo, 2002; Mintzberg, 1994), because they do not oﬀer room for managers to manoeuvre or cope with tensions, or because they create tensions that are hardly amenable to management; and (4) that any prescriptions used for managing tensions have to apply to a large range of situations. Juxtaposing such a perspective alongside the mainstream literature complements ‘traditional’ views on formalization with insights into managerial choice and into the roles that managers assume when structuring their collaborative relationships. It provides the theoretical depth that is needed to fully exemplify the competing forces that are evident in interorganizational relationships (Das and Teng, 2000) and it promises to yield a more comprehensive and integrative picture of interorganizational structuring practices than hitherto available (Das

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Anticipated functions Knowledge of and experience with formalization Firm factors Exchange factors Contextual factors

Duality leading to a trade-off

Anticipated dysfunctions

Actual functions

Level of formalization

Dialectic tensions

Interorganizational performance

Actual dysfunctions

* See Tables 6.1 and 6.2 for the functions and dysfunctions that have been attributed to formalization.

Figure 6.2 A dialectic perspective on formalization in interorganizational relationships* and Teng, 2000; Quinn, 1988). As the conceptual framework depicted in Figure 6.2 shows, I maintain the notion stemming from more ‘traditional’ perspectives on interorganizational governance that ﬁrm, transaction and contextual characteristics aﬀect the need and the ability to formalize. However, I also emphasize that managers need to make trade-oﬀs, as formalization consists of a duality between its functions and dysfunctions, and that they have to cope with or capitalize on the resulting tensions (see De Rond and Bouchikhi, 2004). Concerning trade-oﬀs, I propose that managers do not just balance ‘competition’ with ‘cooperation’, or ‘ﬂexibility’ with ‘control’ (Das and Teng, 2000; De Rond and Bouchikhi, 2004; Volberda, 1998), but I suggest that they poise entire sets of functions and dysfunctions of formalization. The trade-oﬀs that managers make are dependent upon their perceptions of ﬁrm, transaction and contextual characteristics, and on their knowledge of and experience with formalization. These factors inﬂuence the extent to which they are able to anticipate various functions and dysfunctions of formalization, something coinciding with more general arguments in the alliance capabilities literature, indicating that parties which have more experience and that institutionalize their experience may achieve superior performance (Kale et al., 2001). The tradeoﬀs involved do not necessarily have to be made by alliance managers, and they may stem from designed as well as emergent processes (see Ring et al., 2005). Participants at various levels in the alliance make diﬀerent trade-oﬀs, and they anticipate diﬀerent functions and dysfunctions of formalization. The degree of formalization that ensues is therefore likely to be the joint result of trade-oﬀs made by various participants in a relationship,

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bargaining processes and the extent to which alliance managers are willing and able to enforce particular levels of formalization. Formalization may emerge throughout the relationship, but the managers that are held responsible for the performance of the alliance may also impose it on participants. Actual degrees of formalization pertaining to relationships entail functions as well as dysfunctions, including several unanticipated or latent consequences (see Balogun and Johnson, 2004; Blau, 1955; Cardinal et al., 2004; Mintzberg, 1994; Yu et al., 2005). Formalization thus generates contradictory forces that are present simultaneously – beyond the will or power of management – and that have to be recognized and managed (Clegg et al., 2002b; Huxham and Beech, 2003). When managers apply a certain degree of formalization, because it enables them to control their partner, for example, they may simultaneously introduce rigidity in decision making, and increase another party’s inclination to cover itself against all kinds of risks. Similarly, when they use formalization to minimize the negative eﬀects of potential employee turnover, they may concurrently evoke distrust by partners and reduce their willingness to adapt to changes. From a traditional perspective, formalization’s inﬂuence on interorganizational performance is then represented as the net eﬀect of its functions and dysfunctions (Foss et al., 2007; Katz and Kahn, 1966; Luo, 2002; Mintzberg, 1994). A dialectic perspective, however, suggests that managerial eﬀorts may aﬀect the relationship between formalization and performance. As Blau (1955: 13), indicated ‘social action is more constructive and less patient. People attack troublesome conditions, even if they cannot, or will not eliminate the factors that produced them, and without waiting for a negative balance of their consequences’. Congruently, a dialectic perspective on formalization in interorganizational relationships suggests that performance is also inﬂuenced by the accuracy with which managers make trade-oﬀs, and by their abilities to capitalize on the tensions between formalization’s functions and dysfunctions (see also De Rond and Bouchikhi, 2004).

FUNCTIONS AND DYSFUNCTIONS OF FORMALIZATION A dialectic perspective on formalization not only emphasizes the role of managerial choice, but it also stresses the duality inherent in formalization, which involves the coexistence of its functions and dysfunctions. A review of the literature on both the intra- and the interorganizational level discloses that formalization has a variety of functions and dysfunctions (see Tables 6.1 and 6.2), with functions being consequences ‘that change existing conditions in the direction of socially valued objectives’, and

Duality and dialectic tensions

Table 6.1 Functions

155

Functions of formalization References

1. Coordination: formalization as a means to achieve concerted action 1. Division of labour Singh, 1997; March and Simon, 1958 1. Common Grimaldi and Torissi, 2001; Simons, 1995 1. language/communication 1. Signalling device Langley, 1988; Milewicz and Herbig, 1996 1. Fuel interaction processes Mintzberg, 1994; Simons, 1995 2. Control: formalization as a means to restrain or direct behaviour 1. Control of the partner Masten, 1996; Oxley, 1997; Williamson, 1985 1. organization 1. Control of deviation from Delmar and Shane, 2003 1. objectives 1. Control of progress/pace setting Weick, 2001; Simons, 1995 1. Control from a distance Gouldner, 1954 1. Option to forgo control Gouldner, 1954; Langley, 1988 1. Trusting the partner Poppo and Zenger, 2002 3. Legitimacy: formalization as a means to persuade and convince stakeholders 1. Internal legitimacy Meyer and Rowan, 1977; Walsh and Dewar, 1987 1. External legitimacy Dacin et al., 2007; Kale et al., 2001; Sitkin and Bies, 1993 4. Cognition & learning: formalization as a means to make sense 1. Accuracy expectations Cooray and Ratnatunga, 2001; Shenkar and Zeira, 1992 1. Degree of ambiguity Lui and Ngo, 2004; Simonin, 1999; Weick, 1995, 2001 1. Focusing attention Delmar and Shane, 2003; Langley, 1988; Weick, 1995 1. Completeness and consistency Katz and Kahn, 1966; Ketokivi and Catañer, 2004 1. Force people to reflect and think Sampson, 2003; Vlaar et al. 2006; Zollo and Singh, 2004 1. Governability of the relationship Clegg et al., 2002a; Rose and Miller, 1992 1. Anticipation and mind stretching Kale et al., 2001; Kotabe et al., 2003 1. Target for contraction Stinchcombe, 2001; Zollo and Singh, 2004 1. Induce collective learning Avadikyan et al., 2001; Zollo and Singh, 2004 1. Generation of new ideas Langley, 1988; Simons, 1995; Vlaar et al., 2006

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Table 6.2

Dysfunctions of formalization

Dysfunctions

References

1.

Inhibiting Creativity Entrepreneurship Innovation Flexibility Mutual accommodation

Foss et al., 2007 Ireland et al., 2002; Mintzberg, 1994; Volberda, 1998

2.

Reducing Commitment and aspirations Initiatives that fall beyond specifications

Balogun and Johnson, 2004; Gouldner, 1954; Jap and Ganesan, 2000; Hendry, 2002; Katz and Kahn, 1966

3.

Driving out Intrinsic motivation

Fehr and Falk, 2002; Kreps, 1997; Lazzarini et al., 2007

4.

Inducing the risk of Areas of unilateral dependence Hold-up problems

Klein et al., 1978; Lusch and Brown, 1996; Macneil, 1980

5.

Imposing High costs Incompleteness Limited enforceability

Klein et al., 1978; Masten, 1996; Williamson, 1985

6.

Creating the conditions for Data manipulation Organizational strife Short-termism

Marginson and Ogden, 2005; Schweitzer et al., 2004

dysfunctions referring to ‘consequences that interfere with the attainment’ of certain objectives (Blau, 1955: 11). Although the literature is dominated by work on formalization’s coordination and control functions (e.g. Foss and Foss, 2005; Gulati and Singh, 1998; Madhok, 2002), a literature review suggests that it may also enhance legitimacy and facilitate sensemaking. Coordination: Formalization as a Means to Achieve Concerted Action Formalization’s role in ameliorating coordination assumes several forms (March and Simon, 1958). Formalization is associated with the division of labour, and diminishes the interdependence between partners, while helping them to translate complex problems into clear and understandable terms (Singh, 1997). Formalization further entails eﬃcient information processing (Galbraith, 1977) and a common language (Grimaldi and Torrisi, 2001; Simons, 1995), enabling interorganizational participants to

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communicate their goals and permitting them to check on each other’s perceptions. Besides, it is used to signal preferred outcomes and behaviours, thereby bringing partners’ expectations in accordance with each other, and eliminating ineﬃciencies and misunderstandings (Milewicz and Herbig, 1996). Finally, formalization enables coordination by fuelling and punctuating interaction processes (Eccles and Nohria, 1992; Mintzberg, 1994). Control: Formalization as a Means to Restrain or Direct Behaviour The control function of formalization has primarily been emphasized by transaction cost economists (c.f. Masten, 1996; Oxley, 1997; Williamson, 1985) and agency theorists (c.f. Fama and Jensen, 1983; Lassar and Kerr, 1996; Shane, 1996; Prendergast, 1999). These authors contend that relationships are characterized by information asymmetry, conﬂicting interests and ambiguity, so that formalization becomes necessary to circumvent, alleviate or mitigate opportunistic behaviour (Carson et al., 2006; Williamson, 1985). Analogously to controlling partners, formalization enables control from a distance (Gouldner, 1954), control of progress (Simons, 1995; Weick, 2001) and control of deviation from objectives (Delmar and Shane, 2003). Moreover, formalization facilitates control by serving as a bargaining instrument; formal agreements can be given up or they can be used (Gouldner, 1954; Langley, 1988). Finally, formalization facilitates control in the form of trust building. It assists parties in demonstrating their competence and knowledge, and it reduces their uncertainty about the motives of others for engaging in interorganizational relationships (Poppo and Zenger, 2002; Vlaar et al., 2007a). Legitimacy: Formalization as a Means to Persuade and Convince Stakeholders A third function of formalization draws on the concept of legitimacy, stemming from institutional theory (Baum and Rowley, 2002; Dacin et al., 2007; Suchman, 1995). From this perspective, contracts, rules and procedures oﬀer acceptable accounts of interorganizational activities, which enhance the legitimacy of collaborative relationships. They may, for instance, help to establish market legitimacy (showing that the partners have the rights and qualiﬁcations to conduct business in a particular market), relational legitimacy (showing that the organizations are worthy to be a partner), social legitimacy (showing that the organizations conform to societal rules and expectations), investment legitimacy (showing that it is worthwhile to conduct the alliance activity) and alliance legitimacy (showing that it is valid or appropriate to engage in a relationship instead of another governance

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form) (Dacin et al., 2007: 173). Formalization also helps collaborating parties to demonstrate their competence and professionalism, and it oﬀers a legitimate basis for managerial intervention (Langley, 1988; Sitkin and Bies, 1993; Walsh and Dewar, 1987). It thereby increases the resources available for cooperation and augments the survival chances of cooperative endeavours (see Meyer and Rowan, 1977) and it heightens the commitment of both internal participants and external constituents, something which is particularly critical for relationships that are embedded in dynamic and discontinuous business environments (Kale et al., 2001). Collaborating organizations ‘that lack market, relational, social, investment and alliance legitimacy’, however, may be denied access to crucial markets, partners, government funding and support, sources of investment and top management support, and novel opportunities to act as a ﬁrst-mover in alliance formation, ‘thus jeopardizing the potential for competitive advantage’ (Dacin et al., 2007: 182). Cognition and Learning: Formalization as a Means to Make Sense A fourth function of formalization involves cognition and learning. This function refers to formalization’s role in facilitating sensemaking (Ring and Van de Ven, 1989, 1994; Vlaar et al., 2006) and in generating stable and comprehensible expectations and collective structures from which participants in interorganizational relationships can construct their actions (Cooray and Ratnatunga, 2001; Shenkar and Zeira, 1992; Weick and Roberts, 1993). Formalization reduces ambiguity (Adler, 1993; Lui and Ngo, 2004) and thereby fulﬁls basic human needs for stability and role clarity (Marginson and Ogden, 2005; Ring and Van de Ven, 1989). Furthermore, it acts as a binding mechanism and focusing device, holding events together in people’s heads, and providing them with meaning and direction (Langley, 1988; Simons, 1995; Weick, 1995, 2001). Formalization also facilitates sensemaking by increasing the completeness and consistency with which issues are covered, and by reducing the eﬀects of individual biases and errors (Ketokivi and Castañer, 2004; Katz and Kahn, 1966; Mintzberg, 1994). In addition, it forces people to reﬂect and think, resulting in deeper insights about the potential causal factors underlying observed outcomes (Gouldner, 1954; Katz and Kahn, 1966; Vlaar et al., 2006; Zollo and Singh, 2004). This enhances the ‘governability’ of interorganizational relationships (Clegg et al., 2002a; Rose and Miller, 1992). Finally, formalization propels learning processes, including the maintenance of existing knowledge, the improvement of previous know-how, and the creation of completely new knowledge (Avadikyan et al., 2001). It not only acts as a target for contraction (Stinchcombe, 2001; Zollo and Singh, 2004), but also entails mind stretching, possibly resulting in new insights, ideas and strategies (Kale et al., 2001; Kotabe et al., 2003; Vlaar et al., 2006).

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Dysfunctions of Formalization During the last few decades, dysfunctions of formalization have received abundant attention in the literature (see Table 6.2), which possibly results from a shift in perspective on organizational entities from rational to natural and open systems (Scott, 2003) and from researchers’ heightened attendance to issues of trust, social capital, ﬂexibility and relational capabilities. Scientiﬁc inquiries have particularly emphasized formalization’s retarding eﬀect on creativity, innovation and entrepreneurship (Foss et al., 2007) and its role in inhibiting the ﬂexibility that is needed for coping with complex, ambiguous and unstable task environments (Mintzberg, 1994; Nooteboom, 1999; Volberda, 1998). Formalization has also been argued to stiﬂe mutual accommodations (Ireland et al., 2002) and to limit opportunities for mutual adaptation (Nooteboom, 1999). In a similar vein, formal constraints (e.g. contractual constraints) have been advanced to reduce the propensity of participants ‘to create or discover new attributes of productive assets,’ or more generally speaking, new options for value creation (Foss et al., 2007: 7).1 More speciﬁcally, these constraints may reduce the scope for value creation, as they concurrently set the limits to destructive or opportunistic behaviour, but also to more entrepreneurial eﬀorts. Furthermore, it has been found to increase the extent to which conﬂicts arise and reduce partners’ commitment to relationships (Jap and Ganesan, 2000). In addition, formalization is known to entail the risk of reducing performance and aspirations to minimum standards (Gouldner, 1954; Katz and Kahn, 1966) and to limit the scope for initiatives beyond those speciﬁed in agreements (Hendry, 2002). Balogun and Johnson (2004: 532), for example, found that the introduction of contracts in cooperative endeavours sometimes made things worse, ‘with individuals only doing exactly what was speciﬁed and nothing else’. Formalization may then gradually degenerate into formalism (Mintzberg, 1994; Scott, 2003). Moreover, in case formalization incorporates extrinsic incentives, this may lead to reduced intrinsic motivation experienced by the cooperating parties (Fehr and Falk, 2002; Kreps, 1997; Lazzarini et al., 2007). In addition, formalization entails the risk that areas of unilateral dependence (Lusch and Brown, 1996; Macneil, 1980) and hold-up problems arise (Klein et al., 1978). On top of that, formalization’s eﬃcacy may be questioned when the costs of composing formalities, their necessary incompleteness (Bernheim and Whinston, 1998; Williamson, 1985) and the limited opportunities for enforcement are taken into account (Luo, 2007; Masten, 1996; Stinchcome, 2001). Finally, the advantageousness of formalization may be diminished by issues such as short-termism, interdepartmental and interorganizational strife, and data manipulation

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(Marginson and Ogden, 2005). Goals set in formal documents, for example, sometimes give rise to unethical behaviour, including overstatement and false claiming of accomplishments (Schweitzer et al., 2004). Part of the functions and dysfunctions of formalization described here may only surface over time, because contracts, rules and procedures assume the character of an interorganizational memory (De Boer et al., 1999; Mayer and Argyres, 2004). Formalization can enable coordination in later stages of cooperation, for example, by reducing relationships’ vulnerability to fallible memories and to the turnover of personnel (De Rond, 2003). It may also facilitate learning in other relationships, as formal documents are transferred relatively easily to novel relationships (Argyres et al., 2007; Kale et al., 2001).

ILLUSTRATIVE CASE STUDY OF THE STEADY–QUICK ALLIANCE The case study exempliﬁes how the dialectic perspective on formalization that is central to this chapter complements more traditional, deterministic perspectives on this phenomenon. It concerns an interorganizational relationship between a large global retailer, STEADY, and a Europe-based ﬁnancial services ﬁrm, QUICK. This case has been selected for three reasons. First, the size of both parent ﬁrms in terms of employees and turnover was large, which increased the likelihood that formalization would be an issue in the alliance (Zeﬀane, 1989). Second, both companies oﬀered unique access to the enormous amount of documentation that was produced during the relationship, and to their employees, allowing me to explore a signiﬁcant phenomenon under rare circumstances (see Eisenhardt and Graebner, 2007: 27). Finally, the alliance required innovative activities. Coupled with the potentially high demands for formalization, arising from ﬁrm sizes, and the legitimacy, accountability and control required for ﬁnancial services (Vermeulen, 2001), this increased the likelihood that tensions would arise from the coexistence of formalization’s functions and dysfunctions. As such, it permits me to illustrate clearly the gaps in existing theory, rendering it a very powerful example (see Siggelkow, 2007). Data Collection The most important data collection characteristics are captured in Textbox 6.1. I conducted 22 semi-structured interviews between June 2002 and July 2004. Before doing so, an interview guideline was developed, which outlined the issues that were to be explored and which served as a

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checklist during the interviews (McCracken, 1988). The majority of the interviews took place with participants from STEADY, as this ﬁrm employed the lion’s share of the 90 people working for the relationship. All but one of the interviews were tape-recorded and subsequently transcribed verbatim, resulting in 458 pages of interview text. Transcribed interviews were coded in QSR NUD*IST Vivo (see Bazeley and Richards, 2000).

TEXTBOX 6.1

●

●

●

OVERVIEW OF KEY CHARACTERISTICS DATA COLLECTION

Twenty-two semi-structured interviews held between June 2002 and July 2004. All interviews were tape-recorded and transcribed ad verbatim, resulting in 458 pages of interview text. Interviewees included: – Alliance manager (QUICK) – Commissioner on the business side, who later became the manager of the alliance (STEADY) – Two project leaders for central IT applications (STEADY) – General project leader for IT (STEADY) – Project leader for the IT infrastructure (STEADY) – Project leader for the shops (STEADY) – Project leader for the administrative organization (STEADY) – Analyst of customer relationships (STEADY) – Two process and system analysts (QUICK) – Two service-level managers (QUICK and STEADY) – Director shop-systems (STEADY) – In-company legal advisor (STEADY) – System maintenance manager (STEADY) – Customer service manager (QUICK) More than 700 documents were analysed using QSR NUD*IST Vivo, including formal requests and change requests (13), evaluation reports (9), spreadsheet files (74), memos and notes (8), minutes of alliance meetings (178), different versions of service-level agreements (18), conceptual-, functional-, technical-, and test-designs (318), presentations (19), progress reports (24), interview transcripts (22) and others (82).

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During the data collection, descriptive and interpretive validity were secured through tape-recording the interviews, producing verbatim transcriptions and performing accuracy checks with respondents. The reported ﬁndings were reviewed and discussed during a workshop and in individual feedback meetings. Beyond interviews, extensive archival data were collected, including 743 documents containing service-level agreements, project handbooks, reports, memos, letters, web pages, annual reports, agendas, status reports and minutes from alliance meetings. These additional sources of information facilitated the triangulation of evidence (Eisenhardt, 1989b; Strauss and Corbin, 1998; Yin, 1994). In analysing the data, I started with factual or descriptive coding (see Strauss and Corbin, 1998) in order to categorize text fragments in the interview transcripts and documents along the functions and dysfunctions of formalization that I distinguished in Tables 6.1 and 6.2. Text fragments pointing at trade-oﬀs made by participants in the relationship were categorized as ‘trade-oﬀs’, whereas indications of alliance managers’ attempts to cope with tensions between formalization’s functions and dysfunctions were accumulated under the category ‘tension management’. Text fragments hinting at the performance of the relationship were coded under the category ‘interorganizational performance’. Subsequently, I used axial coding procedures (see Strauss and Corbin, 1998) to relate diﬀerent categories and subcategories to each other. I then developed a case narrative, in which I present interview fragments from various categories to illustrate the research framework. Note that, although sometimes seen as ‘subjective’, the case study method becomes surprisingly ‘objective’ here, because of its close adherence to the data (Eisenhardt and Graebner, 2007: 25). General Introduction to the Case Study The objective of the alliance between STEADY and QUICK was to deliver ﬁnancial services in a retail environment, which could radically change the ﬁnancial services landscape in the country in which the relationship was initiated. Potential services related to the provision of savings accounts and insurance packages. Complementarity between the partners’ resources seemed high, with STEADY having a retail channel and a huge customer base, and QUICK possessing a banking licence, a back-oﬃce infrastructure and legitimacy as a provider of ﬁnancial services. Negotiations on the alliance began in March 1999. The ﬁrst round, which led to a contract frame, took around six months. Drafting the ﬁnal contract absorbed almost a year. Although the presence of lawyers sometimes led to polarization, negotiations were generally constructive. Parallel to the negotiations, a business case and an interorganizational

163

Duality and dialectic tensions Reference group QUICK & STEADY Alliance managers QUICK & STEADY

Project manager QUICK

Marketing STEADY

Retail systems group STEADY

Information technology STEADY

Main office systems group STEADY

Legal/administrative audits STEADY

Central systems group STEADY

Work group QUICK

IT auditing group STEADY

Figure 6.3 Interorganizational structure of the QUICK–STEADY alliance

structure were being developed by a group of eight people, four from each ﬁrm. The structure designed for the alliance is depicted in Figure 6.3. As can be seen, the alliance was supervised by a reference group, while its daily management was in the hands of the alliance managers of both ﬁrms. Operational activities at STEADY, which primarily pertained to information technology and marketing, were subdivided over six workgroups. As QUICK needed to perform fewer activities, these were concentrated in one workgroup. Communication and coordination frequently assumed the form of formal documentation and weekly meetings with all project managers guaranteed mutual adjustment. The alliance managers, service-level managers and several other key stakeholders met each other at least four times a year in pre-scheduled meetings, whereas most other participants had bilateral contacts with their counterparts in the other ﬁrm at least once every week. At the beginning of 2001, the ﬁrst ﬁnancial services were distributed through STEADY’s shops. After one month, the alliance served almost 100 000 customers. At the beginning of 2003, this number had nearly tripled, leading STEADY’s alliance manager to state that the alliance represented ‘the most successful introduction of a new ﬁnancial service in the last 10 years’ (interview with alliance manager STEADY, 4 June 2002). As can be seen from Textbox 6.2, most other participants also evaluated the relationship’s performance positively. Following this general introduction to

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the case study, I now illustrate how a dialectic perspective on formalization in interorganizational relationships, as it was described in the framework that I presented earlier, complements more traditional, deterministic perspectives.

TEXTBOX 6.2

EXEMPLARY COMMENTS ON THE ALLIANCE’S PERFORMANCE

Efficiency & management project: ‘STEADY and QUICK are both very cost-conscious companies. So if you see how the project is put up [. . .]. The way in which we have knocked together this infrastructure is simply magnificent [. . .]. Other companies [. . .] would have spend an amount of money that is probably tenfold as high.’ / ‘In terms of project management the final result can be called a success, because it suffices the demanded functionality and specifications. We have produced what was requested.’ End result: ‘It is very positive that a system has been developed that is reasonably bug-proof. In other words, that everything has been gone through in a structured way and that with respect to ITissues no or hardly any problems came up at STEADY.’ / ‘It resulted in a very stable, robust, reliable environment, that does what it should do. I am quite happy about that. And you also see that when considering disturbances.’ / ‘This product can not be copied. If you take a bag of potatoes, and you make a good price, it is easily copied by a competitor. This is much more difficult to copy.’ / ‘What also makes it interesting is that sequel products could be introduced in a short period of time, that enable you to create additional turnover and margin on few square meters.’ Image & customer loyalty: ‘A lot has been written about it, and it has raised a lot of dust. I think that has contributed to STEADY’s image of renewal. It has shown once again that it is an innovative company that can create an innovative product within a short period of time.’ / ‘Of course it also fits within the strategy of onestop-shopping, in which you provide a total package and the client does not need to go to other firms. The client does everything in one hand. He can save, shop, and withdraw money. On the basis of that strategy it fits perfectly well.’ Productivity: ‘A positive point is that we now have the possibility to enhance the efficiency of processes related to the loyalty pro-

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gramme of STEADY. They become cheaper, and faster.’ / ‘With the current means that we have at the cash register, it means that we encounter some productivity losses.’ ‘I expect that the alliance has reduced the efficiency of the operation in the shops. I have to say that as a consumer I also think each time “ah, shit”.’ Expectations not entirely met: ‘The market is more difficult. Interest rates have come down to a level at which saving is not regarded to be attractive. Our competitive position has become worse, because of the high interest rates of our competitors. But they sacrifice profits. That influences the flow of new customers.’ Experience spin-off: ‘The knowledge and experience that we have built up to do this enable us to do similar projects faster and cheaper in future [. . .]. I think we have learned a lot from this alliance. For example, that you need to improve communication, put things down in writing, and come to agreements before you start. That is what we have learned from it and what we now do in another project.’ Data-encryption spin-off: ‘The knowledge that has been built up with respect to data encryption is now possibly deployed again. We are working on a new project in which that also plays a role.’ Calibration of business cases spin-off: ‘We have acknowledged that there are a couple of things which require more attention and better organization. Calibration of business cases for instance. . . I am convinced that if the alliance would not have taken place, other projects might have been started that were doomed to fail. So that is a spin-off of not-effectuated investments or costs that would not lead to successes.’ Processing spin-off: ‘In the framework of the alliance, the monitoring of the processes in the nightly hours has become much more extensive than we were used to within QUICK. And, as soon as you are monitoring, you do not only do that for the alliance, but you can also signal when something goes wrong within QUICK. So the monitoring of the systems has also improved for QUICK’s transactions.’ Documentation spin-off: ‘That document-database is also being used within a new project. So that is an advantage for other projects in similar joint ventures or extensions of such ventures.We were very busy with standardizing the documentation and there were no templates available at that time that fulfilled our new demands.’

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Interorganizational structure spin-off: ‘We will get more and more environments in which we have decoupling points and in which we have to work together with partners in a rather intensive way. I see that happening in the shops and we have started to develop a reasonable structure for that. And that means that manoeuvring becomes easier. At this point in time, we communicate with parking systems, sales machines, loyalty-organizations, QUICK, online loyalty-servers, delivery services. . . . You develop a very organic environment in which external partners can be connected easily.’

From Organization, Exchange and Contextual Characteristics to Trade-oﬀs The interviewees referred to a large number of ﬁrm, transaction and contextual characteristics that collectively invoked a relatively high need for formalization. They pointed to, among other things, the internal organization of STEADY, which already worked according to formal rules and procedures, the complexity of the alliance and the institutional context (e.g. Central Bank and regulatory bodies), which demanded legitimate accounts of the activities undertaken in the alliance. Nonetheless, the alliance managers of both ﬁrms indicated that the trade-oﬀs that they made were based on a small subset of the functions and dysfunctions that were later attributed to formalization by themselves and other interviewees. They primarily decided to sacriﬁce creativity and ﬂexibility for a high rate of development, and for certainty about the rigour and consistency with which work would be carried out in the alliance, and expressed this as follows: Formalization removes creativity and ﬂexibility from a project. That is the downside. The upside is that it guaranteed that the things that we developed worked nearly faultlessly. (Interview with alliance manager QUICK, 28 January 2003) I think that to make sure a project proceeds at a certain pace, one has to be clear about the desired outcomes . . . We had to formulate what we wanted and what the result should look like. On the one hand, that infused speed in the project and simpliﬁed decision making to a large extent. On the other hand, it increased the risk that was taken by us as commissioners, because if things went wrong, it would clearly be our problem. (Interview with alliance manager STEADY, 6 January 2003)

Degree of Formalization During the alliance, both partners worked along formal lines and a standard methodology. They developed multiple business cases, conceptual designs,

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impact analyses, functional designs and technical designs. Documentation from prior stages served as a basis for subsequent phases, and the alliance’s management continuously monitored compatibility of documents. It is hard to assess to what extent formalization was due to managerial intentionality and to what extent it reﬂected the context of the alliance, as both are intricately related. The fact that formalization was relatively high and that this had its origins in ﬁrm, transaction and contextual characteristics as well as managerial choice, becomes obvious from comments issued by a CRM analyst and by STEADY’s alliance manager: They [formal procedures] are handled strictly. A functional design needs to be signed by everybody. And, even if somebody comes with a dodge or a trick that requires adaptation, then these things need to be changed very formally, via change requests. (Interview with CRM analyst, 18 November 2002) Of course it started rather vaguely, but it entered a funnel and became more and more formalized and structured. (Interview with alliance manager STEADY, 5 August 2002) This formal approach has been partly instigated by the IT organization. They said: this is how we want it. This is the best way to work for us, especially as this will become a complex project. (Interview with alliance manager STEADY, 5 August 2002)

Participants from QUICK were not used to acting in such a formal way, but their experience with STEADY’s approach, combined with the intention to transform QUICK into a customer-oriented organization, gradually led them to adopt a more formal working style. This hints at the coevolution of partner ﬁrms and interorganizational relationships (Das and Teng, 2002; Koza and Lewin, 1998; Lewin and Volberda, 1999; Volberda and Lewin, 2003), something receiving support from participants of QUICK: Because I came from QUICK, I was working very ad hoc myself and I paid little attention to recording things; just the things that I thought were really important. Because of the alliance, I have started to record and describe everything. If anything is added, an instruction is made for it, or an education plan is being developed . . . I have adopted a lot of the working practices of STEADY. (Interview with customer service manager, 3 December 2002) And it has led to a little more formalization of things. Nowadays, we have agreed on certain procedures, with which people have to comply. You see that the organization is maturing. The realization that that was necessary has arisen during the alliance. STEADY has been the trigger for that. (Interview with process and systems analyst, 12 December 2002)

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Functions of Formalization Other participants in the alliance emphasized diﬀerent functions and dysfunctions of formalization than those included in the trade-oﬀs made by the alliance managers. Following Tables 6.1 and 6.2, each of these will be discussed brieﬂy. Formalization’s coordination function became apparent from the fact that formal documents accompanied the division of labour between diﬀerent workgroups in the relationship, serving as input for socialization between them. A comment from the project leader for central IT applications is illustrative: After you have made a functional design, it is sent to both the builders and the testers. The testers then deﬁne their test cases, while the builders are building the applications at the same time. (Interview with project leader central applications, 21 November 2002)

Related to this, the formal structure adopted in the alliance reduced the complexity that was perceived by participants in the relationship, as these needed to ‘solve’ smaller parts of the ‘problems’ that had to be tackled. This became evident from the response of a project leader when he was asked whether he regarded the alliance to be complex or not: Complex? No, not really. Because the structure was well devised, it actually was not as complex as it seemed. The structure was really good. (Interview with project leader infrastructures, 15 November 2002)

Formalization’s control function appeared in the form of monitoring progress and preventing frequent stretching of the scope of the alliance. This became obvious from a remark by QUICK’s service-level manager: One has to prevent looking backwards by making a list of decisions made. One has to look forward by means of an action list. If you keep those sharp, things proceed. (Interview with service-level manager, 8 November 2002)

At the same time, the project leader for retail systems indicated that a higher level of formalization by QUICK at the beginning of the relationship would have increased STEADY’s trust in its partner: The status [progress] was verbally communicated, but was not supported by documents that were put on the table, from which it became evident that that was really the status. That would have helped. There would have been less distrust then. It was easy to say: we are now at this stage, and in two weeks, things are ﬁnished. (Interview with project leader retail systems, 15 December 2002)

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Formalization functioned as a means to increase the internal and external legitimacy of the relationship as well. Within the alliance, the mere existence of formalities legitimized rule observation, whereas detailed documentation helped in legitimizing the relationship towards governmental bodies, as is indicated by a comment of STEADY’s service-level manager: I suspect that the detailed documentation has helped to win institution X over. We said ‘Listen, have a look at how precisely we deal with these things.’ I think that has helped. (Interview with service-level manager STEADY, 11 November 2002)

Concerning cognition and learning, formalization enabled partners to set expectations, and to clarify implicit assumptions. It laid bare potential conﬂicts and tempered extreme conﬁdence in the alliance (see also Sampson, 2003), as is illustrated by comments from a project leader and an in-company legal counsellor: At the moment you make your plan, you try to limit uncertainties. You describe the things that you do not know for certain, possibly with alternative directions for solutions . . . If you do not do that, you can be certain that the ﬁnal product will not become what everybody expects. (Interview with project leader central applications, 21 November 2002) Just put it on the table and discuss it. Then you avoid many problems in the future. By putting it on paper, you pave the way for good cooperation. It enables you to estimate what issues you will be confronted with, and how these need to be resolved. Furthermore, it makes clear what you expect from each other. I think many people do not realize that. (Interview with in-company legal advisor, 30 January 2003)

Moreover, remarks by one of STEADY’s project leaders and its alliance manager hinted at the supportive role of formalization in enabling contraction, and in making sure that speciﬁcations were complete, accurate and consistent: Many documents have been produced here, which have led us to state ‘that should be included for subsequent projects!’ (Interview with project-leader infrastructure, 15 November 2002) The good side is that they [formal documents and procedures] kept us sharp with respect to the accuracy and completeness of the speciﬁcations. (Interview with alliance manager STEADY, 6 February 2004)

Besides, formal processes fuelled the interaction between participants in the relationship. According to the project leader of the administrative

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organization, formalities functioned as simultaneously enabling and constraining structures, which triggered debate among participants in the relationship. During the process, it worked as a red line from one meeting to another meeting; to measure progress, to provide a kind of glue, and to communicate to others. In my opinion, it is just for the process: keeping everybody on one line. Also to inform people and to record what should happen. (Interview with project leader administrative organization, 21 November 2002)

Finally, formalization had several positive consequences in the long run. It functioned, among others, as a memory device, reducing the vulnerability of the alliance to personnel turnover and fallible memories: My experience is that if you do not produce action lists, lots of things disappear. Because (a) persons forget things, and (b) after a week you might remember that you need to do something, but you possibly have a diﬀerent interpretation of the task than at the moment at which the issue originated. (Interview with servicelevel manager QUICK, 8 November 2002) The documentation warrants knowledge preservation, which is electronically accessible and on which people can build in a following project. Because people leave . . . you name it . . . Those are not stable factors. (Interview with servicelevel manager STEADY, 11 November 2002)

Dysfunctions of Formalization Respondents also pointed at several dysfunctions of formalization. First, employees from STEADY used formalization to cover themselves against all kinds of risks. This resulted in stiﬀened and rigid relations between its IT departments and its business department, as becomes apparent from quotes of STEADY’s business commissioner and one of QUICK’s process and systems analysts: Employees from STEADY keep their own alley clean. They are very precise. That becomes obvious when one considers the fact that they record everything in the minutes. One can also read between the lines in the progress-reports. They put problems aside, on the plates of others. Moreover, they connect problems to choices that have been made by others . . . They also have a standard list with the risks of the project, from which you can percolate exactly how they try to cover themselves. (Interview with alliance manager STEADY, 6 January 2003) When there was a hitch in the cable, people at STEADY sometimes tried to keep their own alley clean . . . At QUICK we say, some things go wrong and you have to solve them, but that can happen. I had the impression that they thought, they

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cut our heads oﬀ, if something goes wrong. I have to make sure that it is not my fault. (Interview with process and systems analyst, 12 December 2002)

Another negative consequence of formalization consisted of the administrative burden it brought along and the time it consumed. Eventually, this almost turned formalization from a means towards an end in itself. Comments from the general IT project manager and the CRM manager are illustrative: The vision is lacking with respect to why something is formalized. It has to be done like this because somebody says that it should be done like this. (Interview with general IT manager, 6 January 2003) One saw tension at STEADY, where behaviour was very formal. They did not give any space to think about something when it had been previously deﬁned. Exaggerating it a bit, it was as follows: Why do you do it like this? We do it like this, because it is like this on paper. Not because it is best, but because it is written on paper. So, we do it like this. (Interview with CRM analyst, 18 November 2002)

Coping with Tensions The alliance managers attempted to prevent and cope with the tensions arising from the coexistence of formalization’s functions and dysfunctions in three ways (see Figure 6.4). First, they developed a kind of semistructure (Brown and Eisenhardt, 1997), in which some features were prescribed or determined, but others were not. Meyer and Rowan (1977) provide an example of such a semi-structure, indicating that hospitals and schools have highly speciﬁc and rigid rules of administration, while the professionals working in them may have a high degree of freedom in how they approach their work. Analogously, syndicates in the venture capital industry adopt investment agreements that enshrine the rights and obligations of participants, but hardly specify behaviour (Wright and Lockett, 2003). Such an approach provides people with arenas for action, while it leaves the speciﬁc means to achieve outcomes open, enabling an improvised and energized ﬂow of activities (Dougherty and Takacs, 2004). This approach was also evident in the alliance, where objectives, goals and expected outcomes were codiﬁed and enforced strictly, whereas employees were granted considerable latitude in how to accomplish these. STEADY’s alliance manager explained why they adopted such a semi-structure: The role that one chooses as a commissioner is either having them do their work as they wish it themselves, with their own control and consultation structures, and planning cycles. In that case, you only provide input as to what you want

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Functions

Formalization

Tensions

Performance

Dysfunctions

1. Emphasize the different needs of both organizations 2. Refer to factors that appear to be ‘beyond the control’ of alliance mangers 3. Circumvent formalization of outcomes and behaviour at the same time

Figure 6.4

Three ways of coping with tensions arising from formalization

them to realize [outcome formalization]. Alternatively, you also act as a kind of project manager, prescribing how they have to work [process formalization]. We have not done the latter, because you will not succeed in doing this with two persons. So we had them use their own working and planning methods, while providing them with input, telling them what we wanted the output to look like . . . If you provide them with limited freedom concerning what they should do, then you should not also interfere with how they do that, with how they should structure that process. That will take away all the fun they have in managing such a project. (Interview with alliance manager STEADY, 6 January 2003)

This ﬁnding conﬂicts with assertions of Koza and Lewin (1998: 260) that, ‘ceteris paribus, the greater the exploration intent of an alliance, the greater the reliance on behaviour and process controls’. As contingencies are hard to identify in advance and because this type of relationship requires mutual adaptation, behavioural control is inappropriate (Carson et al., 2006; Madhok and Tallman, 1998). It takes away the ability of individuals to exercise their judgment (Goold and Quinn, 1990), reduces their motivation, and results in boredom, alienation, job dissatisfaction and diminished output (Nygaard and Dahlstrom, 2002). Second, the alliance managers tried to cope with the tensions between formalization’s functions and dysfunctions by referring to factors that were beyond their control, such as demands imposed by their own supervisors or regulatory institutions, and the enormous impact that ‘mistakes’ would

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have on the reputation and image of both organizations. They thus attempted to persuade and convince others to work along formal lines by accentuating the external constraints imposed on the alliance, instead of underlining their own preferences for little interference of pressure groups, or their desire to have everyone work according to their own plans. This result is congruent with work from Shaw et al. (2003) and Sitkin and Bies (1993). The following comments hint in this direction: Before any money is spent, the board wants to know in broad lines what the plan is and what the ﬁnancial consequences are. Ideally, they also want to be able to shoot three out of four plans. (Interview with alliance manager STEADY, 6 January 2003) We have a stick behind the door, because we are a bank now. So, many things cannot be discussed anymore, but simply have to happen. (Interview with alliance manager STEADY, 6 January 2003) Everyone realized that nothing should go wrong. We could not aﬀord to lose money that was put in a savings account . . . That has to happen once or twice and you are on the front page of a national newspaper and you have a serious problem. (Interview with alliance manager QUICK, 28 January 2003)

Under the guise of demands from supervisory boards, reference groups and external institutions, and by adducing the magnitude of image risks, the alliance managers were able to maintain high levels of formalization and forestall the development of insurmountable tensions at the same time. This ﬁnding complements results from earlier studies on justiﬁcation and persuasion as inﬂuence tactics adopted in mergers (Steensma and Van Milligen, 2003) and during the implementation of auditing systems (Walgenbach, 2001). Finally, they used diﬀerences in the degree of formalization to which both organizations were accustomed to propagate speed in certain areas and stages of collaboration, and to enhance control in others. Although dissimilar levels of formalization at parent organizations are generally believed to hamper cooperation (Lane and Lubatkin, 1998), the opposite occurred in this alliance. When QUICK was not working thoroughly and accurately enough, STEADY’s performance standards and codiﬁcation requirements were emphasized. In situations in which participants from STEADY were moving too slowly, they were confronted with the fact that their progress was far behind that of QUICK, as expressed by one of the alliance managers. I think that the dissimilarity between the two ﬁrms eventually ensured that the project became a success. They were used to a completely diﬀerent way of

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working. There was much more entrepreneurial spirit in the blood of participants from QUICK compared to those from STEADY. Persons from STEADY, instead, had a much stronger instigation to have everything documented, reported and crystallized out up to the ﬁnal detail, compared to participants from QUICK. And this is what happened . . . We sometimes have, consciously or unconsciously, played these characteristics of the two parties oﬀ against each other. I certainly did it myself, as I had to take care of QUICK living up to its promises. I regularly went to people from QUICK to say: ‘Guys, it’s all okay what you are doing, but I want to have it on paper, because I cannot go to STEADY with this piece of paper. If you do that here, that is all right with me, but this is an external party, so the standard needs to be raise.’ If we needed something done, we could use QUICK to convey strength and speed towards STEADY, whereas STEADY was more of a controlling and auditing master. (Interview with alliance manager QUICK, 28 January 2003)

Managerial action thus reduced the likelihood that vicious circles were formed, in which either the functions or dysfunctions of formalization received exacerbating attention (see also Volberda, 1998). By recognizing the dangers inherent in taking extreme positions on the formalization continuum, and by proliﬁcally capitalizing on the tensions at intermediary positions, the alliance managers tried to amplify interorganizational performance.

DISCUSSION The case study, which has been analysed along the framework presented in Figure 6.2, exempliﬁes that a dialectic perspective on formalization oﬀers a valuable complement to the mainstream literature. It shows that formalization entails a duality, which requires managers to make trade-oﬀs and manage dialectic tensions. In the case study, managers attempted to deal with this duality by (1) applying semi-structures in which either outcomes or behaviour are formalized; (2) justifying particular levels of formalization by referring to factors that appear to be beyond their control; and (3) alternating their emphasis on diﬀerent formalization requirements by each of the partner ﬁrms. The persuasiveness of this argument would be greatly strengthened if serious attention was given to alternative explanations (Siggelkow, 2007), which is what I will do next. Although one could argue that my conclusions may have been driven by retrospective sensemaking and by the attribution of success to managerial action instead of external events (e.g. see Eisenhardt and Graebner, 2007; Weick, 1995), for example, several factors reduce the likelihood that this was actually the case. First, in the interview transcripts, I found several comments that clearly suggested that

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managerial intentionality played a signiﬁcant role with respect to formalization in the alliance. One of the alliance managers, for example, mentioned that ‘it was the conviction of the director of STEADY that the company should pursue innovative projects in a more systematic and formal way, as the lack of a professional approach in similar projects had led to failure before’ (interview with alliance manager STEADY, 8 August 2002). Second, I also found support that is more ‘objective’ for some of the means that were used by the alliance managers to suppress potential tensions. Regarding their frequent referrals to requirements set by external institutions, for example, I observed the following. Minutes of a general alliance meeting on 3 September 1999 already mentioned that ‘the Central Bank approved the concept-design for the alliance’, and that the report that was conferred to and approved of by the Central Bank ‘would function as a basis for the relationship’. This suggests that there was no reason to stress the demands of the Central Bank during the remainder of the relationship to a greater extent than the points of attention reﬂected in this report. Nonetheless, more than 70 per cent of the interviewees advanced the requirements of regulating bodies and the Central Bank as an important motive for formalization. In this respect, the alliance manager of QUICK stated that he may have ‘frightened the participants in the alliance too much in the beginning. Particularly due to the fact that the Central Bank consisted of unknown territory for most participants in the alliance, they may have thought that it was better to raise the degree of formalization instead of reducing it’ (interview with alliance manager QUICK, 28 January 2003). Third, some of the interviewees of STEADY experienced considerable problems with the alliance managers, which reduced the likelihood that they would incorrectly attribute success to their actions. Nonetheless, these interviewees still credited the alliance managers for the structure and the degree of formalization that was adopted in the relationship, and for the way in which they coped with the resulting tensions. The general IT manager, for example, indicated that a misunderstanding between him and the alliance managers ‘escalated in such a way that they had to defend each other’s viewpoints in front of the direction of STEADY’. At the same time, this manager praised the ability of the alliance managers to ‘set expectations’ and to ‘keep the alliance going when problems arose’ (interview with overall IT manager, 6 January 2003). Theoretical and Practical Implications This research has several signiﬁcant implications for research on formalization in interorganizational relationships. First, it suggests that

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formalization can no longer be depicted as being solely determined by ﬁrm, transaction and contextual characteristics. It also appears to be contingent on the extent to which managers anticipate the functions and dysfunctions of formalization, and on the appropriateness of the trade-oﬀs that they make. The case study shows that these trade-oﬀs may be preceded by limited considerations of the entire array of functions and dysfunctions of formalization that may eventually occur in such relationships. In this case, the alliance managers particularly made little reference to (sub-)functions of formalization that seem harder to anticipate, such as ‘forcing people to reﬂect and think’, and those factors that may aﬀect performance in more remote futures, such as ‘the use of formal documents as an interorganizational memory’. This may be the result of bounded rationality and limited foresight, but it may also derive from a lack of knowledge of and experience with formalization, or from the organizational position of alliance managers. Trade-oﬀs can be biased, for example, towards managers’ own, immediate needs. Furthermore, the case study illustrates that alliance managers may not only be preoccupied with making the ‘right’ governance choices, but also, and perhaps primarily, with the trade-oﬀs and tensions that respectively precede and follow them. This underscores the signiﬁcance of the managerial action involved with structuring choices, and it suggests that the relationship between formalization and performance, as it is frequently proposed in the literature, in the form of an inverted U-shape (e.g. Luo, 2002), is probably aﬀected by managers’ abilities to cope with dialectic tensions. A second theoretical implication concerns the functions that can be attributed to formalization (see Table 6.1), which are more diverse than generally acknowledged in the literature. More speciﬁcally, I propose that theoretical explanations for observed levels of formalization should not only focus on its ‘coordination’ and ‘control’ functions (e.g. Foss and Foss, 2005; Gulati and Singh, 1998; Madhok, 2002), but also on its relationships with ‘legitimacy’ and ‘cognition and learning’ (see Vlaar et al., 2006). These functions may help to explain why, despite a changing and probably more turbulent environment, formalization is still endemic in modern business (Hatch, 1999). Moreover, their coexistence suggests that monocausal explanations for interorganizational structuring eﬀorts based on single theoretical lenses are likely to be inappropriate (Adler, 1993; Klein Woolthuis et al., 2005). The managerial implications of this study concern managers’ awareness and understanding of the numerous functions and dysfunctions through which formalization inﬂuences interorganizational performance (see Tables 6.1 and 6.2) and their inclination to apply a dialectic management style. This chapter shows that managers can ameliorate interorganizational performance by

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simultaneously holding and exploring opposing views (Eisenhardt, 2000) and by capitalizing on the tensions emanating from interorganizational governance solutions. Limitations and Future Research I have depicted formalization as being the result of trade-oﬀs by alliance managers and other participants in interorganizational relationships, and I have suggested that formalization may be an emergent process, or a requirement imposed by higher management (see Ring et al., 2005). This indicates a need for research on the extent to which the degree of formalization applied in interorganizational relationships is aﬀected by organizational positions and bargaining processes between stakeholders. In addition, I illustrated the relevance of a more managerial perspective on formalization in interorganizational relationships with only one case study, which restricts the external validity of the study. The data do not permit me to assess to what degree formalization and its relationship with interorganizational performance are inﬂuenced by managerial choice. I therefore encourage researchers to combine questionnaire and interview techniques to study traditional and dialectic perspectives side-by-side. Finally, as the consequences of (not) instituting formalities may diﬀer for various stages of cooperation (Cardinal et al., 2004), future research needs to address the timing of formalization, and potential variations in emphasis on diﬀerent functions during the evolution of alliances. I started this chapter by asking how our view on the role of formalization in interorganizational relationships would change if more attention were paid to managerial choice. To address this question, I complemented traditional, relatively deterministic perspectives on formalization with a view in which dualities, trade-oﬀs and dialectic tensions occupy a more central position. The coexistence of formalization’s functions and dysfunctions, it was argued, entail trade-oﬀs and dialectic tensions. I illustrated such a dialectic perspective on formalization with a case study of a cross-industrial strategic alliance, and I exempliﬁed how managers of interorganizational relationships may diminish the tensions stemming from formalization or convert them into productive forces. By doing so, I have shown that a dialectic perspective on formalization in interorganizational relationships oﬀers a promising complement to the mainstream literature on this topic. In particular, I have elucidated that researchers and managers should be preoccupied, not only with the ‘rightness’ of governance structures, but also, and perhaps primarily, with the trade-oﬀs and dialectic tensions associated with them.

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NOTE 1. Foss et al. (2007: 12) put forward that ‘the notion that contractual constraints deﬁne the scope of entrepreneurship, rather than simply allowing agents to choose the values of particular variables with known distributions, is an inherently dynamic, forward-looking concept of organizational design’.

7.

Contract standardization

Social psychology is replete with theories that take for granted the ‘fact’ that people think [. . .]. They all start with the assumption that people attend to their world and derive behavioural strategies based on current information. (Langer et al., 1978: 635) Mindlessness often overshadows human thought when it comes to actual decision making. (Sharps and Martin, 2002: 272)

INTRODUCTION The application of standard contracts and standard procedures for negotiating and contracting is omnipresent in interorganizational transactions. However, only a few studies on interorganizational governance actually consider how standardization inﬂuences interorganizational relationships. In this chapter, I present an overview of the beneﬁts and drawbacks of contract standardization. A review of the literature indicates that standardization enables an eﬃcient and expeditious eﬀectuation of transactions. Moreover, standard contracts are considered relatively legitimate, robust and easy to interpret compared to tailor-made contracts. However, they also tend to be very generic or non-speciﬁc. Probably even more signiﬁcant, the application of standard contracts is frequently preceded by negotiation and contracting procedures that hardly contribute to the creation of shared expectations. Standardization is therefore argued to prohibit the ‘meeting of minds’ and to encourage ‘mindlessness’ during negotiation and contracting practices. This assertion is empirically assessed by analysing contracting practices in a large sample of buyer–supplier relationships. Structural equation modelling seems to indicate that the use of standard procedures for negotiation and contracting generally diminishes parties’ attention to the substantive details of a transaction, and that it reduces the impact of contracting on interorganizational performance. These ﬁndings imply that academics can draw more accurate descriptions of negotiation and contracting practices if they consider standardization in their research. They also urge practitioners to be cautious with contract standardization. In building the argument, I ﬁrst observe that most research on contracting in interorganizational relationships appears to presume that 179

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actors are (boundedly) rational, and that they act self-interestedly, suggesting that they devise contractual structures that minimize transaction costs and maximize the value created in exchanges (Foss and Foss, 2005; Williamson, 1985). These assumptions imply that more complex and more risky transactions are governed by more detailed and highly speciﬁed contracts (Williamson, 1985). In practice, this frequently appears not to be the case (Eggleston et al., 2000). In this chapter, I oﬀer an explanation for this observation by challenging the idea that contracting always occurs mindfully. I do not contest that cooperating parties match organization- and exchange-level factors with governance structures, but I do indicate that standardization of negotiation and contracting practices tends to prohibit interorganizational participants from devising optimal governance structures. In constructing my argument, I capitalize on the observations from Langer et al. (1978) and Sharps and Martin (2002), indicating that we should not take for granted the idea that people always behave ‘mindfully’. I also recognize the fact that, although pure contract theoreticians presuppose that all contract provisions are being negotiated and read, standard contracts frequently do not meet those conditions (Eisenberg, 1995; Korobkin, 2003). In line with this, I advance that contract standardization reduces the likelihood that parties achieve a ‘meeting of minds’, one of the most fundamental functions attributed to negotiation and contracting processes (Beatty and Samuelson, 2001; Choi and Gulati, 2006; Ring, 2000). Furthermore, I contend that standardization reduces mindful or encourages mindless behaviour by interorganizational participants. As contract standardization is omnipresent in practice, but receives only scant attention in the literature (Korobkin, 2003), I do not solely underpin these assertions here, but I commence by investigating the advantages and disadvantages of using standard contracts more generally. Accordingly, I divide the chapter into two parts. In the ﬁrst part, I review the literature on standard contracts and I develop an overview of the pros and cons for using standardized contracting practices in interorganizational relationships. In the second part, I shift the focus from standard contracts to standardization as an attribute of negotiating and contracting practices. Here, I advance the view that standard procedures for negotiation and contracting involve lower degrees of mindfulness than the formulation of tailor-made contracts. In other words, I posit that participants in interorganizational relationships will act less carefully, critically, purposefully, attentively and conscientiously (Ryle, 1949; Weick and Roberts, 1993) when they adopt standardized procedures to deﬁne, coordinate and control their relationships, possibly harming interorganizational performance. The extension of generic contracting models in the

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Need to govern

Antecedents Organization level Exchange level Context level

Positive consequences

Ability to govern

Figure 7.1

Performance Value discovery Value creation Value appropriation

Governance Contracting Trust

Negative consequences

Research framework: focus of theme ﬁve

literature with a factor capturing the degree to which negotiation and contracting practices are standardized relates to the non-shaded areas of Figure 7.1. It is further clariﬁed in Figure 7.2. The chapter’s main contribution is to illustrate that research on standardization which has hitherto focused on other domains, such as global environmental policies by multinationals (Christmann, 2004), work programmes for building projects (Blyth et al., 2004), quality systems (Walgenbach, 2001) and international marketing programmes (Zou and Cavusgil, 2002), has to be extended to negotiation and contracting practices in interorganizational relationships. In this chapter, I take some initial steps in this direction, by oﬀering an overview of factors that contribute to the rising signiﬁcance of contract standardization, and by noting that there are several downsides to contract standardization that are easily overlooked. My ﬁndings caution practitioners for neglecting the downsides of standardization, and they encourage managers to consider whether and when

Antecedents Organization level Exchange level Context level

Governance Forms Mechanisms Processes –

Performance Value creation Value appropriation Relational quality –

Standardization of negotiation and contracting procedures

Figure 7.2

Generic research model extended with standardization

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mindlessness ambuscades in their transactions, and how it can be prevented or mitigated. The chapter is structured accordingly. In the following paragraphs, I discuss the advantages and disadvantages associated with contract standardization. Subsequently, I deploy structural equation modelling to assess whether the use of standard procedures for negotiating and contracting diminishes the magnitude of the relationships between organization-level and exchange-level factors, contractual complexity and interorganizational performance on a sample of 911 buyer–supplier relationships. In the discussion, I elaborate on the implications of my ﬁndings and on issues that could be addressed in future research.

THEORY ON STANDARDIZATION Standard contracts, here deﬁned as the application of similar contracts or contract terms in a range of contractual transactions, have gained wide currency (Korobkin, 2003). This was already evident in a study by Macaulay (1963: 58), in which lawyers complained that businessmen ‘desire to keep it simple and avoid red tape even when large amounts of money and signiﬁcant risks are involved’. However, this has not been translated into a well-developed scientiﬁc knowledge base, witness the ‘relative silence’ in the law, contracting and management literature regarding the reasons for and the implications of contract standardization (Kahan and Klausner, 1997: 715). The latter aligns with the more general observation that empirical research on contractual structures in economics and business studies has only scarcely investigated evolutionary patterns in contracting, instead treating observed contract designs primarily as equilibrium outcomes of cost–beneﬁt analyses, portraying contract design as a once-and-for-all activity rather than an evolving process (Argyres et al., 2007; Argyres and Mayer, 2007).1 Hitherto it has therefore remained unclear what reasons ﬁrms have for deploying or opting out of standard contracts, and what their eﬀects are on interorganizational cooperation (Kahan and Klausner, 1996; Korobkin, 2003). To investigate these questions, we have to look for the origins of contract standardization. The phenomenon ﬁrst emerged at the end of the 19th century. In that period, industrial ﬁrms aiming at mass-production became more or less forced to use preprinted, standardized contracts, primarily for eﬃciency reasons (Gluck, 1979). Since then, contracts have frequently been formulated in line with certain standards, corresponding to conventional patterns (Young, 1998). Large enterprises started to apply comparable contracts in relationships with diﬀerent clients and suppliers (Eggleston et al., 2000; Macaulay, 1963), thereby utilizing knowledge gained in one transac-

Contract standardization

Table 7.1

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Some major benefits and drawbacks of contract standardization

Benefits of standardization ● Enhances eﬃciency of the exchange ● Increases speed and robustness of the exchange ● Augments possibilities for exploiting information asymmetry ● Raises the legitimacy that is attributed to a contract ● Facilitates unequivocal contract interpretation Drawbacks of standardization ● Increases likelihood that inappropriate governance solutions are used ● Entails a limited potential for achieving a meeting of minds and establishing mutual expectations ● Heightens risk of routinized and mindless behaviour Source: References are provided in the main text.

tion for managing other transactions (Johnson et al., 2004). These contracts contained terms that were incorporated irrespective of the characteristics of the transaction or the collaborative context (Epstein, 1999). Branch organizations, law and accountancy ﬁrms and the legislative power also promoted the development and application of such terms (Hill and King, 2004). This also holds today. In the textile industry, for instance, ‘trade association membership often gives companies boilerplate nonbinding agreements so that parties can become knowledgeable about the key terms of trade they should discuss and negotiate prior to closing a deal’ (Poppo et al., 2008: 13). As ﬁrms have been committing themselves to a steadily proliferating number of interorganizational relationships, a certain degree of standardization has even become imperative, rendering the application of relatively simple standard contracts the rule rather than the exception (Eggleston et al., 2000). In the following paragraphs, I discuss the main factors contributing to the rise of contract standardization (see Table 7.1). Standardization Enhances the Eﬃciency of an Exchange The motive most commonly advanced for the application of standard contracts and standard contract terms derives from the idea that this type of contract is inherently optimal (Kahan and Klausner, 1996). The presupposition here is that the substance of standard contract terms optimizes the value of a transaction, irrespective of the deployment of the same contract clause by other parties, and regardless of its application by parties in prior transactions. Proponents of this argument suggest that quasi-Darwinian competitive processes eventuate in a situation in which clauses that have

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appeared eﬃcient before are being reused, whereas inferior clauses are abandoned and disappear from the scene (Klausner, 1995). Standard contracts then only entail the relatively low costs connected to the mechanical task of formulating and ﬁlling out the forms and they can be replicated almost without costs in other transactions (Kahan and Klausner, 1997). They are associated with exploitation, routinization, systematic cost and complexity reductions and increased eﬃciency (Sussman, 1999). Because the duplication of eﬀorts is circumvented, and as the collective experience from earlier transactions is fully utilized, the application of standard contract terms entails advantages of scale, scope and experience (Klausner, 1995). The development of complex contracts, instead, is costly and often becomes complicated owing to bounded rationality of contracting parties (Goetz and Scott, 1985). Standardization Increases the Speed and Robustness of an Exchange A second advantage of standard contracts is that they can be eﬀectuated quickly (Epstein, 1999; Salbu, 1997). Standardization results in comparatively short negotiation cycles, and it allows ﬁrms to exchange eﬃciently with multiple partners, because it ‘reduces search, monitoring, and enforcement’ eﬀorts (Schilling and Steensma, 2001: 1155). Because of standardization, ﬁrms can increase the pace with which they come to ‘understand and evaluate potential deals, something which ultimately enables them to respond more quickly to potential opportunities and threats in their environment’ (Salbu, 1997). Savings in time are often just as critical as the relatively low costs associated with standardization, because parties may experience high competitive pressures during relationship formation processes, or because partners have the desire to introduce new products on the market before competitors do so (Klausner, 1995). The signiﬁcance of timesaving beneﬁts is manifest in a remark of Norman Goldfarb, the CEO of First Clinical Research, a medical institute in San Francisco. He notes that ‘reducing contract negotiation means we can get life-saving drugs to the market quicker [. . .]. When you ﬁgure that every day of delay in approving a drug costs a drug company an average of $1.3 million, if we save two weeks, we’re talking serious money’ (eyeforpharma.com). Standardized contract terms are also generally robust, and of a high quality. After all, earlier formulations ‘bring to bear a collective wisdom and experience that parties are unable to generate individually’ (Goetz and Scott, 1985: 286). They are only accepted in the business community after they have been exposed to deliberation and reﬂection (Epstein, 1999; Hill, 2001b). As a result, standardized contracts generally exist of time-tested and relatively ‘safe’ provisions that minimize

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the risk of unintended eﬀects (Goetz and Scott, 1985), insulate parties from signiﬁcant downside risks, and reduce the chance that things are forgotten during negotiations (Hill, 2001b). This eﬀect is reinforced by the fact that standard templates help aggregate capabilities which are dispersed throughout corporations (Argyres and Mayer, 2007). Standard contracts and templates build on lawyers and attorney’s expertise to establish a responsible contractual frame, and can then be used by managers and engineers to further specify roles and responsibilities, communication structures and contingency planning. This form of specialization reduces the time needed for discussions between lawyers and managers and it diminishes the likelihood that misunderstandings restrain negotiations. Standardization Augments Possibilities for Exploiting Information Asymmetry Another advantage of contract standardization is that it enables parties in interorganizational exchanges to maintain beneﬁcial information asymmetries. Although a partner that has more information at its disposal is generally better equipped to write detailed contracts, it might not be in its best interest to do so. Consequently, an important rationale for applying standard contracts is that the best informed party only has to concede a limited amount of information to the other party. This can be highly desirable, because revealing information might enable another party to take advantage of the focal organization. Standard contracts thus oﬀer parties the opportunity to withhold strategic information (Eggleston et al., 2000). Moreover, by using this type of contract it may be easier to leave out things that possibly expose parties to litigation. In this respect, one of the managers interviewed by Grandori and Furlotti (2007) mentioned that ‘we leave things out that can give rise to litigation’. In addition, standard contracts signal trustworthiness, and they decrease the risk that parties ‘upset’ each other. Instead, when writing tailor-made contracts, the possibility of some bad event may be raised, possibly damaging the relationship, even if the event never occurs, and even if the party had not reacted in the way that it describes. In this case, the acceptance of contractual incompleteness by transaction parties oﬀers a positive signal, fostering cooperation and preventing a ‘contractual arms-race’ from developing between the partners (Hill and King, 2004). Instead, when contracts and the contracting processes preceding them are considered ‘inscrutably complex, mysterious or ambiguous’, they will tend to deter engagement and conﬁdence, reducing a partner’s comfort with and conﬁdence in a focal ﬁrm (Salbu, 1997: 374).

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Standardization Raises the Legitimacy that is Attributed to a Contract Transaction partners and other stakeholders in interorganizational relationships, such as investors, banks, clients and suppliers, are generally familiar with standard contract terms (Kahan and Klausner, 1996, 1997). This familiarity generally yields them ‘increased comfort with and conﬁdence in decision assessments’ regarding prospective transactions (Salbu, 1997: 373). Standardized contracts have proved to be valid in earlier transactions and their meaning is frequently clearer and less susceptible to diﬀerences in interpretation than tailor-made contracts. Moreover, they are regularly developed by ﬁrms with solid reputations, such as investment companies and law oﬃces (Klausner, 1995). Stakeholders are therefore inclined to believe that standard provisions are necessarily the most suitable for interorganizational transactions. These factors add to the perceived legitimacy of transactions (see Meyer and Rowan, 1977). In particular, standard provisions are surrounded by ‘an aura of stability and objectivity’ (Kahan and Klausner, 1996: 363). Consequently, organizations feel the ‘obligation’ to apply standard contract terms, irrespective of their eﬃciency. In this sense, the institutionalization of standard contracts results from pressures caused by organizations that have already adopted them, resulting in a form of isomorphic behaviour (Fiol and O’Connor, 2003). I make the annotation here that the legitimacy of standard contracts is dependent on the institutional environment in which a transaction is embedded. Whereas a lawyer in Germany comes across aggressively if he or she proposes detailed tailormade contracts, a lawyer in the United States is reproached for lacking inspiration and competence when he or she does not intensively negotiate contract provisions. This diﬀerence may stem from the fact that Germany is probably marked less by a history of adversarial industrial relations (Lorenz, 1999). It may also be due to the smaller size of the German trade community and the more prominent role of branch organizations compared to the United States (Hill and King, 2004). Standardization Facilitates Unequivocal Contract Interpretation Explicitly formulated tailor-made contract terms are also often more liable to diﬀerences in interpretation than standard contracts. Tailored contracts compound costs and uncertainty related to litigation as directly applicable precedents are lacking (Hill, 2001a). Standard provisions, instead, are less likely to contain ambiguous language and inconsistencies. They have a more consistent meaning (Goetz and Scott, 1985; Salbu, 1997), and they are easier to interpret because jurisprudence is available and judgments

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have already been passed about these provisions (Kahan and Klausner, 1996, 1997). In the United States, for example, the American Institute of Architects (AIA) provides the most frequently used contract for the design and construction of buildings. The primary function of these contracts, according to Pietroforte (1997), is the acknowledgement of generally accepted stages, responsibilities and roles, which results in a predictable environment and a common understanding regarding the context of interorganizational transactions and the meaning that parties attach to issues included in the contract. In particular, the relative certainty that contract parties derive from the use of previously applied standard provisions increases the attractiveness of this type of contract (Goetz and Scott, 1985). Standard provisions reduce ambiguity and, consequently, the interpretative burden with which stakeholders are confronted and the risk that inconsistent interpretations arise (Epstein, 1999; Hill and King, 2004). This is not only helpful during litigation, but also reduces the likelihood that parties bring a case to court. This holds both for organizations active in civil law countries as well as for organizations that have to adhere to common law. In civil law, legislation is regarded as the primary source of law. Courts thus base their judgments on the provisions of codes and statutes, from which solutions in particular cases are to be derived, and they have to reason extensively on the basis of general principles, or by drawing analogies from statutory provisions to ﬁll lacunae. By contrast, in the common law system, cases are the primary source of law, while statutes are only seen as incursions into the common law and thus interpreted narrowly (www.wikipedia.org). In both cases, standardization can diminish the equivocality surrounding contract interpretation. However, in civil law cases, standards will be derived more directly from the law, whereas in common law cases standards are frequently based upon prior deals. Reinforcement of Advantages by Network Eﬀects The rationales for adopting standard contracts that have been listed here are ampliﬁed by the existence of network advantages. Network advantages imply that increasing returns to the utilization of standard contracts arise in case more organizations deploy such contracts (Klausner, 1995; Kahan and Klausner, 1997). In case an ever-growing group of organizations adopts certain contracts, many of the advantages of standard provisions that have been discussed previously are reinforced. Standard contracts can be applied, for instance, in a larger number of transactions, while the costs of legal advice are lower, and the pace with which deals can be concluded becomes even higher. The same accounts for the availability

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of jurisprudence, and for the ease with which the meaning of speciﬁc contract provisions for potential partners can be determined. Standardization Increases Likelihood that Inappropriate Governance Solutions are used Despite the many rationales that one may advance for applying standard contracts, such contracts also have several drawbacks. The most obvious drawback is that they are likely to be sub-optimal, because a contract provision that was eﬃcient for the situation in which it came into existence is not necessarily equally suitable for other transactions (Sussman, 1999). Standard provisions might be sub-optimal from the beginning, or organizations might simply adopt standardized provisions in situations in which alternative contracts are more eﬃcient (Kahan and Klausner, 1996). The development of standards is highly sensitive to starting conditions or history-speciﬁc components (Cohen and Bacdayan, 1994). If, in a ﬁrst instance, a standard contract is developed for a transaction between organization A and B, for example, it is likely to look diﬀerent from a ﬁrst initiative to developing a standard contract engrafted on a transaction between organization A and C. This coincidental character of the origins of a standard contract undermines the claim that prevailing practices will converge to an eﬃcient solution for commercial problems (Epstein, 1999). Furthermore, as standards necessarily have to apply to a range of exchanges, they are less likely to do justice to the particularities of individual exchanges. In other words, standard contracts frequently do not eﬀectively capture context and task characteristics. Their content further tends to diverge from the needs of contract parties (Pietroforte, 1997), as adaptations of standards frequently lag behind changes in the contexts and conditions with which parties are being confronted (Goetz and Scott, 1985). Standardization Entails Limited Potential for Achieving a ‘Meeting of Minds’ A second signiﬁcant shortcoming of standard contracts is that they are accompanied by negotiation and contracting processes that are less likely to lead to more advanced and congruent understandings among exchange partners than the processes involved with tailor-made contracts. The rise of standard contracts has thereby destroyed one of the main functions of the negotiation and contracting process, this being the possibility for transaction parties to discover what they want from a transaction and from each other (Hill, 2001a) and reaching mutual understanding (Ariño and Ring,

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2004) or a meeting of minds (Beatty and Samuelson, 2001; Choi and Gulati, 2006; Ring, 2000). Gluck (1979: 74) expresses this as follows: ‘The important thing to be realized is that, with the development of the standard form, the contractual document has drastically changed. While the traditional bargained-out document was in itself evidence of the understanding, the same cannot be said of the standard form document.’ Standard contracts destroy the bargaining process (Gluck, 1979), as they reduce communication about the contents of a promise, right, or obligation, calling into question the reliability of such contracts (Goetz and Scott, 1985). Where non-standardized formal negotiation and contracting processes enable or even force parties to give meaning and make sense of interorganizational relationships and their underlying logics (Ariño and Ring, 2004; Ring and Van de Ven, 1994; see also Chapters 3 and 4), the utilization of standard contracts inhibits these processes. Consequently, processes and acts of sensegiving, sensemaking, sensedemanding and sensebreaking are hampered and the development of mutual understandings and shared expectations becomes more diﬃcult. This is particularly problematic when ambiguity exists between partners, or when relationships do not closely resemble market transactions, so that a meeting of minds entails more than reaching agreement on product speciﬁcations and price. In this respect, Reuer and Ariño (2004) oﬀer the example of an alliance manager that signed each of the two thousand pages of an alliance contract, provoking the question how much he memorized of the contract and what he actually had in mind when signing the contract (Fréchet, 2007). Standardization Heightens the Risk of Routinized and Mindless Behaviour In line with the previous point, standard contracts entail the risk of thoughtless or perfunctionary adoption and application. In a sense, this involves the inappropriate generalization of prior experience towards novel situations (Hoang and Rothaermel, 2005). Freund, who describes a mock merger between Suggestive Software and Proliferating Products oﬀers an example. He quotes a supervisor lambasting a junior associate in a law ﬁrm for having done a rotten job in his ﬁrst draft of an agreement, resulting from the ‘default’ application of contract terms. ‘Merry Christmas, Pete. Now look fella, you’ll just have to forgive my candor, but time’s short and this draft of the Proliferating-Suggestive agreement is an inferior job. The problem is that you just didn’t think. You walked out of here, you went into the library, you grabbed that Screwloose binder oﬀ the shelf, you had a photocopy made of the ﬁnal contract, and you marked it up for the purposes of this draft’ (Freund, 1975: 500, in Hill, 2001b). The example illustrates that the

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adoption of standard contracts is frequently not preceded by thorough analysis (Kahan and Klausner, 1997) and that it locks parties into conventional modes of thought (Young, 1998). This reduces the inclination to consider context and task characteristics that are peculiar to a transaction when writing those contracts.

WHY CONTRACT STANDARDIZATION MAY LEAD TO MINDLESSNESS Now that I have furnished an inventory of the advantages and disadvantages of standard contracts, the attention can be shifted towards the standardization of the negotiation and contracting procedures leading up to these contracts. I investigate how the standardization of these procedures inﬂuences interorganizational cooperation. Merriam Webster’s dictionary provides us with a useful starting point for investigating this question (www.m-w.com). According to the dictionary, a procedure comprises a series of steps followed in a regular deﬁnite order, and it involves a traditional or established way of doing things. Standardization applies when procedures are uniform, well established by usage, and widely recognized as acceptable. It attests to a certain ‘ﬁxedness’ or homogeneity within external exchanges (Brown and Timmins, 1981). Standard procedures then consist of established methods that are followed routinely. They comprise a form of abstracted and explicit representation of collective routines (Cohen and Bacdayan, 1994), which are created and reﬁned over multiple cycles of exchange (Subramani and Venkatraman, 2003). Such standard procedures are frequently rather inertial and relatively invariant to signals and feedback that could call for their revision. As a consequence, negotiating and contracting practices may vary only a little for diﬀerent exchange relationships2 and contracting parties may come to respond to the world in a limited and rigid fashion (see also Luchins, 1942), overlooking simpler or better solutions to similar problems. More speciﬁcally, it appears as though the application of standard procedures for negotiating and contracting involves relatively low degrees of mindfulness. In order to develop this argument further, I explain the concept of mindfulness. ‘Mind’ is a dispositional term that denotes a propensity to act in a certain manner or style (Weick and Roberts, 1993). It ranges from stupid to intelligent (Ryle, 1949). Mindfulness refers to active and ﬂuid information processing, sensitivity to context and multiple perspectives and the ability to draw novel distinctions (Langer, 1989). It implies ‘noticing, taking care, attending, applying one’s mind, concentrating [. . .], alertness, interest, intentness, studying, and trying’ (Ryle, 1949:

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136). Mindfulness is associated with actively drawing distinctions and making meaning, and it involves great sensitivity to one’s environment, openness to new information, the creation of new categories for structuring perception, and awareness of multiple perspectives (Langer, 1989; Langer and Moldoveanu, 2000). In contrast, mindlessness involves relying on past categories, acting on automatic pilot, not attending to new information, and ﬁxating on a single perspective (Langer, 1989). It pertains to cognitive modes that are marked by automatic and limited information processing, little attention to detail and restricted building of cognitive representations of task environments (Dunegan, 1993). When mindless, individuals exhibit behaviour that is largely dictated by the past. They operate from a state of reduced attention, which often leads to the mechanical use of rule-based behaviours (Fiol and O’Connor, 2003) and they pay limited attention to the substantive elements of a situation. Standardization thus reduces the ‘need for organizational participants to think’ (Feldman, 2003: 728). This causes many of the details of on-going, present situations to go unexamined (Langer et al., 1978) or to be evaluated superﬁcially (Dunegan, 1993). In such cases, mindlessness ambuscades (Burgoon et al., 2000; Feldman, 2003; Langer and Moldoveanu, 2000). People start to behave rather routinely or habitually, and they adopt a less careful, critical and purposeful attitude towards situations (Ryle, 1949). Their behaviour involves a lack of seeing, taking notice and being attentive (Dougherty and Takacs, 2004) and they work from a narrow focus of attention (Fiol and O’Connor, 2003), so that procedure-inconsistent information is excluded from consideration. This entails the risk that responses to situations are activated in an over-learned and automated fashion (Burgoon et al., 2000). As a result, standardized negotiation and contracting practices add little to interorganizational participants’ comprehension of their situation and it prevents them from constructing meaning and building understanding. Standardization of negotiation and contracting practices further reduces their inclination to make sense of the transactions they engage in. Consequently, expectations remain imperfectly articulated, and hubris and faddishness may prevail over active consideration of the consequences of interorganizational cooperation (Sampson, 2003). This can result in misunderstandings, misrepresentations and misperceptions among transactors who are individually under the impression that they are engaged with one another in meaningful interactions (Burgoon et al., 2000; Langer and Moldoveanu, 2000). It precludes them from getting to know each other, from clarifying their objectives and intentions, and from strengthening their relationship. In summary, I suggest that the use of standard procedures for negotiating and contracting encourages mindlessness. If this is

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correct, the generic model presented in the literature, in which organization, exchange and contextual factors inﬂuence formal governance, and in which formal governance subsequently inﬂuences interorganizational performance (Anderson and Dekker, 2005; Leiblein, 2003; Sobrero and Schrader, 1998; Stinchcombe, 2001) needs to be modiﬁed. In particular, I propose that the degree of standardization of negotiation and contracting practices moderates both sets of relationships. As standardization is argued to lead to mindlessness, organization, exchange and contextual factors are no longer considered in great length during the negotiation and contracting period, reducing their impact on the degree of contractual complexity. Similarly, the elements included in these contracts tend to be less speciﬁc for the contracting parties and the exchange itself (i.e. these contracts tend to consist of generic clauses). They are also likely to contain fewer terms that may be helpful in addressing performance problems, since contracting parties have presumably paid less attention to all the issues that may loom up in their relationship. These contracts are therefore less likely to be helpful when things go wrong, and parties are less apt to revert to and depend on those contracts in future, diminishing the inﬂuence of contractual complexity on interorganizational performance. This is captured in hypothesis 7.1. Hypothesis 7.1 In the context of interorganizational contracting, standardization of negotiation and contracting procedures reduces mindfulness, so that the associations between contractual complexity and its antecedents, and associations between contractual complexity and interorganizational performance become weaker.

METHOD Statistical Analysis: Structural Equation Modelling To assess the hypothesized relationships, I specify a structural equation model (Anderson and Gerbing, 1988). Such a model consists of a set of linear equations that simultaneously test two or more relationships among directly observable and unmeasured latent variables (Shook et al., 2004). It allows one to test a system of structural equations, where a dependent variable in one relationship becomes an independent variable in a subsequent relationship. The advantage of structural equation modelling over other statistical techniques is that it enables simultaneous estimation of the ﬁt of several structural equations (Bagozzi, 1980), and it accounts for measurement error as well as unobservable constructs (Hulland, 1999). The struc-

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tural model was developed in AMOS 5.0. The general form of the equation specifying the relationships between latent variables, in this software programme is B ,

(7.1)

in which is a vector of endogenous concepts, is a vector of exogenous concepts, and are matrices of structural coeﬃcients for the endogenous and exogenous concepts, and is a vector of errors in the conceptual model. The measurement model for the endogenous latent variables in the model equals: yy,

(7.2)

in which y is a vector of observed endogenous indicators, y is a matrix of structural coeﬃcients and is a vector of errors in the measurement model. The measurement model for the exogenous latent variables in the structural model is: xx,

(7.3)

in which x is a vector of observed exogenous indicators, x is a matrix of structural coeﬃcients and is a vector of errors in the measurement model. For identiﬁcation purposes, scales of multiple indicator constructs are determined by ﬁxing the loading of the indicator that a priori (i.e. theoretically) could be expected to best represent that construct at a value of one. Fixed loadings are indicated by denoting 1 for the ‘reference indicator’. Conforming to this general model, and based on the literature, I develop a recursive system describing the proposed path from antecedents, formalization and performance. A visual presentation of the speciﬁed statistical model is presented in Appendix C. As can be seen from this ﬁgure, I only incorporate relationships between antecedents when their existence appears highly plausible, making the model more meaningful than models in which antecedents are allowed to co-vary freely with each other (see for example, Dekker, 2003). The model is estimated by a maximum likelihood procedure for structural equation models (Arbuckle and Wothke, 1999). To test for the moderating eﬀects of standard procedures for negotiating and contracting on the relationships between antecedents, formalization and performance, I split the sample of buyer– supplier relationships in a subsample of relationships in which standard negotiation and contracting procedures are applied (n479), and a subsample for which this is not the case (n420). To test the hypothesis,

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I compare the eﬀect sizes of relationships between four antecedents, contractual complexity and interorganizational performance for both subsamples. The model encompasses several ﬁrm-level, transaction and relational level factors that, according to the literature, inﬂuence formalization, such as measurability, relation-speciﬁc investments, complexity of the exchange, ﬁrm reputation, ﬁrm size and the existence of alternative options. For the measures that I used in conducting the analyses, I refer to Appendix B.

RESULTS Table 7.2 exhibits the correlation matrices for both subsamples. In order to assess the adequacy of the reﬂective measurement model, checks were

Table 7.2

Correlation matrices for both subsamples*

No standardization

Mean SD

1

2

3

4

5

6

7

8

1. Measurability 2. Asset-specificity 3. Complexity 4. Reputation 5. Size buyer 6. Alternatives 7. Contract 8. Performance

9.01 8.85 5.53 11.3 5.84 5.17 62.0 5.10

Standardization

Mean SD

1. Measurability 2. Asset-specificity 3. Complexity 4. Reputation 5. Size buyer 6. Alternatives 7. Contract 8. Performance

8.22 2.58 1.00 8.47 3.040.40 1.00 5.15 2.050.27 0.40 1.00 11.4 2.07 0.02 0.22 0.22 1.00 5.75 0.89 0.06 0.01 0.01 0.01 1.00 5.51 1.97 0.27 0.25 0.24 0.07 0.08 1.00 63.1 27.9 0.24 0.35 0.40 0.25 0.16 0.18 1.00 4.87 1.58 0.28 0.23 0.22 0.08 0.26 0.09 0.39 1.00

2.70 1.00 3.04 0.38 1.00 1.98 0.33 0.40 1.00 2.13 0.01 0.21 0.18 1.00 .86 0.04 0.12 0.17 0.04 1.00 1.89 0.23 0.21 0.16 0.01 0.14 1.00 26.2 0.08 0.31 0.42 0.32 0.20 0.08 1.00 1.74 0.14 0.29 0.18 0.10 0.19 0.07 0.41 1.00 1

2

3

4

5

6

7

8

* Correlations higher than 0.072 are significant at the 0.05-level, whereas correlations higher than 0.085 are significant at the 0.01-level. N420 for the subsample without standardized negotiation and contracting procedures. N479 for the subsample in which negotiation and contracting procedures are standardized.

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performed on (1) individual item reliabilities, (2) the convergent validity of the measures associated with individual constructs, and (3) discriminant validity between constructs (Hulland, 1999). The Kaiser–Meyer–Olkin measure of sampling adequacy equals 0.79, indicating that factor scores could be used as reliable indicators of discriminant validity. The factor scores for all items on their respective variables all display acceptable coeﬃcient alphas (see Hulland, 1999). Following Anderson and Dekker (2005), I ascertain whether a ﬁxed measurement model for both subsamples is appropriate. This appears the case, since the model shows conﬁgural invariance (i.e. items load on similar factors between groups) and metric invariance (i.e. no meaningful diﬀerences exist in the factor loadings between groups). Table 7.3 exhibits diﬀerent measures to assess the model’s ﬁt. Assessing a model’s ﬁt is one of structural equation modelling’s most controversial aspects. Most ﬁt indices ascertain whether the covariance matrix derived from the hypothesized model is diﬀerent from the covariance matrix derived from the sample. A Chi-square test serves as the most common ﬁt measure (Shook et al., 2004). In general, a non-signiﬁcant value for the ratio of Chi-square over degrees of freedom of less than 3.0 indicates a good ﬁt, meaning that the model is not signiﬁcantly diﬀerent from the underlying data (Rothaermel and Deeds, 2004). The likelihood ratio Chi-square statistics are 2.29 for the subsample without standard procedures and 1.64 for the subsample with standard procedures, indicating reasonable ﬁts for the models. As ﬁt measures based on the Chisquare statistic have often been criticized for being inﬂated by sample size (Jöreskog and Sörbom, 1993), I also calculate other ﬁt measures. The Root Mean Square Error of Approximation has recently been recognized as ‘one of the most informative criteria in covariance structure modelling’ (Byrne, 1998: 112). According to Byrne, values less than 0.08 represent reasonable errors of approximation, whereas values less than 0.05 indicate good ﬁt. The RMSEAs for both subsamples are equal to 0.055 and 0.043, indicating medium to good ﬁts for both subsamples. In addition, MacCallum et al. (1996) recommend that a 90 per cent conﬁdence interval is reported around the RMSEA value, in order to reﬂect the precision of the estimate. Narrow conﬁdence intervals would argue for good precision of the RMSEA. The 90 per cent conﬁdence interval for both subsamples ranges between acceptable values, indicating that one can be reasonably conﬁdent that values of the RMSEA do not exceed critical values. Moreover, the Normed Fit Index is close to 0.90 for both subsamples, and high values for the Comparative Fit Index, 0.927 and 0.952, respectively, lead to the conclusion that an acceptable ﬁt to the data exists, since values higher than 0.90 indicate an acceptable ﬁt to the data (Bentler,

196

Table 7.3

Contracts and trust in alliances

Model fit for both subsamples RMSEA LO 90 HI 90 PCLOSE NFI CFI HOELTER

Subsample without standard negotiation and contracting procedures

Default model Saturated model Independence model

0.055

0.047 0.064

0.130

0.879 0.927 239 (0.01) 1.000 1.000

0.175

0.169 0.180

0.000

0.000 0.000

39 (0.01)

Chi-square: 315.624 Degrees of freedom: 138 Chi-square/degrees of freedom: 2.29 Subsample with standard negotiation and contracting procedures

Default model Saturated model Independence model

0.043

0.035 0.051

0.930

0.915 0.958 332 (0.01) 1.000 1.000

0.177

0.172 0.183

0.000

0.000 0.000

38 (0.01)

Chi-square: 258.92 Degrees of freedom: 138 Chi-square/degrees of freedom: 1.64

1992). A ﬁnal goodness-of-ﬁt statistic consists of Hoelter’s (1983) critical N. This measure diﬀers substantially from the measures previously discussed, in that it focuses directly on the adequacy of sample size rather than on model ﬁt (Byrne, 1998). The purpose of this measure is to estimate a sample size that would be suﬃcient to yield adequate ﬁts for a Chisquare test. Hoelter (1983) proposes that a value in excess of 200 is indicative of a model that adequately represents the data. In this case, Hoelter’s N equals 239 and 332, indicating that results are not inﬂuenced by insuﬃcient sample sizes, and that the model has adequate power (Shook et al., 2004). Now that I have assessed that the model adequately ﬁts the data, we can proceed with testing the hypothesis. To do so we have to compare the proposed relationships between variables for the subsample in which no standard procedures for negotiating and contracting are used with the relationships for the subsample in which they are applied. Figure 7.3 visualizes the moderating inﬂuence of standard procedures for negotiating and contracting on the relationships between various antecedents and contractual complexity, and on the relationship between contractual complexity and interorganizational performance. Table 7.4 exhibits the standardized direct eﬀects for both subsamples, which are generally consistent with previous research on the same data (see Batenburg et al., 2003; Buskens, 2002). My

197

Contract standardization 0.5

0.4

Absolute effect sizes Asset specificity on contractual complexity Exchange complexity on contractual complexity Reputation on contractual complexity Size buyer on contractual complexity Contractual complexity on performance

0.3

0.2

0.1

0

Non-standardized negotiation and contracting procedures

Figure 7.3

Standardized negotiation and contracting procedures

Moderating eﬀects of standardization

hypothesis on the moderating eﬀects of using standard procedures for negotiation and contracting is only partly supported. From the results it accrues that relationships between contractual complexity and asset speciﬁcity, the importance of reputation, transaction complexity and the size of a buyer are of a smaller magnitude for the subsample of transactions in which standard procedures for negotiation and contracting have been used, supporting the hypothesis. The same holds for the relationship between contractual complexity and interorganizational performance. However, the relationship between measurability and contractual complexity is of a larger magnitude

Table 7.4

Comparison of effect sizes for both subsamples† Eﬀect size Non-standardized Standardized B Sig. B Sig.

Relationship Measurability on contractual complexity Asset specificity on contractual complexity Exchange complexity on contractual complexity Reputation on contractual complexity Size buyer on contractual complexity Contractual complexity on performance † Correlations

0.11 0.31 0.41 0.27 0.25 0.24

*** *** *** *** ***

significant are at the 0.05-level (**) and the 0.01-level (***).

0.15 0.22 0.38 0.19 0.15 0.14

** *** *** *** *** **

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in the subsample of transactions in which standard procedures were used, contradicting my expectations. I can thus conclude that my hypothesis holds, except for this relationship, on which I elaborate in the discussion section. To assess the threat of reverse causality, implying that the relationships between the proposed antecedents, contractual complexity and interorganizational performance have a reversed direction, two procedures have been applied. First, analogously to Rothaermel and Deeds (2004) and in line with recommendations of Shook et al. (2004), several alternative recursive models were tested with structural equations describing reverse paths. These models eventuated in less acceptable overall ﬁts with the data, and rendered several paths insigniﬁcant. Second, I compared the chronological order with which the constructs appear in the model with the chronological order of eﬀects that one would expect in practice. For each relationship between two constructs, the reverse of the relationship was speciﬁed and discussed in order to assess whether the alternative was more plausible or not. The temporal ordering of variables presumed in the model used for the analyses appeared to be the most plausible.

DISCUSSION In this chapter, I elaborated on the standardization of negotiation and contracting practices. Although the application of standard contracts and standard procedures for negotiating and contracting is widespread, academic studies on this subject are still sparse. In this chapter, I attempted to redress this imbalance between practice and research. I stipulated an overview of the advantages and disadvantages of contract standardization. I posited that the most fundamental drawback of contract standardization has to do with its role in precluding the creation of shared expectations, prohibiting parties from reaching a ‘meeting of minds’ and encouraging ‘mindless’ behaviour during negotiation and contracting practices. This hypothesis was empirically assessed by an analysis of contracting practices in buyer–supplier relationships. Structural equation modelling generally supported the idea that the use of standard procedures for negotiation and contracting generally diminished parties’ attention to the substantive details of a transaction and that it reduces the inﬂuence of contractual complexity on interorganizational performance. There was one exception, consisting of the relationship between measurability and contractual complexity, which was stronger for the subsample with standardized negotiating and contracting practices. This may be

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caused by the fact that standardization of negotiation and contracting practices is frequently accompanied by a low degree of information acquisition and information processing, which leaves measurability problems unresolved, possibly increasing its impact on contractual complexity. When negotiation and contracting processes do not follow standardized patterns, instead, measurability problems are more likely to be alleviated by the collection and processing of information, which then tempers the eﬀect of measurability problems on contractual complexity (see also theme one). Theoretical and Practical Implications The ﬁndings of this research imply that transactions and contracts can no longer be studied on a case-by-case basis (Goetz and Scott, 1985; Klausner, 1995), as procedures in one exchange inﬂuence the use of contracts and the contracts used in other exchanges. My ﬁndings also exemplify that the process by which formal contracts come about partly determines what role they play in interorganizational relationships. In line with previous inquiries (Hatch, 1999; Ring and Van de Ven, 1992), I therefore encourage researchers to complement research on organizational structures with inquiries into the structuring processes from which they emanate. The results indicate that research on structuring processes requires new impetus, and that the logic of interorganizational theorizing should be drawn away from structured entities, outcomes and end-states, towards the underlying thought-structuring processes, which produce these outcomes (see also Chia, 1997: 703; Hatch, 1999: 82). I expect that such a shift in attention could explain, for example, why ‘human beings can possess high intelligence and yet evince frequent lack of intellectual awareness when making decisions’ (Sharps and Martin, 2002: 273),3 and why contracts are generally simple, although predictions derived from theory suggest they should be complex (Eggleston et al., 2000). Furthermore, the ﬁndings do not coincide with statements saying that ‘more extensive contracts [. . .] tend to reﬂect a more elaborate ex ante problem-solving eﬀort and greater clariﬁcation of goals and other issues’ (Carson et al., 2006). In fact, many standardized contracts are highly voluminous and extensive, but the processes by which they are adapted to particular relationships may involve limited problem-solving eﬀorts and more or less mindless behaviour. My ﬁndings also indicate that standard procedures for negotiation and contracting may result in a failure to communicate the content of a promise or to deﬁne the rights exchanged between partners (Goetz and Scott, 1985). By decontextualizing the contracting process, standard procedures reduce

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the degree to which parties can ‘create a bigger transactional pie in a world where parties’ incentives are misaligned and [where] they need to coordinate the production of information, specify future rights, duties, and procedures, and allocate risks’ – the central aim of contracting (Hill and King, 2004: 890). In other words, I ascertain that the use of standard procedures for negotiation and contracting potentially leads to reduced mindfulness by contracting parties, which diminishes the usefulness of interorganizational contracts. This conforms to a description of the role of contracts in an alliance between two ﬁrms aiming to developing a packaging machine by Klein Woolthuis et al. (2005). These authors ﬁnd that the adoption of a standard contract was not accompanied by much thought. As a result, ‘the contract did not provide a source to fall back on when the relationship broke up’ (Klein Woolthuis et al., 2005: 829). The analysis has several practical implications as well. First, it indicates that care should be taken not to eliminate sensemaking eﬀorts from negotiation and contracting processes. Instead, mindfulness should be nourished in order to enable participants in interorganizational relationships to grasp new opportunities and prevent them from initiating non-sensible relationships. In order to do so, standardization of negotiating and contracting processes could be accompanied by the hiring of sensitive, attentive and vigilant staﬀ. Organizational departments that support and supervise interorganizational governance processes could use contract management tools to gather information and prevent non-sensible relationships from occurring. A second and related option concerns the development of a ‘contracting capability’ (Argyres and Mayer, 2007; Mayer and Argyres, 2004). Analogously to ‘alliance capabilities’, which are directed at the institutionalization and adoption of earlier alliance experience in novel interorganizational relationships (Draulans et al., 2003; Dyer et al., 2001; Heimeriks and Duysters, 2007; Kale et al., 2002; Sarkar et al., 2006), organizations might develop contracting capabilities to harness and exploit experiences derived from earlier contractual agreements in future collaborative relationships (Argyres and Mayer, 2007; Reuer and Zollo, 2005). Such contracting capabilities are built from experience with series of contracts, and thus stress the signiﬁcance that has recently been attributed to successful relationship management at the portfolio level (Heide, 2003; Lavie, 2007; Wuyts et al., 2004). Contracting capabilities can be created by comparing the contract performance of various relationships, or by casting light on entire sets of contractual relationships with one partner. They suggest that superior exchange performance over time is not only stimulated by aligning contract terms to organization, exchange and contextual attributes, but also by developing and exploitating contract

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design capabilities, which enable ﬁrms to design more eﬀective contracts (Argyres and Mayer, 2007). A third possibility for restricting mindless contracting consists of the incorporation of ‘sensemaking triggers’ in contracts and procedures for negotiating and contracting. Sensemaking triggers ‘force’ managers of cooperating organizations to ask themselves questions about the underlying logic of relationships, the anticipated risks, costs, investments and returns involved, and the possibilities of pushing performance to higher levels. Sensemaking triggers can form the impulse for the explication of expectations of both parties, possibly leading to a better understanding of the various factors that might play a role in interorganizational relationships (Vlaar et al., 2006). They comprise intentionally manipulated elements of contracts and negotiating and contracting procedures that are included to elicit more thoughtful, creative and ﬂexible states of mind (Burgoon et al., 2000: 112). Limitations and Opportunities for Future Research This chapter contains several limitations, indicating opportunities for future research. First, one has to realize that it is impossible to process every piece of information mindfully (Langer, 1989). After all, in today’s world the scarce resource is typically not information, but the amount of mindful attention that decision makers allocate to making the information meaningful (Hansen and Haas, 2001). As one cannot mindfully process every piece of information, and as there are signiﬁcant costs associated with creating and maintaining mindfulness, it becomes essential to discover ‘when standard operating procedures are appropriate and when they are not’ (Karina, 1998: 202). Stated diﬀerently, it becomes worthwhile to investigate when mindfulness or standardization have the largest payoﬀs. In this respect, standardization is believed to be a very poor strategy, for example, in case organizations face unexpected contingencies (Roberts and Bea, 2001). One could also investigate how the degree of standardization varies between diﬀerent institutional contexts. Hill and King (2004: 890), for example, argue that German contracting ‘cuts short the costly and ineﬃcient “arms race” in which U.S. transacting parties’ and their lawyers too often engage in their negotiation and drafting of contracts. It creates and uses ‘good enough’ standardized solutions to common problems faced by transacting parties. By some accounts, this results in German agreements being one-half or two-thirds the size of otherwise comparable US agreements (Hill and King, 2004). This issue receives more attention in theme six, where I investigate the antecedents of standard contracts.

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Second, standardization was included as a dichotomous moderating variable in the analysis, while it might be more accurately described as a continuous variable. In future research, negotiation and contracting processes may be depicted and measured as being more or less standardized. Third, the chapter oﬀered only a few insights into factors that inﬂuence whether standard procedures and standard contracts are applied, and when they ought to be (see theme six). Do prior relationships, for example, inﬂuence the use of standard procedures? Here, Madhok (1995) has advanced the view that, when parties have previously cooperated, the role of the contract is more in the nature of a routine or a standard operating procedure. Hill and King (2004: 926) add that the ‘protracted negotiations involved in elaborate customization may be more useful for parties coming to know each other for the ﬁrst time’. A ﬁnal option for future research concerns the fact that the majority of research on mindfulness still pertains to crisis situations in high-reliability organizations, including those involving ﬂight operations (Weick and Roberts, 1993; Weick and Sutcliﬀe, 2001), ferries and cruise-ships (Roberts and Bea, 2001) and chemical and nuclear plants (Weick, 2001). The chapter demonstrates that mindfulness may inﬂuence everyday practices in ‘normal’ organizations, indicating a need for incorporating mindfulness in organizational research (see also Argote, 2006; Feldman, 2003; Fiol and O’Connor, 2003; Weick and Roberts, 1993; Weick and Sutcliﬀe, 2006). In conclusion, the chapter has shown that the use of standard procedures for negotiation and contracting may introduce mindlessness in interorganizational exchanges. It may diminish parties’ attention to the substantive details of a transaction, and reduce the impact of contractual structures on interorganizational performance. These results call for more research paying attention to the interplay between the nature of negotiation and contracting processes and the structural aspects of interorganizational exchange.

NOTES 1. A notable exception consists of the work by Argyres and Liebeskind (1999) discussing governance inseparability, and showing that prior governance choices constrain subsequent choices. 2. Findings from previous investigations show that standardization of procedures is closely related to formalization of the same procedures (Mansﬁeld, 1973). In the National Study, for example, Child (1972) found a correlation of 0.87, whereas in the Aston studies Pugh et al. (1969) found a correlation of 0.83 between both constructs. In my inquiry, however, standardization is regarded as an attribute of the negotiation and contracting process (see Lillrank, 2003), a process that can be more or less standardized. This is supported by the insigniﬁcant value for the correlation between contractual

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complexity and standardization for my sample of buyer–supplier relationships (Kendall’s tau-b 0.022, p0.429, n899). 3. Sharps and Martin (2002: 272–3) oﬀer the following example: ‘In September 1999, NASA lost a Mars orbiter because the scientists working on the mission did not convert English units to metric units.’

8.

Governance trajectories

Despite a clarion call for further examination of multiple control mechanisms, few empirical studies have investigated this issue. (Jap and Ganesan, 2000: 227–45)

INTRODUCTION Interorganizational governance eﬀorts – attempts to coordinate and control activities and outcomes in external collaborative ventures – are composed of multiple, interrelated decisions that are taken over a relationship’s life cycle. Notwithstanding this multidimensionality, academic studies on interorganizational governance frequently pertain to only one or a few governance choices. Little attention is paid to the interrelationships between governance choices, and to the dynamics characterizing value-creation and value-claiming activities in interorganizational relationships. I challenge this deﬁciency by conceptualizing interrelated governance decisions made during diﬀerent stages of a collaborative relationship as ‘governance trajectories’. I propose that the decisions embedded in these trajectories possess dissimilar organization-level and exchange-level antecedents, and that decisions made in earlier stages of cooperation aﬀect decisions made later on. Analyses of six governance decisions for a sample of 911 buyer–supplier relationships support my arguments. By challenging the conventional focus on singular governance decisions, and by replacing it with the concept of governance trajectories, the chapter contributes to a more comprehensive and dynamic picture of interorganizational governance. Interorganizational relationships are believed to consist of several stages, including a search and selection phase, a negotiation phase and a contracting phase (see Buskens et al., 2003a; Jap and Ganesan, 2000; Reuer, 1999, 2000; Zollo and Singh, 2004). These three stages in an interorganizational relationship’s life cycle (see De Rond, 2003; Jap and Ganesan, 2000) correspond to diﬀerent governance decisions aimed at the coordination and control of interorganizational activities and outcomes. Despite the distinction between these three stages, studies on series of successive governance decisions are still rare in the literature (Anderson and Dekker, 2005; Long et al., 2002; Narayandas and Rangan, 2004). In particular, most of 204

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the research on exchanges between organizations treats them as discrete events instead of as mechanisms for managing ongoing relationships (Dwyer et al., 1987). Research on interorganizational governance is generally centred on static typologies, paying little attention to the origins and evolution of interorganizational governance (Argyres et al., 2007; Cardinal et al., 2004; Narayandas and Rangan, 2004). Moreover, ‘there has been little work that examines the simultaneous use of multiple mechanisms to structure exchange relationships’ (Jap and Ganesan, 2000: 228; see also Lusch and Brown, 1996). This is due, among other things, to the precedence that has been given to analytical precision and theoretical rigour over rich descriptions of reality (Zollo and Singh, 2004). It also derives from researchers’ attempts to determine single best controls (Long et al., 2002) and the presumption that one governance mechanism should be used over another, depending upon a given activity or context (Cardinal, 2001; Eisenhardt, 1985; Ghoshal and Moran, 1996; Ouchi, 1979). Such an ‘overly rational conceptualization’ of managerial attention and action only leads to correct conclusions when single governance decisions are compared (Long et al., 2002). It neglects the fact that particular governance solutions, such as the use of a particular contract, may be interdependent with other governance solutions (Argyres et al., 2007). Moreover, it does not take into account that managers use distinct governance mechanisms to accomplish the same functions (Bradach and Eccles, 1989; Miller et al., 2004) and that they have to address a complex array of organizational functions and contingencies (Cardinal, 2001; Cyert and March, 1963; Kirsch, 1997; Long et al., 2002). It also remains agnostic to the fact that diﬀerent governance mechanisms may complement or substitute one another (Anderson and Dekker, 2005). The resulting gaps in our understanding of interorganizational governance are signiﬁcant, given that governance systems are widely acknowledged to be ubiquitous and critical to the functioning of organizations and interorganizational relationships (Buskens et al., 2003a; Cardinal, 2001; Cardinal et al., 2004; Cyert and March, 1963; Reuer and Ariño, 2003; Ring, 2002). To address this issue, I focus on the following research question: to what extent are decisions on the degree of contractual complexity to be applied to an exchange related to other governance decisions? This question concerns the non-shaded areas of the research framework depicted in Figure 8.1. To investigate this question, I propose the concept of ‘governance trajectories’, which I deﬁne as a sequence of interrelated decisions that are made to control, direct, or inﬂuence the actions and conduct of participants in interorganizational relationships during successive stages of an interorganizational life-cycle. Adoption of the life-cycle concept underscores the importance of distinct phases of collaboration as elements of

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Need to govern

Antecedents Organization level Exchange level Context level

Performance Value discovery Value creation Value appropriation

Governance Contracting Trust

Ability to govern

Figure 8.1

Positive consequences

Negative consequences

Research framework: focus of theme six

value creation (Reuer and Zollo, 2000: 171). Examining how organizations govern collaborative relationships during multiple stages of cooperation oﬀers a broader, more realistic, perspective on interorganizational governance (Cardinal, 2001; Narayandas and Rangan, 2004). I recognize that it is virtually impossible to conduct an exhaustive study of interorganizational governance arrangements, because organizations have a large number of potential governance mechanisms at their disposal (Heide and John, 1990). However, a review of the literature suggests that interorganizational governance trajectories at least comprise decisions with respect to the following: 1 2 3 4 5 6

Type of partner selected (e.g. Gulati, 1995; Ryall and Sampson, 2006); exhaustiveness of selection eﬀorts (e.g. Luo, 1997; Nielsen, 2003); advance payments (e.g. Helm and Kloyer, 2004); exhaustiveness of negotiations (e.g. Ariño and Ring, 2004; Korobkin, 2000); use of standard contracts (e.g. Epstein, 1999; Korobkin, 2003); and contractual complexity/speciﬁcity (e.g. Luo, 2002; Mayer, 2006; Poppo and Zenger, 2002).

By means of binary logistic regressions and multiple regression analyses on a sample of 911 buyer–supplier relationships, I demonstrate that each of these governance decisions can be explained by disparate sets of explanatory variables, and I describe the interrelationships between various governance decisions. Accordingly, the chapter contributes to the interorganizational governance literature in several ways. Although other studies have begun to examine combinations or portfolios of control modes (Kirsch, 1997), this research is one of the ﬁrst endeavours to explore sequences of interrelated

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governance decisions made during successive stages of an interorganizational life cycle (other examples are Heide, 2003, and Wathne and Heide, 2004). By proposing the concept of governance trajectories, I move the analytic focus from the application of singular governance mechanisms, towards series of governance decisions. The chapter thereby diﬀers from earlier governance analyses with the same or similar data in which either single governance decisions were studied (see Buskens, 2002; Rooks et al., 2006), or in which interorganizational governance was measured by additive measures capturing multiple governance decisions at once (Batenburg et al., 2003). Besides, the chapter diverts the primary focus in governance research from studying contracts to inquiries into other means of coordination and control. Interorganizational relationships are thereby portrayed as organizational forms that, either simultaneously or over time, operate distinct governance mechanisms for similar (Bradach and Eccles, 1989) and/or diﬀerent functions (Avadikyan et al., 2001). Although examinations of contract completeness have proliferated (Masten and Saussier, 2002), inquiries into other governance decisions, such as those concerning advance payment of suppliers or the use of standard-form contracts, are much scarcer. Similarly, limited research eﬀorts have been devoted to partner search and selection processes (e.g. Blumberg, 2001; Buskens et al., 2003b; Hitt et al., 2000), despite their inﬂuence on the mix of skills and resources available to interorganizational relationships (Geringer, 1991), and organizations’ apparent quests for suitable partners. Finally, this research renders empirical support for the assumption that governance decisions are intricately related to each other, and that governance decisions made early on in a relationship inﬂuence successive decisions. The chapter is organized as follows. First, I propose the concept of governance trajectories. I argue that governance decisions embedded in these trajectories have disparate antecedents, and that they possess signiﬁcant interrelationships with each other. To test these assertions, I subsequently analyse 911 buyer–supplier relationships involving IT suppliers and smalland medium-sized buyers. I conclude with a summary of the major ﬁndings.

THEORY ON INTERORGANIZATIONAL GOVERNANCE DECISIONS Organizations govern their interorganizational relationship by directing the behaviour and performance of participants in interorganizational relationships towards the production of actions desirable to the relationship

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or to themselves. They attempt to restrict the occurrence of problems arising from goal divergence and asymmetrical objectives (Buskens et al., 2003a; Doz, 1996; Ireland et al., 2002; Kale et al., 2000), by pursuing partial control over a partner’s resources and behaviour (Blumberg, 2001) and by limiting their potential for opportunistic behaviour (Williamson, 1985). Besides, governance eﬀorts may be directed towards minimizing coordination costs resulting from the complexity and uncertainty involved in managing a cooperative relationship (Park and Ungson, 2001) and at reducing the variability in partners’ expectations about the value that can be created in the relationship (Inkpen and Beamish, 1997). In other words, governance eﬀorts in interorganizational relationships are aimed at both control and coordination. They contemporaneously aﬀect value creation and value appropriation (Gulati and Singh, 1998; Gulati and Wang, 2003; Heiman and Nickerson, 2004). Hitherto, most governance research has devoted attention to contracting practices. However, Heide and John (1990) have demonstrated that governance can be accomplished in a more discriminating way, and that multiple mechanisms are often available to address a speciﬁc issue. Several governance mechanisms have been proposed to help circumvent, mitigate or alleviate coordination and control problems. These include, among others, exhaustive partner selection eﬀorts (Ireland et al., 2002), equity exchange between partners (Oxley, 1997) and partner negotiations (Adair and Brett, 2005; Ariño and Ring, 2004). In fact, organizations implement a variety of mechanisms or processes to ensure that tasks are conducted in a way that is consistent with organizational goals (Heide, 1994; Kirsch, 1997). It is presumed that these and other governance mechanisms are related to each other. In this regard, Klein (2002: 62), for instance, pointed out that ‘[i]ncreased contractual speciﬁcation involves rent-dissipating search and negotiation costs’. Others suggest that multiple governance mechanisms, including the selection of appropriate partners and alliance designs, jointly warrant value creation in interorganizational relationships (Reuer, 1999). However, not every governance mechanism may serve coordination and control in the same way. Whereas partner selection eﬀorts may be primarily directed at selecting a partner with appropriate knowledge and capabilities, drafting a contract might be predominantly required to mitigate ex post opportunistic behaviour by partners. Moreover, it has been noticed that diﬀerent governance mechanisms are used to facilitate coordination and control during successive stages of interorganizational collaboration. In her study of information systems development projects, for example, Kirsch (1997) ascertains that stakeholders implement a portfolio of control modes containing a mix of overlapping and redundant mechanisms. By

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deploying multiple governance mechanisms, managers develop competencies across an entire collaborative process, which makes them better equipped to capitalize on a wide array of opportunities for achieving eﬃciency and eﬀectiveness during the entire relationship (Cardinal et al., 2004; Simons, 1995). These assertions have led scholars to argue that research eﬀorts should be redirected from examining singular forms of governance to evaluating more complex governance systems (Long et al., 2002). Although research has been conducted into possible links between formal governance, prior experience and trust (see for instance Gulati, 1995; Luo, 2002; Poppo and Zenger, 2002), and into relationships between partner selection criteria and other governance decisions (Nielsen, 2003), inquiries into larger series of governance decisions have remained absent in the literature until now. In this chapter, I adopt the life-cycle metaphor of strategic alliances (De Rond, 2003; Reuer, 2000; Van de Ven, 1992) as a means to develop a more dynamic and integrative perspective on interorganizational governance.

SEQUENCES OF GOVERNANCE DECISIONS Congruent with life-cycle descriptions of interorganizational relationships, I propose the concept of governance trajectories. I deﬁne these trajectories as sequences of interrelated decisions that are made to control, direct or inﬂuence the actions and conduct of participants in interorganizational relationships during successive stages of an interorganizational life cycle. I discern three cooperative stages in which governance eﬀorts are known to be ubiquitous: the partner selection stage, the negotiation stage and the contracting stage. Each stage entails at least two decisions. During the partner selection stage, for example, decisions are made on the selection of a familiar or an unfamiliar partner, and on the exhaustiveness of partner selection eﬀorts. In the negotiation stage, decisions pertain to advance payments of suppliers or other partners and to the exhaustiveness of negotiations. Finally, in the contracting stage, collaborating parties decide whether to use standard-form contracts or not, and they determine to what extent contracts should be complete, complex and speciﬁc. The six governance decisions distinguished depend on diﬀerent sets of antecedents and on preceding governance decisions. In light of recent debates on the factors determining relationship eﬃciency and eﬀectiveness (Colombo, 2003; Heiman and Nickerson, 2004; Koza and Lewin, 1998; Madhok, 2002; Oxley, 1997; Reuer and Zollo, 2005; Takeishi, 2001), I include both organization- and exchange-level factors as explanatory variables of governance choices. In Figure 8.2., I depict the three governance

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(3) Advance Payment

Neg otia tio n

sta

ge

(4) Extensiveness Negotiations

(2) Selection Efforts

Interorganizational performance

(1) Prior Cooperation

(5) Standard Contract

Se

t lec

s ion

ta g e

Antecedents

on

c tra

g tin

sta

ge

Figure 8.2

C

(6) Contract Completeness

Governance trajectories

stages, the decisions associated with them, and their relationship with antecedents and interorganizational performance in an integrative conceptual framework. Consonant with life-cycle theories, I pay attention to the starting conditions, functional end-points, and the processes of change between them (Van de Ven, 1992). I brieﬂy elaborate on each governance stage and the decisions associated with it here, starting with the partner selection stage. Partner Selection Stage After an organization has made the decision to engage in an interorganizational relationship, the selection of an appropriate partner is the next critical event (Hitt et al., 2000). Partner selection refers to acts involved in identifying potential exchange partners and assessing their quality and intentions (Buskens et al., 2003b; Gulati, 1995; Rangan, 2000). The general purpose served by partner selection is to ‘proactively solve potential governance problems’ (Wathne and Heide, 2004: 75). Partner selection is crucial to interorganizational performance as it aﬀects the complementarity of allying ﬁrms and their combination of strengths and weaknesses (Doz and Hamel, 1998). It primarily entails two governance decisions. First, a focal

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organization has to decide whether it is desirable and possible to work with a familiar partner, or not. Second, a decision has to be made as to the amount of eﬀort that is invested in selecting a partner (Buskens et al., 2003b). Concerning the ﬁrst decision, it is recognized that organizations show a propensity to initiate interorganizational relationships with partners with which they have previously cooperated (Gulati, 1995; Gulati and Gargiulo, 1999; Kale et al., 2002). Cooperation with familiar partners is generally preferred above cooperation with organizations less well known to the focal organization, as familiar partners have had the opportunity to build up interorganizational trust (Gulati, 1995; Macaulay, 1963). Prior relationships also serve as repositories for information on a partner. They reduce the focal organization’s uncertainty about a partner’s intentions, interests, reliability, resources and capabilities (Gulati and Gargiulo, 1999; Li and Rowley, 2002; Rangan, 2000; Saxton, 1997). Focal organizations can, for example, ‘make vicarious inferences’ about the likely behaviour of their partners in new collaborative ventures by extrapolating past records into the future (Parkhe, 1998: 421).1 Moreover, familiar partners frequently intend to maintain a proﬁtable relationship during long time horizons, which reduces their scope for opportunistic behaviour (Lui and Ngo, 2004; Madhok, 1995; Palay, 1996; Ryall and Sampson, 2006). Besides, organizations are known to select familiar partners routinely, without engaging in exhaustive evaluation processes (Li and Rowley, 2002), as there are more certain rewards for exploiting existing relationships opposed to developing new relationships (March, 1991). The decision to select a familiar partner helps these organizations to circumvent the evaluation of potential partners with unknown characteristics and less predictable behaviour (Li and Rowley, 2002), and it prevents these organizations from selecting partners based on technical criteria (Hoetker, 2005). Finally, although the motives or inducements for selecting a familiar partner might be obvious, organization and relational characteristics can prohibit the selection of a familiar partner. The opportunities for selecting familiar partners may be restricted and opportunities to collaborate in general are not equally available to all organizations (Ahuja, 2000). Focal organizations, for example, might not have had prior relationships in a certain business area. I therefore conceptualize the selection of a familiar or an unfamiliar partner as an explicit governance decision, which is inﬂuenced by several relation- and organization-level characteristics. The second governance decision in the partner selection stage concerns the extent to which search and selection eﬀorts are employed for assessing whether an organization would be an appropriate partner for a particular cooperative endeavour. Although the eﬀorts put into partner selection

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comprise a distinct decision in the alliance formation process (Geringer, 1991; Nielsen, 2003), analysis of search and selection eﬀorts has been a rather neglected topic in the interorganizational governance literature (Blumberg, 2001; Nielsen, 2003). Search and selection eﬀorts have only recently attracted systematic attention in the theoretical and empirical literature on interorganizational network formation and dynamics (Buskens et al., 2003b). Despite a lack of clarity and insuﬃcient solid empirical evidence, researchers have maintained that partner selection is a major variable in the formation and operation of interorganizational relationships (Blumberg, 2001; Buskens et al., 2003b; Gulati and Gargiulo, 1999; Nielsen, 2003). It reputedly assists in assessing the overall viability of interorganizational relationships (Geringer, 1991) and in reducing the occurrence of problems and conﬂicts of interests stemming from cultural, organizational, resource and strategic misﬁts (e.g. see Barkema and Vermeulen, 1997; Lane and Lubatkin, 1998; Luo, 1997). In his analysis of 116 international joint ventures, for example, Luo (1997) revealed that partner selection inﬂuenced ﬁnancial returns, local market expansion, export growth, risk reduction and overall performance.2 Negotiation Stage Then negotiation stage typically encompasses activities concerned with relational positioning, identiﬁcation of the problem that has to be solved, generation of solutions, and reaching of agreement (Adair and Brett, 2005). During negotiations, partners exchange proposals for cooperation (Putnam, 2003) and participants in interorganizational relationships work towards agreement on key issues. During this stage, organizations have to at least make decisions on whether a partner has to be paid in advance, and on the appropriate length or exhaustiveness of negotiations. With respect to the ﬁrst decision, I note that equity exchange between partners has received abundant attention in alliance research. In particular, the alliance literature is infested with studies focusing on the choice between equity and non-equity relationships (see Gulati and Singh, 1998; Oxley, 1997). However, other types of cooperation, such as buyer–supplier relationships, also entail decisions on equity transfer. Buyers and suppliers jointly decide whether advance payments for products and services are made. Advance or up-front payments minimize the risk of hold-up experienced by a supplier (Helm and Kloyer, 2004). When higher risks are anticipated, advance payments become more probable. Therefore, advance payment is likely to be dependent on factors such as the ﬁnancial volume associated with a transaction and the ﬁnancial strength of both parties. Advance payments may subsequently inﬂuence successive governance decisions,

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as they pose additional risks for buyers, aggravating their dependence on suppliers. Next to advance payments, this stage is reminiscent of a focus on formal bargaining processes surrounding the logic of a business proposal (Ariño and Ring, 2004). Bargaining is deﬁned as the process whereby, in the face of resistance, parties rearrange their mutual distributions of obligations, beneﬁts and burdens (Dwyer et al., 1987: 16). The extent of these negotiations is conceptually diﬀerent from search and selection eﬀorts and from contractual issues. Search and selection eﬀorts, for example, might improve one’s ability to negotiate, whereas partners might not be able to lay down issues that are ﬁercely negotiated, owing to bounded rationality and the existence of a plethora of unforeseen contingencies. Furthermore, they might be reluctant to lay down certain outcomes of their negotiations, as these might lead to hold-up problems (see Klein, 2002), high transaction costs (Williamson, 1985) or a deteriorated bargaining position (Eggleston et al., 2000; Olekalns and Smith, 2006). The extent of negotiations thus forms a separate means to coordinate and control in interorganizational relationships. Contracting Stage In the contracting stage, parties have to make decisions involving formalization. In particular, parties have to choose whether standard contracts are being applied and they have to ascertain how complete, speciﬁc and complex contracts should be. On the one hand, standard contracts lower the eﬀorts required to specify or compose contracts, and they enable fast interaction with a broad range of partners. Furthermore, the clarity of terms in standard contracts can reduce the strain on interpretive practices, and minimize the risk of inconsistent interpretations of contract clauses (Epstein, 1999). On the other hand, standard contracts have been argued to preclude active buyer involvement and ﬂexibility. They are reputed to reﬂect the requirements of the organization that formulated the contract, possibly leading to dissatisfaction on the part of partners. Standard contracts between hardware or software suppliers and buyers, for instance, usually beneﬁt suppliers (e.g. Asner, 1983; Nevers, 1987). In general, standard contracts initiated by suppliers merit scrutiny, as buyers are boundedly rational, and mainly consider contracting terms that are salient when relationships commence. Besides, buyers often fail to read the terms in standard form contracts, as the usual content of standard contract terms makes them unlikely to attract a buyer’s attention, and because search and deliberation costs, which are necessary to understand the contract terms, are high (Eisenberg, 1995). This endows

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suppliers with the ‘incentive to draft non-salient contract terms to their own advantage’ (Korobkin, 2003: 1207). The foregoing assertions indicate that the decision to apply standard or non-standard contracts is a signiﬁcant one. The second decision in this stage concerns the degree of contracting. Contractual detail, speciﬁcity, completeness or complexity have frequently served as proxies for the extent to which participants in interorganizational relationships attempt to coordinate and control interorganizational activities and outcomes (e.g. Anand and Khanna, 2000b; Masten and Saussier, 2002). Although higher levels of contract completeness facilitate coordination and control, they also entail higher costs (Williamson, 1985), reduced ﬂexibility (Luo, 2002; Mintzberg, 1994) and a loss of entrepreneurship (Foss et al., 2007). This dilemma heightens the salience of contract completeness decisions.

INTERRELATIONSHIPS BETWEEN GOVERNANCE DECISIONS Relatively little is known about why and in what way governance mechanisms are combined (Kirsch, 1997). Argyres and Liebeskind (1999) introduced the notion of governance inseparability to describe situations where there are interdependencies between governance decisions, and where prior governance choices constrain or enable subsequent choices. Leiblein adds that ‘a ﬁrm’s past and current governance decisions constrain [and enable] the range and types of governance mechanisms that it can adopt in subsequent exchanges’. More generally speaking, Avadikyan et al. (2001: 1448) suggests that the life of an interorganizational relationship should be considered as ‘a succession of [value] allocation and creation problems and the events taking place within a given phase have strong impacts on the following periods’. Although these and other researchers have presumed potential interdependencies across individual governance decisions (Ghosh and John, 1999; Heide, 2003), it is unclear as to what the nature of these interdependencies is. Authors have suggested that some governance decisions might serve as constraints on subsequent attempts to coordinate and control activities and outcomes (Heide, 1994). Others have demonstrated that governance decisions made at the beginning of relationships inﬂuence governance decisions made later on. The selection of a familiar partner, for example, has been found to inﬂuence contract completeness, as the need to reduce opportunistic behaviour is probably lower (Gulati, 1995), whereas the ability to contract tends to be higher (Poppo and Zenger, 2002). Similarly,

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higher selection eﬀorts might enhance partners’ abilities to record certain issues, heightening levels of contract completeness. It appears that combinations of governance mechanisms generate positive synergy or negative tensions (Cardinal, 2001), making examinations of the way governance decisions relate to each other highly pertinent (Heide, 1994; Reuer, 2000). The six governance decisions that have been identiﬁed here should each at least possess one direct link with another governance decision, for the concept of governance trajectories to be of any value. In fact, if governance decisions are independent from each other, investigations of singular decisions remain appropriate. I formally state this in my ﬁrst hypothesis. Hypothesis 8.1 Each of the six governance decisions in the selection, negotiation, and contracting stages at least inﬂuences, or is inﬂuenced by another governance decision in the same governance trajectory.

ANTECEDENT SETS OF GOVERNANCE DECISIONS I am interested in whether the antecedents of the six governance choices diﬀer.3 If this appears to be the case, the value of studying entire governance trajectories would increase as opposed to investigating singular governance decisions. After all, in their eﬀorts to coordinate and control, organizations are likely to deploy those governance mechanisms that ﬁt most with the characteristics of the organization and the speciﬁc relationship (Colombo, 2003; Madhok, 2002). Coordination and control requirements that cannot be fulﬁlled by a particular governance mechanism might be accomplished through other governance mechanisms, depending on the characteristics of the organizations involved in the relationship and the characteristics of the relationship itself. Examining the connections between antecedents and a range of governance decisions appears to oﬀer a more comprehensive picture of partners’ governance eﬀorts in this case. Conversely, when each of the governance mechanisms discerned has the same set of antecedents, investigating singular governance decisions suﬃces. In this case, results for one type of governance decision can serve as a basis for inferences about other decisions. Consistent with prior work (e.g. Chen, 2003; Reuer and Zollo, 2005; Saxton, 1997), and in line with recommendations by Colombo (2003), Heiman and Nickerson (2004), Madhok (2002), Reuer and Zollo (2005) and Takeishi (2001), I include both organization- and exchange-level factors as explanatory variables of governance choices. This also conforms with Williamson’s (1999: 1103) argument that, rather than ask the question

216

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what is the best way to organize X, which is the traditional transaction cost query, the question to be put instead is ‘How should ﬁrm A [. . .] organize X?’ This also aligns with ﬁndings from McGahan and Villalonga (2003) that governance forms depend on enduring ﬁrm characteristics. Not only do transaction particulars matter, but also ﬁrm characteristics, like resources, governance skills and experience (Madhok, 2002). However, ‘little has been done speciﬁcally in examining the eﬀect of partner characteristics on the choice of alliance forms’ (Chen, 2003: 115). Colombo (2003: 1224) therefore remarks that ‘bringing the consideration of ﬁrms’ idiosyncratic capabilities into the governance question [. . .] is a valuable complementary addition to more traditional arguments based on TCE and other contractual theories’. The eﬀects of most of these antecedents on each of the governance decisions are intuitively straightforward; antecedents inﬂuence the need for coordination and control, or the ability to do so (Gerwin, 2004; Helm and Kloyer, 2004), or both by means of the governance mechanism in question. Based on existing literature, I distinguish several relationallevel and organization-level antecedents that have been found to relate to one or more of the six governance decisions. Relational-level antecedents include the ﬁnancial volume, complexity and asset-speciﬁcity involved in a relationship, and the measurability of inputs, outputs and behaviour. Organization-level variables predicting governance decisions include the size of the organizations involved, their expertise with respect to legal issues and considering the goods and services exchanged, and their experience with other interorganizational relationships. As some context-structure boundaries might be more salient predictors of structure and performance than others (Khandwalla, 1974) and because multiple contextual factors might have conﬂicting implications for the appropriate structure of an organization (Child, 1997), I take into account a broad range of antecedent variables here. When diﬀerent governance strategies are found to be appropriate under diﬀerent conditions, this would provide support for the fact that interorganizational governance is a heterogeneous phenomenon, subject to systematic variation (Heide, 1994; Macneil, 1980). It would not imply that ‘conditions’ for applying diﬀerent governance mechanisms are mutually exclusive (Grandori, 2000), since antecedent sets of various governance decisions may partly overlap. However, as long as entire sets of antecedents predicting distinct governance decisions do not coincide, this would demonstrate the eﬃcacy of the concept of governance trajectories. In line with this, I propose that the six governance decisions have disparate sets of antecedents..

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Hypothesis 8.2 Each of the six governance decisions in the selection, negotiation and contracting stages is associated with different sets of organization-level and relational-level antecedents.

METHOD Gathering longitudinal data to examine process dynamics across collaborative stages is extremely hard. Analogously to Jap and Ganesan (2000), I therefore examine data that have been collected at one point in time, and I classify variables along diﬀerent stages of a relationship. Subsequently, I perform ordinary logistic regression to explain variation in governance mechanisms which are measured on continuous scales, and I apply logistic regression analyses to predict the application of governance mechanisms that are measured on dichotomous scales. Although my results are generally consistent with other research based on the same data (see Batenburg et al., 2003; Buskens, 2002; Rooks et al., 2006), I shift the analytic focus from the application of singular governance mechanisms towards series of governance decisions. My analysis diﬀers from these studies, because they either involve a smaller number of governance mechanisms (Buskens, 2002; Rooks et al., 2006) or because they reduce the governance mechanisms that I distinguish to one additive measure (Batenburg et al., 2003). To circumvent duplication, I refer to Appendix B for the measurement of the variables used in this study.

RESULTS I argued that, if governance decisions at various stages of cooperation are inﬂuenced by diﬀerent antecedents, and if they show an association with at least one other governance decision in the same relationship, this would support my conceptualization of governance trajectories. Before drawing any conclusions, several steps have to be taken. First, I oﬀer numerous descriptive statistics of the data used in the analyses. The three dichotomous governance decisions show signiﬁcant variance, as is depicted in Figures 8.3 to 8.5. It appears that a familiar partner is selected in about half of the cases in the sample. Advance payment of a supplier occurs in around 25 per cent of the cases, whereas standard contracts are used in the majority of the relationships studied. The extent of selection eﬀorts, negotiations and contract completeness are not visualized, but they exhibit normal distributions. Table 8.1 depicts correlations between the six governance decisions (Appendix D presents the remainder of the correlations). Familiarity is associated with lower selection eﬀorts, fewer instances of advance

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Contracts and trust in alliances

Table 8.1

Bivariate correlations*

Prior cooperation Selection eﬀorts Advance payment Negotiations Standard contract Contract completeness

Mean

SD

0.50 1.58 0.26 40.2 0.70 10.7

0.50 0.71 0.44 7.86 0.46 5.84

1

2

3

4

5

1.00 0.18 1.00 0.10 0.15 1.00 0.13 0.38 0.14 1.00 0.02 0.16 0.16 0.16 1.00 0.13 0.41 0.21 0.58 0.10

6

1.00

* Correlations with binary variables consist of Kendall’s tau-b. Correlations higher than 0.072 are significant at the 0.05 level. Correlations higher than 0.085 are significant at the 0.01 level.

payment, less exhaustive negotiations and less complete contracts. The correlations between the other governance mechanisms all favour a complementarity view on governance mechanisms. Selection eﬀorts, advance payment, exhaustiveness of negotiations and contract completeness exhibit positive relations with each other, while they correlate negatively with the application of standard contracts. In order to test the hypotheses, I now perform binary logistic regression analyses (for dichotomous governance decisions) and multiple regression analyses (for governance decisions with a continuous character). 700

800

600

600

500

600

500

400

400 300

400

300

200

0

200

200

100

100 No

Figure 8.3 Prior cooperation

Yes

0

0 No

Figure 8.4 Advance payment

Yes

No

Yes

Figure 8.5 Standard contract

BINARY LOGISTIC REGRESSION ANALYSES The objective of the binary logistic regression analyses is to predict correctly decisions concerning collaboration with a familiar or an unfamiliar partner,

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Governance trajectories

Table 8.2

Compilation of classification and fit statistics

Prior cooperation Predicted

Observed

No Yes

No 132 74

Yes 73 141

Overall percentage Hosmer–Lemehow test Nagelkerke R2

65.0 0.77 0.17

Advance payment

Observed

Predicted No Yes

No 285 92

Yes 13 27

Overall percentage Hosmer–Lemehow test Nagelkerke R2

Overall percentage Hosmer–Lemehow test Nagelkerke R2

% Correct 95.6 22.7 74.8 0.29 0.15

Standard contract

Observed

% Correct 64.4 65.6

Predicted No Yes

No 50 25

Yes 82 239

% Correct 37.9 90.5 73.0 0.27 0.19

advance payment of a supplier and the application of standard contracts. Predictions of these decisions for particular interorganizational relationships are based on the values of organization- and relation-level antecedents, which were distinguished earlier. The prediction equations equal: eB0B1FINANCIAL VOLUMEB2COMPLEXITY . . .. . . B15AGE RESPONDENT Prob(Y) 1 eB0B1FINANCIAL VOLUMEB2COMPLEXITY . . .. . . B15AGE RESPONDENT

Table 8.2 exhibits a compilation of classiﬁcation and ﬁt statistics for the analyses of each of the three dichotomous governance decisions. The inquiry into the decision to select a familiar or an unfamiliar partner, for example, encompasses 420 observations. In 215 instances, previous cooperation had

220

Table 8.3

Contracts and trust in alliances

Results: binary logistic regression analyses Prior cooperation

Advance payment

Standard contract

B

B

B

Sig. Exp(B)

Sig. Exp(B)

0.86 0.39 *** 0.92 0.10 0.88 0.01 1.10 0.01

1.48 1.11 1.00 1.01

0.29 *** 0.15 ** 0.02 0.01

0.75 0.86 1.02 1.01

Size buyer 0.01 Size supplier 0.00 Legal expertise 0.01 Other relationships 0.01 IT expertise 0.39

1.01 0.04 1.00 0.01 1.01 0.20 1.01 0.39 0.68 0.20

0.96 1.01 1.22 1.47 0.82

0.47 *** 0.39 *** 0.10 0.02 0.19

0.63 1.47 1.11 0.98 1.21

Reputation 0.11 * Alternatives 0.11 * Dependence 0.25 ** First user group 0.50 ** Age supplier 0.34 *** Age of respondent 0.01 Constant 1.06

1.11 0.01 1.11 0.07 1.28 0.19 * 0.61 0.34 1.40 0.34 *** 0.99 0.01 0.06 2.59 ***

1.01 0.93 1.20 1.40 0.71 1.01 0.08

0.03 0.08 0.22 ** 0.28 0.04 0.02 5.17 ***

1.03 0.93 0.81 1.32 0.96 0.98 175.0

No. of observations † Hosmer–Lemehow test Nagelkerke R2

420 0.77 0.17

417 0.29 0.15

Financial volume Complexity Asset-specificity Measurability

0.15 0.09 0.12 *** 0.09 **

Sig. Exp(B)

396 0.27 0.19

†

Owing to the fact that the number of observations per variable was large, cases with missing values were excluded listwise. Correlations significant at the 0.10-level (*); correlations significant at the 0.05-level (**); correlations significant at the 0.01-level (***).

taken place, rendering 51.2 per cent of predictions as being correct if no explanatory variables were included in the analysis. Instead, the model predicts 65 per cent of the cases correctly. Nagelkerke R2, an alternative measure of the amount of explained variance for binary logistic regression analyses, equals 0.174. The p-value of the Hosmer–Lemehow test indicates that all models adequately ﬁt the data (see Tabachnick and Fidell, 1996). Table 8.3 displays the results from the binary logistic regression analyses. Higher degrees of asset-speciﬁcity are associated with a lower likelihood that a familiar partner is selected. This ﬁnding suggests that buyers in interorganizational relationships might beneﬁt from relation-speciﬁc investments, which they have made in earlier transactions with the same

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221

supplier. Congruent with arguments from Lane and Lubatkin (1998), Dyer and Singh (1998) and Zollo et al. (2002), I therefore suggest that organizations tend to select familiar partners for their collaborative ventures because this reduces investments required for developing knowledgesharing routines and partner-speciﬁc knowledge, which are likely to have already taken place in prior exchanges between these organizations. In Williamson’s (1999: 1103) words ‘the alignment calculus will be tilted in favour of the form that possesses such specialized’ capacity. This ﬁnding thus lends support to Williamson’s (1985) description of the ‘fundamental transformation’ phenomenon. Williamson argues that, in the presence of relation-speciﬁc investments – in this case, investments that have been conducted in previous exchanges – partners can create higher gains from trade if they stay together, than if they separate. When partners have already committed themselves to each other through previous investments in coordination mechanisms, which aid in the governance of subsequent interactions, for example, they have to invest less during new transactions with the same partner (Richardson, 1972; Sobrero and Roberts, 2002). Relation-speciﬁc assets thus foster long-term and repeat relationships (Brown et al., 2004). In relationships marked by high measurability, high importance of reputation and large numbers of alternative options, cooperation with a familiar partner is more likely, suggesting that buyers revert to suppliers they know when assessments of product or service quality are more diﬃcult, or when products are highly standardized. The positive relationship between measurability and the selection of a familiar partner corroborates Hoetker’s (2005) ﬁnding that notebook computer manufacturers tend to opt for more hierarchical governance choices when uncertainty increases. In this chapter, higher measurability appears to be associated with the selection of a familiar partner, suggesting that uncertainty reduction stemming from learning (see also Williamson, 1999) was one of the factors inﬂuencing partner selection. The positive association between the selection of a familiar partner and perceived dependence suggests that organizations are occasionally forced to work with a familiar partner, possibly owing to lock-in eﬀects or relation-speciﬁc investments made earlier on. This could explain why organizations turn to familiar partners for new cooperative endeavours even though partner-speciﬁc experience has been found to inﬂuence interorganizational performance adversely (Hoang and Rothaermel, 2005). Klein Woolthuis et al. (2005) oﬀer an example of this eﬀect in their description of a cooperative relationship between FoodCom, a large producer and seller of specialty foods, and Processor, a ﬁrm specialized in developing a wide range of food ingredients. They remark that ‘the reason that the partners did cooperate again was due to FoodCom’s dependence on Processor’s specialist

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Contracts and trust in alliances

knowledge, for which FoodCom had very few alternative partners to turn to’ (Klein Woolthuis et al., 2005: 823). When the buyer belongs to the ﬁrst user group in its industry, cooperation with a familiar partner also becomes less likely, as previous cooperation has probably never taken place between any of the potential partners. Finally, the older the supplier, the more likely it seems to be that the partners have cooperated before. The odds ratios indicate that the most inﬂuential antecedents consist of age of the supplier, ﬁrst user group and perceived dependence. The odds that a buyer selects a familiar partner, for example, decrease by a factor of 0.609 when it belongs to the ﬁrst user group of a product in its industry. These ﬁndings suggest that the selection of a familiar partner is not only inspired by a focal organization’s ability to discern capable and reliable partners, or the routinized and standardized selection of partners (Li and Rowley, 2002). It is also determined by the availability of familiar partners (see also Singh and Mitchell, 2005), which is partly determined by the age of a familiar partner, and whether the focal organization belongs to the ﬁrst user group. Moreover, it is inﬂuenced by the diﬃculty on the part of focal organizations to break away from familiar partners (e.g. Lazzarini et al., 2007), as indicated by investments in relation-speciﬁc assets performed during earlier interactions, and the perceived degree of dependence on a familiar partner. The ﬁndings reveal that collaborations between familiar partners are probably reminiscent of lower degrees of asset-speciﬁcity, and higher degrees of measurability and perceived dependence. They are also more likely to involve older supplier organizations. The decision to pay a supplier in advance or not was found to be predicted by the ﬁnancial volume involved in a relationship and the perceived dependence of a buyer on a supplier. Both variables had a positive relationship with advance payments. In contrast, the supplier’s age had a signiﬁcant negative inﬂuence on the likelihood that a supplier was paid in advance. The odds ratios indicate that the most inﬂuential antecedent of advance payment consists of the ﬁnancial volume involved in a relationship. When the ﬁnancial volume increases by one level, the odds that advance payments are made grows by a factor 1.480. This indicates that suppliers primarily demand advance payments from their buyers when the ﬁnancial volume associated with an interorganizational relationship carries signiﬁcant costs and/or risks if not passed on to the buyer. Antecedents of the use of standard contracts consist of ﬁnancial volume, complexity, size of the buyer and perceived dependence. These are all found to have a negative association with the use of standard contracts. Besides, the size of a supplier assumes a positive relationship with the use of standard contracts. Here, the odds ratios indicate that the most inﬂuential antecedents consist

Governance trajectories

223

of size of the buyer and size of the supplier. This might be explained by the fact that larger suppliers possess more resources and experience to develop standard contracts, and that they have better opportunities for leveraging standard contracts over a larger number of transactions. Given that standard contracts are generally beneﬁcial to suppliers (Korobkin, 2003), the ﬁnding that larger buyers show stronger resistance to the application of standard contracts is not surprising.

MULTIPLE REGRESSION ANALYSES The three other governance decisions pertain to the eﬀorts put into partner selection processes, the exhaustiveness of negotiation processes and the level of contract completeness. As these variables are measured on continuous scales, multiple regression analyses are performed. The models are speciﬁed accordingly: Y0 1 Financial volume2 Complexity . . . 15 Age. Table 8.4 displays the results of the regression analyses. Approximately 30 per cent of the variance in selection eﬀorts is explained by the speciﬁed antecedents (R2 adjusted0.297). Consistent with previous work on partner selection (Buskens, 2002; Buskens et al., 2003b), selection eﬀorts are inﬂuenced by ﬁnancial volume, importance of reputation and the prevalence of other relationships between a buyer and external organizations, which have a signiﬁcant positive association with selection eﬀorts. Investments in relation-speciﬁc assets tend to increase the exhaustiveness of ﬁrms’ selection eﬀorts, something consistent with previous ﬁndings (e.g. Heide and John, 1990). Measurability appears to have a negative eﬀect on search and selection eﬀorts, which is congruent with descriptions of partner selection eﬀorts as being driven by uncertainty (Beckman et al., 2004). Finally, a supplier’s age also negatively inﬂuences search and selection eﬀorts, which can be explained by the fact that older suppliers have better-known accomplishment records, while they might also be perceived as being less risky business partners. Considering negotiation exhaustiveness, the speciﬁed antecedents explain almost 25 per cent of the variance. Financial volume, complexity, asset-speciﬁcity, size of the supplier, importance of reputation and perceived dependence are found to have a signiﬁcant positive association with the extent of negotiations. Age of the supplier and age of the respondent exhibit a signiﬁcant negative relationship to negotiation exhaustiveness. Finally, the speciﬁed antecedents explain more than 30 per cent of the

224

Table 8.4

Contracts and trust in alliances

Results: multiple regression analyses Selection eﬀorts B Sig.

Financial volume Complexity Asset-specificity Measurability Size buyer Size supplier Legal expertise Other relationships IT expertise Importance reputation Alternative options Perceived dependence First user group Age supplier Age of respondent Constant

Negotiation eﬀorts Contract complexity B Sig. B Sig.

0.32 *** 0.03 0.14 *** 0.18 **

0.14 ** 0.12 ** 0.12 ** 0.04

0.23 *** 0.08 * 0.07 0.10 **

0.05 0.06 0.07 0.09 ** 0.03

0.01 0.11 ** 0.06 0.02 0.03

0.04 0.30 *** 0.09 ** 0.00 0.04

0.24 *** 0.07 0.15 *** 0.04 0.12 ** 0.08 * 22.6 ***

0.16 *** 0.08 * 0.07 0.08 * 0.07 0.04 2.87

0.11 ** 0.01 0.05 0.02 0.09 * 0.02 0.42

Number of observations† 406 R2 adjusted 0.30

419 0.25

419 0.31

†

Owing to the fact that the number of observations per variable was large, cases with missing values were excluded list-wise. Correlations significant at the 0.10-level (*); Correlations significant at the 0.05-level (**); correlations significant at the 0.01-level (***).

variance in contract completeness. Financial volume, complexity, measurability, the importance of reputation, legal expertise and the size of the supplier have a signiﬁcant positive relationship to contract completeness. The existence of alternative options and membership of a ﬁrst-user group have a negative relationship to contract completeness. The latter conforms with ﬁndings of Gainey and Klaas (2003) indicating that partners that are less experienced and knowledgeable about a certain type of relationship ﬁnd it more diﬃcult to avoid incomplete contracting. I now extend previous work by researchers using the same database (Batenburg et al., 2003; Buskens, 2002; Rooks et al., 2006) by assessing whether previous governance decisions inﬂuence subsequent governance decisions. I perform hierarchical analyses in which I add preceding governance decisions in the analyses one at a time. In Appendix E, I furnish an overview of the relationships between the antecedents and the six governance decisions. In the models with extensions b, c, d, e and f, I subse-

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225

quently add the variables familiarity with a partner, selection eﬀorts, advance payments, negotiation eﬀort and standard contract as explanatory variables for subsequent governance decisions. It appears that the decision to cooperate with a familiar partner has a negative eﬀect on selection eﬀorts, negotiation exhaustiveness and contract completeness. The latter corroborates ﬁndings from Anand and Khanna (2000b) who suggested that contracts between familiar organizations are systematically diﬀerent from the ones in de novo pairings. It also conforms to the observation from Klein Woolthuis et al. (2005: 828) that some ﬁrms do not fear opportunism when negotiating and contracting, because of their earlier experience with the other party. This ﬁnding might further indicate that a greater familiarity between partners may shift their focus from value appropriation concerns to value creation issues (Koka and Prescott, 2002). Selection eﬀorts, in turn, positively inﬂuence negotiation eﬀorts and contract completeness, while they exhibit a negative relationship to the use of standard contracts. This conﬁrms Rooks’ (2002) assertion that search and selection is a potential mediator of the relationship between antecedents and formalization. However, although searching, screening and selecting suppliers and products helps to reduce the risk related to a transaction as it enables parties to assess the reliability and competence of a potential supplier, their positive inﬂuence on contractual complexity seems to indicate that their eﬀect on the ability to formalize is stronger than their eﬀect on the need to formalize. Advance payment, in turn, does not appear to be inﬂuenced by other governance decisions, but it does itself inﬂuence the degree of contract completeness. Finally, the exhaustiveness of negotiations reduces the use of standard contracts and propagates contract completeness. In Figure 8.6, I have depicted the interrelationships found between the governance decisions and the relationships between sets of signiﬁcant antecedents and each of the governance decisions. It appears that each of the governance decisions discerned in the chapter at least inﬂuences one other governance decision in the same governance trajectory, which leads us to accept hypothesis 8.1. Moreover, each of the six governance decisions discerned is associated with diﬀerent sets of organization-level and relationallevel antecedents, supporting hypothesis 8.2.

DISCUSSION In theme six, I noticed that ﬁndings from empirical investigations on interorganizational governance frequently concentrate on single governance modes in isolation (Kirsch, 1997) and that most studies on interorganizational governance are not integrative across mechanisms, with each study considering

226

Contracts and trust in alliances + + + + +

Financial volume + Perceived dependence + Other relationships –

Complexity Importance reputation Perceived dependence Size supplier Age of the respondent

Neg otia (3) Advance payment

(2) Selection efforts

t ag e ction s

– +

–

(1) Prior cooperation

(5) Standard contract

–

–

Financial volume Size supplier Legal expertise IT expertise Age of the respondent

ge sta

– – + + + – +

+ + + – +

Co nt ra c

(6) Contract completeness

Asset-specificity Measurability Importance reputation Alternative options Perceived dependence First user group Age supplier

ge

g

Sele

+

+

–

sta

+ + + + –

(4) Extensiveness negotiations

+ –

tion

tin

Financial volume Asset-specificity Measurability Importance reputation Other relationships

Financial volume Complexity Size buyer Size supplier Age of the respondent

– – – + –

Figure 8.6 Relationships between governance decisions and sets of antecedents one or two rather than a range of mechanisms (Geringer and Hébert, 1989). However, examining only one or two governance mechanisms at a time is at odds with the observations that multiple mechanisms are strongly interrelated and that they all have their bearing on interorganizational performance.

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Reuer (1999), for instance, contends that potential value creation in interorganizational relationships warrants appropriate selection of partners, alliance designs and adaptations by the partners. The disparity between managers facing a plethora of presumably connected governance choices, and the attention that researchers have given to the connections between these choices, led me to introduce the concept of governance trajectories. I proposed that these trajectories are composed of multiple interrelated governance decisions, each of which is predicted by diﬀerent sets of antecedent variables. Findings on a sample of 911 buyer–supplier relationships support my assertions, suggesting that governance eﬀorts can no longer be conceptualized as one-time events. It appears that managers govern their relationships during multiple stages of development, and that the decisions they make early on in a relationship inﬂuence the decisions they make in later stages. Moreover, congruent with evidence from, amongst others, Chalos and O’Connor (2004), interorganizational governance decisions appear to be inﬂuenced by diﬀerent sets of antecedents. This implies that, although certain context and task characteristics might prohibit the application of particular governance mechanisms, they may not necessarily restrict the utilization of others. I therefore recommend managers to take multiple governance mechanisms, task characteristics and contextual attributes into account when deciding on how they want to govern their relationships. Beyond supporting my conceptualization of governance trajectories, the results encompass various ﬁndings related to each of the six governance mechanisms, on which I brieﬂy elaborate here. The negative relationship between investments in relation-speciﬁc assets and the selection of a familiar partner conﬁrms earlier ﬁndings and assertions on the signiﬁcance of developing partner-speciﬁc skills and routines (Dyer and Singh, 1998; Gulati and Wang, 2003; Kale et al., 2002; Kotabe et al., 2003; Luo, 2002; Zollo et al., 2002). Besides, the positive relationship between measurability and the selection of a familiar partner coincides with arguments that familiar partners develop joint understandings that allow uniquely eﬃcient communication, and which tend ‘to help mitigate coordination, conﬂict resolution, or information-gathering problems’ (Zollo et al., 2002: 703). Collectively, my ﬁndings suggest that the selection of familiar partners is not only determined by a focal organization’s ability to discern capable and reliable partners, or by the routinized and standardized selection of partners (Li and Rowley, 2002), but also by the sheer availability of partners (see also Singh and Mitchell, 2005) and by the diﬃculty involved in breaking away from a familiar partner (Lazzarini et al., 2007). Consistent with work from Ahuja (2000), this indicates that both inducements and opportunities (or needs and abilities) inﬂuence governance choices.

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As far as I am aware, the decision to pay a supplier in advance and the decision to apply standard contracts have seldom been analysed empirically. The results suggest that advance payment of suppliers primarily hinges on the ﬁnancial volume of a transaction, while the selection of standard contracts appeared to be inﬂuenced mainly by ﬁrm sizes. In addition, I analysed factors predicting the eﬀorts put into the selection of partners for a transaction. Although more and more attention is paid to partner selection in the empirical literature, most attention has been paid to selection criteria, which diﬀer per context and task characteristic (Geringer, 1991) and which complicate the generalization of ﬁndings from these studies. My ﬁndings on the factors determining selection eﬀorts can be more easily extrapolated to other interorganizational relationships, as the antecedents investigated have a more universal character. Particularly interesting was the observation that buyers that have more external relationships tend to exhibit more selection eﬀorts, which suggests that these organizations are probably more aware of the signiﬁcance of partner selection eﬀorts compared to more inward-looking companies. Regarding the exhaustiveness of negotiations and contract completeness, I observed that investments in relation-speciﬁc assets had a signiﬁcant positive relationship with the exhaustiveness of negotiations, but no relationship with contract completeness. This contrasts with empirical studies from, among others, Shelanski and Klein (1995), Masten (1996) and Rindﬂeisch and Heide (1997). It could indicate that buyers realize that they have to make relation-speciﬁc investments, but that they ﬁnd it diﬃcult to protect themselves against these risks by writing complete contracts. Another explanation would be that relation-speciﬁc investments are relevant to broad level governance choices, but not to narrower choices such as the level of contract completeness (see also Carson et al., 2006). Moreover, measurability was found not to be associated with negotiation exhaustiveness, whereas it did exhibit a positive relationship to contract completeness. This indicates that higher degrees of measurability might not inﬂuence the need for coordination and control, but only the ability to do so. Furthermore, in line with arguments from Colombo (2003), Madhok (2002) and Reuer and Zollo (2005), organization-speciﬁc factors appeared to inﬂuence governance decisions. Both negotiation eﬀorts and contract completeness were positively inﬂuenced by supplier size, while the presence of legal expertise on the part of the buyer raised contract completeness. Finally, I elucidated how diﬀerent governance decisions inﬂuence each other. It appeared that the decision to cooperate with a familiar partner has a negative eﬀect on selection eﬀorts, negotiation exhaustiveness and contract completeness. Selection eﬀorts, in turn, positively inﬂuence negotiations and contract completeness, while they exhibit a negative relation-

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ship to the use of standard contracts. Advance payment is not dependent on other governance decisions, but it does drive the degree of contract completeness. Finally, the exhaustiveness of negotiations reduces the use of standard contracts and propagates contract completeness. Theoretical and Practical Implications This research departed from prior studies by simultaneously considering the application of multiple governance mechanisms along diﬀerent stages in interorganizational relationships. Several theoretical and practical implications can be discerned. First, my ﬁndings imply that researchers might beneﬁt from shifting their attention from studying singular governance decisions to investigating series of governance decisions. As I have shown, intricate relationships exist between governance decisions, while each of these decisions is inﬂuenced by diﬀerent sets of antecedents. This suggests that more ﬁne-grained analyses of managers’ attempts to coordinate and control interorganizational behaviour and outcomes are needed. Managerial implications predominantly concern managers’ awareness of the eﬀects of governance decisions made in earlier stages of cooperation on decisions and outcomes in later stages of cooperation. It appears that managers might use interdependencies between governance decisions deliberately (Heide, 2003). They may invest more in partner selection, for instance, to increase their ability to negotiate with potential partners, to use bettertailored contracts, and to write more complete contracts. Limitations and Opportunities for Future Research This research entails several limitations as well, which could be addressed in future research. First, I did not include interorganizational performance in my analyses. Performing path-time analyses, which was beyond the scope of this chapter, could well elucidate how sequences of governance decisions jointly inﬂuence interorganizational performance. Future studies might measure the performance eﬀects related to the diﬀerent governance mechanisms and governance decisions. These measures could refer to the interaction process between partners and to the outcomes of interorganizational relationships (for a further elaboration on this distinction, see Ariño, 2003). Another possibility is to specify and measure explicitly the functions and dysfunctions mediating the relationship between each governance mechanism and interorganizational performance. Furthermore, Cardinal et al. (2004: 426) have advanced the view that, to be eﬀective, controls should be constantly rebalanced, like the eﬀective guided missile whose trajectories are rarely correct. Although I acknowledged the signiﬁcance of time, dynamics

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related to the continuous balancing of controls were not included in this chapter. Inquiries into day-to-day adaptations in contracts, rules and procedures might oﬀer us the opportunity to ascertain how we can make sure they achieve their targets. Finally, the data did not permit me to investigate the inﬂuence of network characteristics on organizations’ attempts to coordinate and control their interorganizational activities. Recent empirical studies (cf. Rowley et al., 2004) reveal that including network variables in interorganizational governance may oﬀer valuable new insights.

NOTES 1. Batenburg et al. (2003:170) found support for the signiﬁcance of prior cooperation for the selection of partners in novel transactions. In the same data-set as the one used in this study, they observed that hardly any of the cases in the data consists of business partners with a negative shared past. This suggests that searching for another partner is a highly likely response to a problematic transaction. 2. One should not forget that, similar to contracting, search and selection eﬀorts both have positive and negative eﬀects on interorganizational performance. Beyond some level, the accumulation of more information and the expenditure of more time on deliberation can involve costs that oﬀset advantages, and so diminish proﬁts (Furubotn, 2002: 92). 3. Explanations underlying the use of diﬀerent governance mechanisms have rarely been empirically investigated (for an exception, see Kumar and Seth, 1998).

9.

Discussion and conclusion

INTRODUCTION This manuscript started with the observation that, although interorganizational cooperation has become an important phenomenon in today’s business environment, it is also marked by many problems. I then advanced the view that these issues may be circumvented, mitigated or alleviated by adopting appropriate governance mechanisms. This requires better understandings of the forces shaping collaborative agreements (Olk and Elvira, 2001; Osborn and Hagedoorn, 1997) and of the processes that are used to design and manage interorganizational relationships. Such understandings would not only assist researchers in moving beyond a sheer focus on the coordination and control functions of formal governance and the antecedents– governance–performance framework (see Figure 1.5), but it would also contribute to improved managerial practices and a reduction in cooperative failures (Barringer and Harrison, 2000). In particular, I observed that several authors have pointed at the signiﬁcance of governance mechanisms and processes for interorganizational performance (e.g. Grandori and Soda, 1995; Masten and Saussier, 2002; Reuer, 1999; Sampson, 2004a; Zollo and Singh, 2004). Others have called for new inquiries into the skills, mechanisms and processes associated with the governance of interorganizational relationships (Colombo, 2003; Thatcher, 2004; Wright and Lockett, 2003). Some researchers have noted, for example, that ‘an integrated perspective that simultaneously considers the relationships between task characteristics, the contractual and procedural dimensions of inter-ﬁrm relationships and the outcome of the relation’ deserves more attention (Sobrero and Schrader, 1998: 601; see also Faems et al., 2007). Others have put forward that ‘the next step should be a more comprehensive perspective on governance’, as ‘it may be less fruitful to attempt to resolve past debates than it is to foster cross-pollination among diﬀerent perspectives’ (Shapira, 2000: 64). Jointly, these comments suggested that a critical examination of the role of governance in interorganizational relationships was necessary. However, as such an endeavour is unlikely to be valuable in the absence of a clear focus, I decided to investigate two types of governance mechanisms that have received considerable and increasing attention in the literature over the last few decades, namely 231

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contracting and trust. This led to a more reﬁned research question: what role do contracts and trust play in interorganizational relationships? To explore this issue, I built on the two main theoretical perspectives currently prevailing in the literature, which tend to focus either on the control or on the coordination function of interorganizational governance (Foss and Foss, 2005; Gulati and Singh, 1998; Madhok, 2002; Salbu, 1997). I contended that contributions to this literature typically inquire into the relationship between various governance mechanisms or processes and its antecedents, or into their relationship with performance (e.g. see Anderson and Dekker, 2005; Leiblein, 2003; Mayer and Nickerson, 2005; Poppo and Zenger, 2002; Sampson, 2004a; Sobrero and Schrader, 1998; Stinchcombe, 2001). The ﬁrst group of inquiries presumes that antecedents of governance mechanisms and processes, such as complexity, asset-speciﬁcity or measurability, are associated with the need or the ability to coordinate and control interorganizational behaviour and outcomes (e.g. Barthélemy and Quélin, 2006; Carson et al., 2006; Gerwin, 2004; Geyskens et al., 2006; Helm and Kloyer, 2004; Luo, 2002; Reuer and Ariño, 2007). The second category of studies focuses on the relationship between governance and interorganizational performance (e.g. Sobrero and Schrader, 1998; Mayer and Nickerson, 2005; Poppo and Zenger, 2002; Rooks et al., 2006; Sampson, 2004a, 2007). I captured these generic approaches to the research problem in what I call the antecedents–governance–performance framework (see Figure 1.5). I then claimed that, although the richness and variety of previous studies focusing on the antecedents–governance–performance framework have signiﬁcantly contributed to our understanding, an integrative perspective on the role of contracts and trust in interorganizational relationships has remained absent in the literature thus far (e.g. Faems et al., 2007; Foss, 1999; Leiblein, 2003; Sobrero and Schrader, 1998; Stinchcombe, 2001). In previous chapters, I have therefore constructed such a perspective around the integrative framework presented in Figure 1.6. I have illustrated that contracting and trust are aﬀected by organization-, exchange- and contextlevel antecedents and I have shown that these antecedents may inﬂuence the ability as well as the need to write and apply contracts and to trust a partner. Moreover, the framework shows that contracting and trust aﬀect performance, as both governance mechanisms exhibit positive as well as negative consequences, or functions and dysfunctions. Finally, yet importantly, I have clariﬁed that the performance eﬀects of contracting and trust can be categorized in terms of value creation and value appropriation, i.e. constructs that are common to the literature, as well as value discovery. I subsequently formulated six research themes to explore the research framework in more depth.

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MAJOR FINDINGS FOR ALL THEMES A summary of the major research questions and ﬁndings for each of the six themes can be found in Figure 9.1. In theme one, I investigated how the ability and the need to contract would eventually inﬂuence the degree of contracting in interorganizational relationships. I noticed that the literature reveals contradictory ﬁndings regarding the direction of a number of

Central to theme one: How managers cope with tensions between the need and the ability to contract. When a need– ability paradox prevails, firms tend to invest in information processing & sensemaking (e.g. time spent on partner selection/negotiation), to enable contracting

Central to theme two: The coevolution of contracting and trust. Intermediate degrees of both governance forms appear most conducive to performance and starting conditions have a fundamental impact on the evolution of collaboration in later stages of development

Need to govern

Antecedents Organization level Exchange level Context level

Positive consequences

Performance Value discovery Value creation Value appropriation

Governance Contracting Trust

Ability to govern

Central to theme four: How managers cope with tensions arising from the coexistence of formalization’s functions and dysfunctions. They may (1) emphasize the different requirements of firms, (2) refer to factors that appear to be beyond their control, and (3) adopt semi-structures

Figure 9.1

Central to theme three: Contracting functions as a means to give, make, demand and break sense of one’s partners, relationships and the collaborative contexts in which they are embedded. These acts result in understandings that enhance value creation in multiple ways

Negative consequences

Central to theme five: How standardization of negotiation & contracting procedures moderates relations in the antecedents–contracting– performance framework. It attenuates these relations, because it inhibits the ‘meeting of minds’ and induces mindless behaviour

Central to theme six: Contracting’s relationship to other governance decisions. Contracting is influenced by decisions taken during partner selection and negotiation stages, while different sets of exchange and organization characteris tics shape distinct governance decisions

Research framework: overview contributions of the six themes

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relationships between antecedents and contracting, which needed to be reconciled. This led to the following research questions. RQ To what extent do relationships between antecedents and the ability to contract diverge from their relationships with the need to contract? RQ How do partners in interorganizational relationships cope with the tensions between the need and the ability to contract (i.e. the need–ability governance paradox)? My ﬁndings extend previous theoretical work on contracting by underscoring the idea that antecedents that are commonly associated with formal governance (e.g. investments in relation-speciﬁc assets, interorganizational complexity, cooperation with an unfamiliar partner, and small focal organizations) give rise to multiple, contradictory forces. In particular, they may increase the need to contract activities and outcomes, but they concurrently diminish the ability to do so. From the results, it accrues that tensions resulting from the coexistence of these two forces induce participants in interorganizational relationships to invest in information processing and sensemaking activities, in order to make sure that contracting can be appropriately applied. Main ﬁnding theme one Antecedents that are commonly associated with formal governance may increase the need to contract activities and outcomes, while they concurrently diminish the ability to do so. Firms tend to cope with this need–ability governance paradox by investing in information-processing and sensemaking activities (so as to facilitate contracting in situations for which this is hard). In theme two, I built on the observation that the relationship between formal and relational governance, in particular that between contracting and trust, requires more attention. Empirical results, for example, ‘suggest a need to explore more carefully and predict more cautiously the relationship between formal contracts and relational governance’ (Poppo and Zenger, 2002: 721). More speciﬁcally, researchers have noted that little attention has been paid to the evolution of both phenomena in cooperative relationships (De Wever et al., 2005; Inkpen and Curtall, 2004; for notable exceptions, see Ferrin et al., 2005; Klein Woolthuis et al., 2005; Serva et al., 2005). As a result, practitioners are frequently confronted with conﬂicting recommendations (see Huxham and Beech, 2003) and academics are left with unclear perspectives

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on the evolution of contracting and trust in interorganizational relationships. In the second theme, I therefore investigated how contracting and trust coevolve in interorganizational relationships. RQ How do contracting and trust coevolve in interorganizational relationships? Building on the work of other researchers (Ferrin et al., 2005; Klein Woolthuis et al., 2005), I indicated that intermediate levels of contracting and trust are probably most conducive to interorganizational performance. Trust was shown, for example, to have several detrimental eﬀects on interorganizational performance, including the fact that it sometimes ‘binds and blinds, making economic actors insuﬃciently vigilant and excessively vulnerable’ (McEvily et al., 2003b: 98), and that it can lead to naïveté and a take-it-for-granted mind-set in which relationships are put on cruise control (Anderson and Jap, 2005; Carson et al., 2006; Mesquita, 2007). In addition, high levels of trust may lead to overconﬁdence in the information provided by partners, limited alertness and excessively high levels of cognitive comfort. This may restrain the vigilance with which actors scan their environments and it may reduce the likelihood that partners engage in constructive discussions that lead to the cross-fertilization of diﬀerent views (Krishnan et al., 2006). Furthermore, I advanced the view that starting conditions, being the levels of trust and formal contracting in early stages of cooperation, are crucial to the development of both governance modes in later stages of development. Initial levels of both governance mechanisms aﬀect the performance of collaborative relationships directly, but also indirectly, through the positive and negative interpretations that managers attribute to the behaviour and outcomes produced by their partners (see Krishnan et al., 2006). In line with these arguments, interorganizational cooperation was proposed to develop along self-reinforcing cycles. I captured these assertions in an integrative conceptual framework (see Figure 4.2), which reconciles hitherto fragmented views on the evolution of contracting and trust in interorganizational relationships. Main ﬁnding theme two Intermediate levels of contracting and trust are probably most conducive to interorganizational performance. Moreover, starting conditions, being the levels of trust and formal contracting in early stages of cooperation, are crucial to the development of both governance modes in later stages of development.

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Theme three was born out of the observation that understanding why economic agents use formalities, such as contracts, ‘is crucial to understanding the organization and eﬃciency of economic exchange’ (Masten and Saussier, 2002: 273). It was denominated ‘functions of negotiation and contracting’, because it concerned the underlying reasons or rationales for instituting formal interorganizational structures and practices. I observed that existing studies tend to focus either on formal governance as a means to coordinate, or on formal governance as a means to control (see for instance Gulati and Singh, 1998; Madhok, 2002) and to a lesser extent on formal governance as a means to gain legitimacy (see Kale et al., 2002; Meyer and Rowan, 1977). These studies generally pass over the fact that formal governance might have other functions (for notable exceptions see, for example, Ariño and Ring, 2004; Lindenberg, 2003; Zollo and Singh, 2004) and that there is a need for novel understandings of formal structures and practices (Hatch, 1999). I also expected that multiple functions of formal governance would coexist, rendering an examination of how these functions are related to each other (see Foss and Foss, 2005; Madhok, 2002), how they inﬂuence interorganizational performance, and in which contexts or for which temporal stages each of the functions is most pertinent. This led to the following research questions. RQ

What are the functions of negotiation and contracting?

RQ

How do these functions relate to each other?

RQ

What is their relationship with interorganizational performance?

RQ What is the relative importance of each of these functions in diﬀerent collaborative contexts and in diﬀerent stages of interorganizational development? By theorizing in broad conceptual categories, I was able to look beyond the narrow boundaries of single theoretical lenses supportive of the coordination, control and legitimacy functions of negotiation and contracting practices. This opened up a new way of thinking about the meaning of these practices for the management of interorganizational relationships. Building on Weick (e.g. 1979, 1995, 2001) and Ring and Van de Ven (1989, 1994), I argued that negotiation and contracting practices assist participants and stakeholders in interorganizational relationships in giving, making, demanding and breaking sense of the relationships that they are engaged in, and the collaborative contexts in which those relationships are embedded. I explained that this sense function is closely intertwined with

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the other functions of negotiation and contracting and that it is generally more pronounced in the beginning of interorganizational relationships, and in exploratory contexts. Consistent with prior research (e.g. Kijkuit and Van den Ende, 2007; Ko et al., 2005; Lin et al., 2005; Ramirez et al., 2002), I postulated that knowledge and experience asymmetries and complex, novel, ambiguous and unstable tasks prompt actors to engage in acts of sensegiving, sensedemanding and sensebreaking. I then proposed that these acts increase the likelihood that congruent and actionable understandings emerge. The iterative communication cycles associated with this function of negotiation and contracting were then argued not only to diminish problems of understanding (e.g. Cronin and Weingart, 2007; Vlaar et al., 2006) and enable the transfer of preexisting understandings, but also to facilitate the co-creation of novel understandings (Bechky, 2006; Gergen et al., 2001; Hargadon and Bechky, 2006). In contrast to some famous authors on innovation, such as Schumpeter and Knight, who treated novelty as exogenously given (Witt, 2002), I thus took some prelimenary steps in explaining the emergence of novelty. Main ﬁnding theme three Negotiation and contracting practices do not only function as a means of coordination, control and legitimacy, but they also assist participants in interorganizational relationships in giving, making, demanding and breaking sense of their partners, the relationships in which they are engaged, and the collaborative contexts in which those relationships are embedded. This augments value creation by diminishing problems of understanding, facilitating the transfer of pre-existing understandings and enabling the co-creation of novel understandings. In theme four, I embraced the idea that dialectic tensions arising from the coexistence of positive and negative consequences – or functions and dysfunctions – of formalization are hard to solve (Ring and Van de Ven, 1989), and may have to be managed instead (Huxham and Beech, 2003). By emphasizing managerial choice (Child, 1997), I aimed to elucidate how managers cope with the tensions arising from the coexistence of formalization’s functions and dysfunctions (see Das and Teng, 2000; De Rond, 2003; De Rond and Bouchikhi, 2004). In line with this, I formulated the following research question: RQ How do managers of interorganizational relationships cope with tensions arising from the coexistence of formalization’s functions and dysfunctions?

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A review of the literature revealed that formalization functions as a means to coordinate, as a means to control, as a means to persuade and convince stakeholders, and as a means to give, make, demand and break sense. It also highlighted a number of dysfunctions associated with formalization, including, for example, its retarding eﬀect on entrepreneurial activity, creativity and innovation (Foss et al., 2007) and its role in inhibiting ﬂexibility needed for coping with complex, ambiguous and unstable task environments (Camillus, 1975; Mintzberg, 1994; Nooteboom, 1999). By means of a case study of a cross-industrial strategic alliance, I illustrated that managers attempt to cope with the resulting tensions between functions and dysfunctions of formalization in at least three ways. First, they alternate their emphasis on disparate levels of formalization required by each of the partners. Second, they justify formalization by referring to factors that appear to be beyond their control. Third, they use a kind of semi-structure, emphasizing either the formalization of outcomes or formalization of processes and behaviours. Main ﬁnding theme four Although managers may make the ‘right’ decisions, in that they select an appropriate degree of formalization considering the organization, exchange and contextual characteristics at hand, they are inevitably confronted with tensions between the functions and dysfunctions of formalization. In line with this, managers can improve interorganizational performance not only by aligning the degree and type of formalization with all kinds of antecedents, but also by coping with and capitalizing on the resulting tensions. In theme ﬁve, I observed that the use of standard form contracts and standard procedures for negotiation and contracting is widespread (Korobkin, 2003). Nonetheless, hardly any inquiries have been made into the inﬂuence of contract standardization on interorganizational cooperation, apart from some incidental research in law schools (e.g. Epstein, 1999; Kahan and Klausner, 1996, 1997; Korobkin, 2003). I redressed this imbalance between research and practice by examining how a discussion of standardization could shed new light on the role of contracting in interorganizational relationships. I addressed the following research questions: RQ What are the advantages and disadvantages of using standard contracts in interorganizational relationships? RQ What does the introduction of standard procedures for negotiating and contracting imply for the antecedents–governance–performance framework?

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To investigate these questions, I reviewed the literature and developed an overview of the factors that explain why managers deploy standard contracts and standard procedures for negotiation and contracting. Motives pertained to the eﬃciency of transactions; transaction speed and robustness; exploitation of information asymmetry and prevention of unintended signalling; the legitimacy granted to standardized contracts; beneﬁts of unequivocal interpretation; and network eﬀects. Subsequently, I elaborated on the disadvantages associated with standardizing negotiation and contracting practices, such as reduced levels of contractual speciﬁcity and a limited potential for developing mutual expectations and joint understandings. Following this, I exploited the assumption that standard procedures are accompanied by lower degrees of care and vigilance (Weick, 1979, 1995), proposing that the degree to which interorganizational negotiation and contracting processes are standardized moderates the relationships in the antecedents–governance–performance framework. From the literature, it accrued that standard procedures for negotiation and contracting might eventuate in a failure to communicate the content of a promise or to deﬁne the rights exchanged between partners (Goetz and Scott, 1985). Furthermore, by decontextualizing the contracting process, standard procedures reduce the degree to which parties can ‘create a bigger transactional pie in a world where parties’ incentives are misaligned and [where] they need to coordinate the production of information, specify future rights, duties, and procedures, and allocate risks’ is the central aim of contracting (Hill and King, 2004: 890). In other words, I argued that the use of standard procedures for negotiation and contracting may hamper the achievement of a ‘meeting of minds’ (Beatty and Samuelson, 2001; Choi and Gulati, 2006; Ring, 2000) and that it potentially leads to reduced mindfulness by contracting parties, which may eventually diminish the usefulness of contracts. The results of empirical analyses on standardized negotiation and contracting procedures in buyer–supplier relationships are in line with these arguments. Main ﬁnding theme ﬁve Whereas standardization of negotiation and contracting procedures is known to have many advantages, it may also hamper the achievement of a ‘meeting of minds’ and reduce ‘mindfulness’ by contracting parties. Standardization may thereby attenuate the relations incorporated in the antecedents–governance–performance framework, and it possibly diminishes the usefulness of negotiation and contracting practices.

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In theme six, I advanced that empirical inquiries into governance problems in interorganizational relationships frequently concentrate on single governance modes in isolation (Kirsch, 1997); most studies on interorganizational governance are not integrative across mechanisms, with each study considering only one or two rather than a range of mechanisms (Geringer and Hébert, 1989). This appears to be at odds with the observation that several governance mechanisms are strongly interrelated and that multiple mechanisms have their bearing on interorganizational performance (Klein, 2002; Reuer, 1999). The disparity between managers facing a plethora of presumably connected governance choices and the attention that researchers have given to the connections between these choices led to the following, ﬁnal, research question. RQ To what extent are decisions on contracting related to other governance decisions? I investigated this question by introducing the concept of governance trajectories. These trajectories consist of multiple interrelated governance decisions that are inﬂuenced by diﬀerent sets of antecedent variables. My ﬁndings suggest that governance eﬀorts should no longer be conceptualized in the form of one-time events, as managers govern their relationships during multiple stages of development, and because decisions that they make early on in a relationship appear to inﬂuence the decisions they make in later stages of development. Moreover, congruent with Chalos and O’Connor (2004), interorganizational governance decisions were inﬂuenced by diﬀerent sets of antecedents, indicating that optimization occurs at the level of series of governance decisions and sets of context and task characteristics. Main ﬁnding theme six Governance eﬀorts should no longer be conceptualized in the form of one-time events, as governance decisions are interdependent and as optimization of governance solutions occurs for series of governance decisions and entire sets of organization, exchange and contextual characteristics.

SHIFTING PARADIGMS: FROM THE CREATION AND APPROPRIATION TO THE DISCOVERY OF VALUE Jointly, these ﬁndings suggest that we may need to alter fundamentally our thinking on interorganizational cooperation. Particularly, I suggest that

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our current emphasis on the creation and appropriation of value needs to be complemented with a better understanding of the nature and signiﬁcance of the discovery of value by partners in interorganizational relationships. To develop this argument, it is necessary to elaborate on the constructs of value creation and value appropriation ﬁrst. Priem (2007: 233) has argued that ‘much of the strategy work on value, to date, generally has [. . .] blurred the distinction between value capture and value creation by often labeling the distribution of existing value among ﬁrms as value creation’. Nickerson et al. (2007: 211) have added that ‘although strategy scholars pay lip service to the notion of value creation, the vast majority of strategy research has focused on value capture and underemphasized the challenge of crafting organizations and strategies that continuously create value’. Lepak et al. (2007) even contend that little consensus exists on what actually constitutes value creation. Fortunately, there seems to be agreement on the fact that value is being created when customers or clients are willing to pay more for an organizational eﬀort or outcome than the costs that were made to produce it (Kang et al., 2007; Priem, 2007; Sirmon et al., 2007). Moreover, value creation is considered to be higher when the quality of a job, task, product or service as perceived by users or clients in relation to their needs is considerable (Bowman and Ambrosini, 2000). This may result, amongst others, from the exploration and exploitation of knowledge (Kang et al., 2007) and innovation (Priem, 2007). In general, it implies that the parties involved with a relationship achieve synergistic supernormal outcomes (Jap, 1999). To achieve this, organizations collaborating in interorganizational relationships have to develop synergistic combinations of their resources (Dyer and Singh, 1998; Madhok and Tallman, 1998), and they should pursue the eﬃcient and eﬀective development, deployment, allocation and exchange of resources (Lado et al., 1997) so as to reduce transaction costs (Foss and Foss, 2005). Value creation alone, however, is insuﬃcient for ﬁnancial success. More speciﬁcally, ‘ﬁrms have little incentive to engage in value creation in the absence of “isolating mechanisms” that prevent the immediate dissipation of proﬁts associated with a value creating initiative’ (Mizik and Jacobson, 2003: 63). Stated diﬀerently, ﬁrms should be able to capture the economic surplus of value creating activities by engaging in value appropriation.1 The most famous intraorganizational example of a ﬁrm that created enormous value, but was unable to appropriate or capture the surplus, is Xerox’s Palo Alto Research Center. This centre was best known as the breeding ground for innovations from which Xerox was unable to achieve strategic or commercial success (e.g. the personal computer, Ethernet, graphical user interface, page-description language) (Mizik and Jacobson, 2003).

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Next to value creation, organizations are thus believed to take value appropriation into account when forming interorganizational relationships (Heiman and Nickerson, 2004). Value appropriation concerns the relative share or distribution of relational rents that a focal ﬁrm can appropriate (Lavie, 2007). In contrast to value creation, value appropriation regards the individual outcomes of cooperating parties (Jap, 1999), which depends, among other things, on the existence of competition, the availability and use of isolating mechanisms (Lepak et al., 2007)2 and ﬁrm and exchange characteristics that aﬀect partners’ relative bargaining power (Coﬀ, 1999; Khanna et al., 1998; Lavie, 2007). Value creation and value appropriation thus occur at diﬀerent levels of analysis, with value creation taking place at the relational level and value appropriation pertaining to the performance eﬀects of collaboration at the ﬁrm level. Collaborating organizations take both value creation and value appropriation into account when managing and governing their collaborative initiatives with other organizations. This introduces a third tension in interorganizational relationships, next to the need–ability governance paradox and the tension between formalization’s functions and dysfunctions. After all, attempts to create value and attempts to appropriate value tend to be in conﬂict with each other (Zeng and Chen, 2003). Whereas the prospect of value creation may stimulate cooperation, the prospect of value appropriation by the other party diminishes the incentive to collaborate. Moreover, organizations engaged in cooperative initiatives may fear that the value that they jointly create at the relational level of analysis may be captured primarily by their partners (e.g. see Lepak et al., 2007). I will oﬀer several examples of the tension between value creation and value appropriation here.3 The ﬁrst example concerns investments in relation-speciﬁc assets. Such investments are undertaken because they heighten the potential for value creation, having the potential to expand the ‘pie’ (Jap, 1999). Relationspeciﬁc investments facilitate expectations of continued exchange into the future (Heide and John, 1990) and they represent credible commitments to relationships (Williamson, 1985). Besides being an enabler of strategic outcomes, they may form idiosyncratic and hard-to-imitate resources that stimulate value creation in interorganizational relationships (Jap, 1999). In line with this, some researchers have depicted relation-speciﬁc investments as crucial to realizing particular value propositions and competitive advantage (Ghosh and John, 1999). However, ‘speciﬁc investments are valuable but vulnerable’ (Ghosh and John, 1999: 134). They involve considerable risk (Williamson, 1985). As asset-speciﬁcity increases, redeployability diminishes and contracting hazards magnify (David and Han, 2004; Klein et al., 1978; Subramani and Venkatraman, 2003). For parties that have

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performed such investments, switching to another partner becomes more costly and termination of the relationship inevitably results in an irrevocable loss of their speciﬁc investments (Heide and John, 1988). These organizations further run the risk that their investments are used as hostages by their partners, making it diﬃcult for them to recoup value from the relationship (Jap and Ganesan, 2000). In this case, the receiver of the investment threatens the investor ﬁrm to terminate the relationship as soon as it has made relation-speciﬁc investments, in order to capture more of the relationship’s value (Reuer and Ariño, 2007). In this case, the receiver opportunistically exploits or expropriates the investments’ value (Rokkan et al., 2003). Ultimately, these concerns may reduce a ﬁrm’s incentive to invest in relation-speciﬁc assets in the ﬁrst place (Wathne and Heide, 2000).4 In such cases, concerns over value appropriation may diminish the potential for value creation,5 particularly if it is not possible to write complex, contingent contracts in which side-payments or sharing rules are agreed upon that provide the investor with suﬃcient incentives to pursue the investment (Ghosh and John, 1999). A second example of tensions between value creation and value appropriation concerns the incentives that parties have to share or expropriate knowledge. In this respect, Heiman and Nickerson (2004: 401) have noted that ‘[t]o create value, collaborators may have to adopt a variety of practices to facilitate knowledge transfer. Deploying these practices [however] may increase the likelihood that economically valuable knowledge, which is (1) beyond the scope of the collaboration, and (2) diﬃcult to legally protect, is expropriated’. The dilemma then becomes ‘[h]ow can ﬁrms manage the transfer of agreed upon knowledge in their collaborations while avoiding the expropriation of other, non-agreed upon, yet economically valuable knowledge?’ (Heiman and Nickerson, 2004: 402). A manufacturing manager of a consumer products ﬁrm touched upon this dilemma by stating ‘[k]nowledge leakage is a big issue up front. In contracts and using exclusivity agreements, we still have to be very, very careful’ (Heiman and Nickerson, 2004: 412). More speciﬁcally, the distribution of knowledge, in conjunction with selfinterest, leads to two knowledge-related hazards, knowledge appropriation and strategic knowledge accumulation (Nickerson and Zenger, 2004: 622). Concerning knowledge appropriation, Arrow (1973: 171) has explained that the value of knowledge to a receiver is not known until after the knowledge is received. However, once the knowledge is revealed, the potential acquirer has no need to pay for it and can resell it at low marginal cost. While contracts provide some protection here, cognitive limits render contractual protections diﬃcult to identify and costly to draft. Consequently, knowledge is not placed into the hands of those who will ﬁnd it most valuable (Nickerson

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and Zenger, 2004). Next to the hoarding of knowledge, individuals possess the incentives to shape the development of knowledge, and they prefer to shape the search for knowledge in ways that optimize the value of the knowledge that they personally accumulate as solutions are explored. They favour searching for knowledge that enhances their specialized knowledge or that complements the knowledge they already possess, while avoiding eﬀorts that require knowledge sharing (Nickerson and Zenger, 2004). In this case, self-interest reduces the incentives to share and exchange knowledge (Hsieh et al., 2007). Finally, a third example of the tensions between value creation and value appropriation relates to an organization’s choice of a particular partner. In this respect, Stuart (2000: 791) suggests that ‘large ﬁrms and those that possess leading-edge technological resources are posited to be the most valuable associates’, as they provide access to resources and confer legitimacy upon one’s organization through the partner’s reputation. However, Lavie (2007) warns that such partners may also be well positioned to appropriate a large share of the value that is being created at the focal ﬁrm’s expense. He states, ‘The paradox is that prominent partners that stand to make a signiﬁcant contribution to joint value creation may also be able to restrict the appropriation capacity of the focal ﬁrm, and consequently undermine its market performance’ (Lavie, 2007: 7). This observation aligns with the idea that ‘Most resources [as well as organizational characteristics and governance solutions] cannot be exclusively classiﬁed as pertaining just to value creation or to value appropriation: they inﬂuence both’ (Mizik and Jacobson, 2003: 65).6 These examples and the literature from which they originate support recent calls for research into the relationships between value creation and value appropriation (e.g. see Heiman and Nickerson, 2004; Lavie, 2007; Lepak et al., 2007). However, they neglect a crucial aspect of interorganizational collaboration, namely the discovery of value. Throughout this book, I have touched upon this construct several times. Here, I will argue that most cooperative activities should not only be understood in terms of the creation and appropriation of value, but also, and sometimes perhaps primarily, in terms of the value that collaborating parties discover during their relationship. I will further specify the argument underlying this assertion here. Discovering new opportunities and value has been related to the identiﬁcation of valuable products or services, new markets, raw materials, methods of production and ways of organizing (Hsieh et al., 2007; Schumpeter, 1934). It has also been associated with being alert to new opportunities (Kirzner, 1973) and conceiving what has to be developed and how this has to be done (Witt, 1998, 2000). More speciﬁcally, discovery

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rests on the ability of a diverse set of actors with diﬀerent backgrounds and experiences to bring together their perspectives and knowledge through social interactions, possibly changing how they deﬁne and think about concerns and situations (Baba et al., 2004; Hargadon and Bechky, 2006). By accessing others’ knowledge, experience and perspectives, participants in collaboratve endeavours can gain insights and ‘discover higher-order themes, generalizations, and ideas’ that move beyond individual deductions (Weick and Roberts, 1993: 358). In this spirit, communicative acts allow them to uncover previously hidden opportunities for value creation (Gergen et al., 2001; Sandberg and Targama, 2007), to explore knowledge of diﬀerent parties (Kang et al., 2007) and actively reframe situations, problems and possible solutions (Hargadon and Bechky, 2006). This may lead to new images, conceptions or accounts of what to do, how to do it and under what constraints to do it (Witt, 2000). It conﬁrms ‘the importance of imagination as an integral part of human decision making’, showing that the pursuit of intelligence requires us to occasionally shift the focus from the actual and knowable to the future and the things not to be known (Augier and Kreiner, 2000: 659). In contrast to this focus on the discovery of value and of how value can best be created, most theories in the alliance ﬁeld presuppose the existence of a preordained set of known parameters and factors that have to be taken into account to jointly create value (see Nickerson et al., 2007).7 The problem here ‘is that nothing is said about the origin and formation of beliefs’ (Foss, 2001: 365), despite the fact that ‘the solution to the wide majority of economic problems [including governing for alliance performance] requires a logic of discovery: discovery of relevant alternatives, attainable and desirable objectives, and likely consequences’ (Grandori, 2001: 252). In this respect, Foss (1999) provides the illustration of a simple bargaining game between A and B (see Figure 9.2), where both organizations could either opt for x or y. In this case, the (4, 1) equilibrium has a higher joint surplus than the (2, 2) equilibrium, so that it will be in A’s interest to bribe B to play the y-strategy. However, when taking Figure 9.2 as a starting point, many things are considered as ‘given’ for the agents. As Foss (1999: 14) notes: Such representations obscure some rather fundamental questions [such as] How do players come to know the payoﬀs? Or each other? Or the available strategies? Will they hold the same views of the payoﬀs? Of each other? Of the available strategies? How do they know which game, and type of game, they play?

Foss (1999: 14) concludes that ‘The basic problem with the economics of organization as it applies to inter-ﬁrm relations is [. . .] that cognitive bargaining costs are assumed away.’ Whereas bargaining situations are taken

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Y

X

(2,2)

(0,0)

Y

(0,0)

(4,1)

A

Source: Adapted from Foss (1999).

Figure 9.2

A simple bargaining game

as given, many of them are ill-structured (Grandori, 2001). In these cases, ‘parties have to understand and set up the bargaining game they are engaged in’, something which has so far ‘received very little attention in the theory of economic organization’, despite its signiﬁcance in the context of interorganizational relations (Foss, 1999: 15). In contrast to mainstream research, the perspectives on formal governance presented in this book do not presume that participants in interorganizational relationships know ex ante the nature of the pie, the size of the pie, and the processes and resources that can and should be used to create the pie (Jap, 2001). Instead, I advance that participants in collaborative relationships tend to have limited understandings of their partner organizations (e.g. its structure, culture, competencies, intentions) the collaborative relationships in which they are engaged (e.g. what do we want and can we do it together? How are we going to realize this?) and the environments in which these relationships are embedded (e.g. which constraints do we have to take into account? Who are our most important stakeholders?). In fact, I argue that a large proportion of the eﬀorts that partners invest in collaborative relationships is aimed at trying to discover the answers to these questions. Partners attempt, for example, to envisage a pie, the process by which it can be created, and the opportunities for expanding it (see Jap, 1999). They also try to discover where knowledge resides at the partner, what knowledge may be available at the partner and how it can best be obtained (see also Nickerson and Zenger, 2004).8 Inquiries into such attempts at discovering value require a strong focus on the ‘processes that enable actors to deliberately ﬁnd new sources of value’ (Nickerson et al., 2007: 212) and on the substantive aspects of cognition, instead of the procedural elements that are usually emphasized by organizational theorists (Witt, 1998). Moreover, although processes of

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opportunity identiﬁcation and discovery have frequently been regarded as being carried out by single individuals, such as leaders or actors involved in bargaining games (Foss, 2001, 2007a; Foss et al., 2007),9 this has led to a ‘rather one-sided portrait of the source and driving force of the selftransformation process in the economy’ in general (Witt, 2002: 21) and of the emergence of novelty in interorganizational relationships in particular. Instead, I wish to emphasize that ‘the discovery of value and opportunity generally demands [. . .] a wide range of knowledge [. . .] discovery typically involves multiple actors’ (Hsieh et al., 2007: 1255). The processes involved therefore tend to require ‘knowledge sharing to produce the necessary (collective) cognitive maps used for discovering opportunities’ (Hsieh et al., 2007: 1259). This renders the question ‘where most heterogeneity lies’ concerning the primary source of new value creation, be it on the individual or the collective level (Felin and Hesterly, 2007: 201),10 somewhat inappropriate, as asymmetries in knowledge and experience (individual level), and the social interaction needed to advance understanding and create value appear to be interrelated (see Vlaar et al., 2008). Because individuals represent a problem or situation in accordance with their knowledge, beliefs and experience (Cronin and Weingart, 2007), asymmetries on the individual level necessarily give rise to sociocognitive acts at the collective level (see Vlaar et al., 2008). The latter coincides with work from authors on creativity, which suggests that the discovery of value is commonly social and collaborative in nature. Only in rare cases do breakthrough innovations occur as a ‘burst of creativity from a lone genius’ (Sawyer, 2006: 258, as cited in Nickerson et al., 2007). Despite their signiﬁcance, the literature remains relatively silent on these sociocognitive acts and communication processes used to interrelate and advance understandings (for notable exceptions, see Ahuja and Galvin, 2003; Cramton, 2001; Gibson and Earley, 2007; Hargadon and Bechky, 2006; Kellogg et al., 2006; Vlaar et al., 2008). In earlier chapters, I have advanced that negotiation and contracting may constitute one of the means by which parties arrive at such understandings. The central argument here was that negotiation and contracting practices may be instrumental, not only in creating and appropriating value, but also in discovering where value resides and how it can best be created.11 After all, by creating more congruent and actionable understandings, negotiation and contracting practices may not only reduce problems of understanding, enable the transfer of pre-existing understanding and economize on explicit coordination and control costs, but they may also facilitate the co-creation of novel understandings. Understanding thus contributes to the creation and appropriation, as well as the discovery of value. These eﬀects are particularly signiﬁcant in the context of interorganizational relationships, because such relationships bring people together that

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are likely to have dissimilar conceptions of reality. This is caused, among other things, by the fact that they are not embedded within the same organizations (e.g. they are accustomed to diﬀerent structures, cultures, processes, routines and strategies, and their thinking is shaped by their experience and dominant logics) and because participants in such relationships frequently cannot rely on routine behaviour and hierarchical governance mechanisms (Thatcher, 2004). In the ‘future research’ section of this ﬁnal chapter, I will take this point further, suggesting that the interplay between the three ‘valueconstructs’ merits more attention in further research.

THEORETICAL AND PRACTICAL IMPLICATIONS Hitherto, I have proposed that our attention may need to be shifted from the antecedents–governance–performance framework and the coordination and control perspectives on formal governance that are currently dominating the literature, towards a perspective in which the creation of advanced understandings and the discovery of value occupy a more central position. However, this study has several other theoretical and practical implications. First, it suggests that ‘the manager’ has to be brought back into research on interorganizational governance. This became apparent, among other things, in the themes labelled ‘Need versus ability to contract’ and ‘Duality and dialectic tensions’, in which I showed, respectively, that managers have to cope with tensions between the need and the ability to contract and that they may attempt to capitalize on tensions between the functions and dysfunctions of formalization. The ﬁndings from both themes indicate that next to investigating the ‘right’ degree of formal governance, that is, examining the aligment between organization and exchange characteristics and governance decisions (Foss and Foss, 2005; Madhok, 2002; Williamson, 1985, 1991), researchers could explore which managerial actions increase the likelihood that formal governance has a positive impact on the performance of interorganizational relationships. ‘The manager’ has to be brought back into research on interorganizational governance. Research attention should shift from the ‘right’ degree of formal governance towards the managerial eﬀorts that are required to make sure that formal governance has a positive inﬂuence on interorganizational performance. A second theoretical implication concerns the functioning of formal governance in interorganizational relationships. Whereas researchers have

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called for ‘more systematic attention’ for the coordination function of formal governance (e.g. Carson et al., 2006: 36; see also Mayer and Argyres, 2004), the studies presented in this book suggest that researchers should at least explore four main functions of formal governance. These are associated with establishing coordination, control and legitimacy, and with eﬀorts aimed at giving, making, demanding and breaking sense of their partners, the relationships in which they are engaged and the collaborative contexts in which these are embedded. Explicitly distinguishing the sense function of negotiation and contracting from its coordination, control and legitimacy functions enables researchers and practitioners to state more explicitly why contracting takes place and how it contributes to interorganizational performance. In conjunction with the argument that contract standardization may prohibit the meeting of minds, and introduce mindless behaviour, it also provokes the question as to whether it is formal governance as an outcome or formal governance as a process contributing most to interorganizational performance. Researchers should consider four major functions of formal governance (i.e. coordination, control, legitimacy and sense) and they should ask themselves whether it is formal governance in terms of its outcomes (e.g. contracts), or formal governance in terms of the sociocognitive processes associated with it (e.g., sensegiving, sensemaking, sensedemanding and sensebreaking) that contribute most to interorganizational performance. A third implication of this study concerns the interplay between contracting and other governance mechanisms. In themes two and six, I have demonstrated that contracting is intricately related to other governance mechanisms, and therefore hard to isolate. Changes in formal coordination and control, for example, may provoke changes in trust (theme two), but reductions in selection eﬀorts may do so as well (theme six). Moreover, theme two has shown that these changes can have positive as well as negative performance outcomes, dependent on the dominance of substitution or complementarity eﬀects, and on the interpretation that managers give to the behaviour exhibited by their partners. The multifarious relationships between contracting and other governance mechanisms complicate assessments of its eﬀects on interorganizational performance. More speciﬁcally, if governance mechanisms other than contracting are not explicitly included in analyses of interorganizational performance, they may still inﬂuence the result. When researchers ﬁnd a positive relationship between the degree of contracting and interorganizational performance, for

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example, this may be due to higher selection and negotiation eﬀorts that preceded contracting, or to high levels of trust that enabled information sharing, and subsequently contracting. I therefore conclude that studies that do not take into account series of governance decisions and their evolution (see theme two and theme six) may lead to spurious ﬁndings, erroneous interpretations, and faulty recommendations. Intricate interrelationships between contracting and other governance mechanisms complicate assessments of its relationship with interorganizational performance. A fourth theoretical implication of this study concerns the notion that prescriptions based on the antecedents–governance–performance framework should be regarded with caution. The ﬁndings from all themes cast substantial doubt over the tenability of this conventional, generic framework, showing that it may have little normative value (see also Ghoshal and Moran, 1996). Managers may not align organization, exchange and contextual characteristics with degrees of contracting as predicted by transaction cost economics or agency theory, for example, because of variation in (1) managerial responses to gaps between the need and the ability to contract (theme one); (2) contracting’s relationship with trust (theme two); (3) the functions that managers seek to fulﬁl with contracting (themes three and four); (4) managers’ capabilities to diminish tensions between functions and dysfunctions of formalization (theme four); (5) the use of standardized procedures for negotiation and contracting (theme ﬁve); and (6) the availability of other governance mechanisms, which may show a better ﬁt with organization, exchange and contextual characteristics than contracting solutions (theme six). Prescription based on the antecedents–governance–performance framework should be regarded with caution. A ﬁnal theoretical implication concerns researchers’ allegiance to single research paradigms. The results show that research on contracting and trust may strongly beneﬁt from moving beyond the conﬁnes of single theoretical streams, and from crossing the domains of theories, schools of thought and even scientiﬁc disciplines. Although the use of multiple theories across the research themes may have seemed to lead to theoretical incommensurability at ﬁrst sight, it has also led to multiple extensions of the generic antecedents–governance–performance framework currently

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dominating the literature (see Figure 9.1). This study thereby clearly shows that a pluralistic approach to research on the governance of interorganizational relationships promises to lead to rich and meaningful insights. Research on the governance of interorganizational relationships may strongly beneﬁt from moving beyond the conﬁnes of theoretical streams, crossing the domains of theories, schools of thought and even scientiﬁc disciplines. The research presented in this book also entails several practical implications. First, it shows managers that, in order to be eﬀective, contracting generally has to be accompanied by information processing and sensemaking eﬀorts. Such eﬀorts reduce possible tensions between the need and the ability to contract (see theme one). Second, it appears that trust and contracting are intricately related and that changes in one of them are likely to elicit changes in the other. In particular, I have clariﬁed that starting conditions – or initial degrees of contracting and trust – may have disproportionate impacts on the evolution of collaborative relationships. I have also explained why very low and very high levels of contracting and trust are probably less conducive to interorganizational performance than intermediate levels. Jointly, these observations signal to managers that it is of uttermost importance to quickly establish intermediate degrees of contracting and trust in interorganizational relationships, so as to prevent the development of self-reinforcing cycles of trust deterioration and formalism from occurring (see theme two). Third, I have developed the argument that contracting has alternative functions, beyond coordination and control. It also acts as a means to legitimate interorganizational collaboration and as a means to give, make, demand and break sense. Practitioners can use this knowledge to discuss more meaningfully the rationales they have for formalizing their relationships, and to justify attempts at formalization in situations where coordination and control may be hard to attain by contracts, rules and procedures (see theme three). Fourth, my study indicates that managers should not only be working on getting the degree of formalization ‘right’ (Foss and Foss, 2005; Madhok, 2002; Williamson, 1985, 1991), but also, and maybe even primarily, on managing the tensions that precede and arise from formalization. I have discussed ways of solving the need–ability governance paradox (see theme one) and I have discussed several strategies for circumventing, alleviating or mitigating the detrimental performance eﬀects associated with the coexistence of formalization’s functions and dysfunctions (see theme four). Fifth, I have argued that, although the use of standard contracts and

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standard procedures for negotiation and contracting may seem tempting or attractive at ﬁrst sight, it may also prohibit partners from achieving a ‘meeting of minds’ and it could introduce ‘mindless’ behaviour. These results imply that researchers have to consider attempts to standardize with caution (see theme ﬁve). Sixth, it appears that contracting practices only constitute one of the means by which coordination, control, legitimacy and understanding can be developed in interorganizational relationships. I therefore recommend managers to consider their full array of governance options when making decisions on the management and governance of their relationships. Furthermore, they have to be conscious of the fact that some governance mechanisms are more conducive to particular sets of organization and exchange characteristics than others, and that they may enable or constrain the use of supplementary governance mechanisms later on (see theme six). Considering managerial implications across the six themes, the following picture emerges. First, formalization appears to require more managerial eﬀorts than just the codiﬁcation and enforcement of outcomes and activities in contracts, rules and procedures. It also entails investments in information processing and sensemaking, and it requires eﬀorts directed at managing the tensions between formalization’s functions and its dysfunctions (see themes one and three). Second, functions of formalization appear to be associated both with formalization in terms of outcomes (e.g. contracts, rules and procedures) and with formalization in terms of processes (e.g. codiﬁcation and enforcement, giving, making, demanding and breaking sense) (see themes three and four). Although parties may utilize comparable contracts, rules and procedures in similar relationships, their eﬀects on interorganizational performance may diﬀer owing to variation in the processes from which these structural elements have emerged and variation in the processes through which they are applied. Managers should therefore pay attention to the structuring of interorganizational relationships next to the structures of interorganizational relationships (see also Ranson et al., 1980; Simons, 1990, 1995). The degree to which managers standardize structuring processes, for example, may signiﬁcantly alter their performance implications (see theme ﬁve). Third, formalization does not stand on itself, but appears to be intertwined with other governance mechanisms, such as trust and partner selection (see themes two and six). This suggests that practitioners need to take entire governance systems or governance trajectories, as well as the evolution of governance mechanisms, into account when thinking about contracting and trust in their relationships. To summarize, I believe that managers should consider the entire research framework (see Figure 9.1) when contemplating how to govern their relationships. They could proceed according to the following steps.

Discussion and conclusion

1

2 3

4

5

6

7

253

Identify the needs for coordination, control, legitimacy, and sensegiving, sensemaking, sensedemanding and sensebreaking, in the relationship (see theme three). Identify through which mechanisms these needs can be fulﬁlled (see themes two and six). Identify whether there is a gap between the need and the ability to contract. If such a gap exists, think of ways in which it can be reduced (see theme one). Consider the preferred nature or character of the governance process. Think, for example, of the persons that should be involved in the process, and assess whether the process should be standardized or not (see theme ﬁve). Initiate the contracting process, but keep a close eye on possible tensions arising from the coexistence of its functions and dysfunctions. Take an active stance in managing these tensions (see theme four). Try to establish intermediate degrees of trust and formal coordination and control early on and prevent self-reinforcing spirals of trust deterioration and formalism from occurring by continuously assessing and monitoring their development (see theme ﬁve). Finally, constantly reassess the previous six steps to make sure that (a) gaps between the need and the ability to contract are diminished; (b) changes in the degrees of trust and formal coordination and control favourably inﬂuence each other and interorganizational performance; (c) contracting meets all your needs; (d) there are no mechanisms that could fulﬁl those needs better; (e) attributes of the contracting process do not become detrimental to interorganizational performance; and (f) tensions between contracting’s functions and dysfunctions are managed adequately.

LIMITATIONS AND FUTURE RESEARCH In interpreting this study some caveats have to be kept in mind, which may be addressed in future research. The ﬁrst limitation of this study is that, although each of the six themes ﬁts in the research framework, they have been investigated separately. Some of these themes were treated conceptually (themes two and three), while others have been investigated by means of a case study (theme four) or a survey (themes one, ﬁve and six). Although I believe that this approach has been fundamental to the development of an integrative perspective on the role of contracting and trust in interorganizational relationships, I am also aware of the fact that various parts of the framework have not been empirically tested yet. Future research should

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therefore demonstrate the relevance and validity of various parts of the research framework. An experimental research approach may oﬀer a high potential here, as it (1) guarantees variation in certain factors through manipulation; (2) limits idiosyncrasies or variation due to external factors; (3) allows researchers to use multiple means to capture the values for the variables they are interested in and to assess the relationships between those variables, including observations, surveys and interviews; (4) enables researchers to capture dynamics; and (5) allows them to test the entire framework in a single study. The latter is almost impossible through any other method of inquiry. In future research, experiments could be designed, for example, that enable a comparison between various collaborative projects, each with distinct relational and sub-group characteristics, initial degrees of contracting and trust, et cetera. Researchers can ask participants in these experiments why they apply certain degrees of contracting, referring to both their needs and their abilities to contract (theme one). In addition, they can set up the experiment in such a way that actors have to go through several rounds of (non-)cooperation, after which the researchers assess how trust, contracting and interorganizational performance evolve (theme two). They can also ask participants to rate the degree to which contracting fulﬁls any of the four functions distinguished in this study (theme three). Furthermore, researchers may code and analyse transcripts capturing the collaborative dynamics in the experiments in order to ﬁnd out how actors attempt to reduce gaps between the need and the ability to contract, and how they cope with tensions between the functions and the dysfunctions of formalization (themes one and four). Moreover, researchers could manipulate each of the collaborative group’s negotiation and contracting eﬀorts by introducing standard procedures (theme ﬁve). Finally, they can oﬀer participants other means to achieve coordination, control, legitimacy and advanced understandings, after which they can assess when managers use these means, why they do it and how it inﬂuences contracting and interorganizational performance (theme six). A second limitation of the study concerns the extent to which I have capitalized on my own deﬁnition and typology of formalization and contracting. I deﬁned formalization as the process of codifying and enforcing inputs, outputs and activities (Ouchi, 1979) and the outcomes of this process in the form of contracts, rules, standard policies, procedures and regulations (Aiken and Hage, 1966). I also distinguished three attributes of formalization: (1) the degree of formalization that is applied (Makhija and Ganesh, 1997), (2) the extent to which it pertains to inputs and outcomes, or to processes (e.g. Ouchi, 1979; Koza and Lewin, 1998), and (3) its enabling or coercive character (e.g. see Adler and Borys, 1996). Although I

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have emphasized diﬀerent parts of this deﬁnition and typology throughout the study, I have not used it as much and as explicitly as I could have done. The distinction between processes and outcomes of formalization, for example, was highly evident in theme ﬁve, where I discussed standard contracts (formalization as an outcome) and standardized negotiation and contracting procedures (formalization as a process), but it was not made explicit in some of the other themes. I believe that future research could beneﬁt from using the typology more proactively. A third limitation, and one of the major opportunities for future research, concerns the extent to which I have focused on aspects of contracting that have the potential to bridge disciplines of strategic management, law and cognitive psychology (see Figure 9.3). In this study, examples already abound. Information processing, sensemaking, mindfulness and trust, for example, are concepts that have their roots in cognitive psychology, but which have been applied here to study management processes. Similarly, contract standardization (a topic in the law and contracting literature) has been connected to mindlessness (a concept stemming from cognitive psychology) and to the governance of interorganizational relationships (an issue in the strategic management literature). However, this manuscript is still limited in the extent to which it has explored the cross-sections between these three disciplines. I suggest that parts of

Strategic Management

Law & Contracting

Figure 9.3

Cognitive Psychology

Major opportunities for cross-disciplinary research

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Figure 9.3 in which the literatures show a potential for convergence oﬀer highly promising avenues for further research (for a notable attempt, see Mayer et al., 2007). An example of such an area consists of the factors driving contract incompleteness. Whereas most of the law and contracting literature presumes that parties to a relationship record and enforce outcomes and activities in a way that minimizes transaction costs, cognitive psychology suggests that managers may not be able to do so, owing to, among other things, bounded rationality, memory problems and fears of upsetting their partner. At the same time, the law and strategic management literatures suggest that partners withhold information from contracts on purpose, as they may use information asymmetry to capture most of the value that is being created in a relationship (see Eggleston et al., 2000; Olekalns and Smith, 2006). Another example in which the three disciplines come together revolves around utilizing the law and legal instruments to develop new business strategies. As Bagley (2005) convincingly promulgates, organizations may use changes in these areas proactively and strategically. Managerial cognition, in particular managers’ legal astuteness, or their ability to recognize and pursue the opportunities that arise from legal changes, may be a key element here (Bagley, 2005). In summary, I believe that this study has contributed to bridging the literatures on strategic management, law and contracting, and cognitive psychology, but I also think that there are still many promising opportunities for exploring some of the crossroads between these disciplines. Another direction for future research concerns attempts at explicating several of the processes that possibly mediate the antecedents–governance–performance framework (see Figure 9.4). In this respect, Geyskens et al. (2006: 532) note that ‘in future empirical work researchers should attempt to gain insight into the underlying mechanisms driving governance decisions, by measuring the managerial motivations mediating the relationships between transaction dimensions and governance modes chosen’. Others have called for more attention to the relationships between contractual structures and post-formation dynamics (e.g. Ariño and Reuer, Antecedents Organization level Exchange level Context level

Precontracting processes

Governance Forms Mechanisms Processes

Postcontracting processes

Performance Value creation Value appropriation Value discovery

Source: Vlaar and Faems (2007).

Figure 9.4 Research opportunities regarding pre- and post-contracting processes

Discussion and conclusion

257

2004; Contractor, 2005; Faems et al., 2007; Reuer and Ariño, 2002; Reuer et al., 2002; Salk, 2005). Recently, scholars have taken up these issues. Concerning the ﬁrst type of processes, Fréchet (2007), for example, has conducted ﬁve exploratory case studies on innovative partnerships that have been embroiled in relational diﬃculties. He ﬁnds support for the idea that discrepancies between parties’ psychological contracts and the formal contracts written for the relationships frequently lead to the deterioration of relational quality.12 He also observes that, when individuals come across ambiguous regions within contracts, they embark on construal processes (Rousseau, 2001) by which they try to ﬁll lacunae or equivocalities in the contract (i.e. ‘ﬁll in the blanks’). Parkhe (2007) and Ring (2007) also emphasize the signiﬁcance of achieving a meeting of minds and the challenges that parties may face in doing so. They point out, amongst others, boundaries on human rationality, interorganizational diversity, the absence of alliance champions, tensions between value creation and value appropriation, and the fact that diﬀerent minds (persons) are sometimes involved with diﬀerent stages of contract negotiation and application. Regarding the second type of processes, Reuer et al. (2002) have examined 145 relationships involving biotech and pharmaceutical ﬁrms, showing that alliances with a lower division of labour and/or a broader scope are more likely to experience alterations in alliance contracts and monitoring mechanisms. Moreover, in a case study of two alliances among the same partners, Faems et al. (2007) describe how contract design, contract application and trust dynamics aﬀect each other, suggesting that cooperation may develop along self-reinforcing vicious and virtuous cycles (see also Vlaar et al., 2007a). In another attempt focusing on postcontracting processes, Lumineau and Oxley (2007) have analysed 107 disputes managed by a law ﬁrm. They found that court ordering (litigation) was more common for relatively simple contracts, whereas private ordering was preferred for more complex contracts. In a similar vein, Ariño and Reuer (2007) conducted a study on contractual complexity and alliance dynamics. They observed that alterations in the contract become more likely when ﬁrms employ less extensive contractual safeguards in their alliances. Finally, Mayer et al. (2007) advance that contracts with presumably comparable economic ramiﬁcations may have distinct sociopsychological eﬀects. Their inquiry into the use of early termination and extendibility provisions in 338 supplier relationships of a large IT ﬁrm is directed at disentangling these eﬀects. Next to research focusing on pre- and post-contracting processes, new insights are also likely to emerge from a nascent research stream on the nature and content of contracts (e.g. see Faems et al., 2007; Grandori, 2007; Grandori and Furlotti, 2007; Hagedoorn and Hesen, 2007; Mayer and

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Argyres, 2004; Mellewigt and Eckhard, 2007; Oxley and Sampson, 2004; Reuer and Ariño, 2007). Grandori (2006, 2007), for instance, argues that contracts tend to become more procedural (focusing on how parties are going to interact) instead of substantive in nature (emphasizing the outcomes that have to be delivered) when uncertainty prevails. She explains that this type of contracting is ‘focused on specifying procedures for selecting actions, rather than on the content of actions themselves’, and contends that it is applicable in situations of higher uncertainty and novelty, ‘because there is no need to know and specify actions in advance’ (Grandori, 2006: 131).13 In a similar vein, Grandori (2006: 131) argues that, in more uncertain and novel situations, the matter of contracting may be shifted ‘from task and contingency speciﬁcations to resource commitment speciﬁcations and to rights allocations’.14 Relatedly, Reuer and Ariño (2007) argue that the eﬃciency of individual alliances hinges upon the particular contractual provisions that ﬁrms put into their collaborative agreements, something which they suggest has received very little research attention to date. Also in line with this, Poppo and Zenger (2002) have called for research that investigates particular contract provisions rather than global indicators of contractual complexity. A study of two equity joint ventures, two nonequity partnerships and two licensing contracts by Hagedoorn and Hesen (2007) is a nice exemplar of such research. It shows that similar types of contractual clauses, such as dispute resolution, adaptation and damage clauses are employed for each form of interorganizational cooperation, but that these clauses are given a diﬀerent content, and presumably have distinct eﬀects on the performance of each of the relationships. These and other studies suggest that ‘future research should no longer focus solely on the mere presence, absence or completeness of contract[s]. Rather, future researchers should look at the precise content of clauses included’ (Klein Woolthuis et al., 2005: 835–6). Finally, I call for more research examining the multifaceted relationships between governance mechanisms and the creation, appropriation and discovery of value. As this study suggests, contracts and trust aﬀect each of these constructs. They provide the incentives and self-enforcing safeguards for value creation, while oﬀering ‘guarantees’ for appropriating part of this value by cooperating parties. Moreover, as trust may both facilitate and inhibit information sharing (see Krishnan et al., 2006), and as contracting generally entails information processing (see theme one) and sociocognitive processes of sensemaking, sensedemanding, sensegiving and sensebreaking (see themes one, three and four), both governance mechanisms are intimately related to the discovery of value. As Chapter 2 indicates, moderate levels of trust may provide the context in which contracting processes could lead to new accounts, conceptions or understandings of partners, the

259

Discussion and conclusion

relationships in which participants are engaged and the collaborative contexts in which these relationships are embedded. Contracting processes occurring in such environments may diminish problems of understanding, enable the transfer of pre-existing understandings, and stimulate the cocreation of novel understandings. It may allow parties to discover where new value resides and how it can best be created. Although Lepak et al. (2007: 191, 192) suggest that ‘[i]n particular, research is encouraged that examines a party’s willingness to engage in value creation activities’ as ‘the ability to create value does not necessarily mean that parties will do so’, several of the chapters in this book suggest that examining ‘the relationship between anticipated value capture and willingness to engage in activities that create value’ (Lepak et al., 2007: 192) may be insuﬃcient. Instead, research on interorganizational governance should take into account not only the eﬀects of governance on the creation and appropriation of value, but also its eﬀect on the discovery of value, and the interrelationships between these four constructs (see Figure 9.5).

Current research

Future research

Discovering value

Governance Contracts Trust

Creating value

Appropriating value

Figure 9.5 Future research on governance: creating, appropriating and discovering value

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As Figure 9.5 shows, I do not argue for a sequential (e.g. see Priem, 2007) but for a concurrent approach (e.g. see Mizik and Jacobson, 2003) in which the eﬀects of one or a variety of governance solutions on each of the three value-related constructs is assessed simultaneously. I will illustrate here why such an approach is warranted. Take the choice to include contractual provisions on sharing of proprietary knowledge in a particular alliance. This choice may have implications for the discovery, creation and appropriation of value. First, when parties contractually agree on sharing proprietary knowledge, the likelihood increases that new value is being discovered. Second, collaborating partners become more likely in this case to develop sophisticated coordination and control structures so as to augment joint value creation. Each party then attempts to appropriate part of the pie resulting from these eﬀorts. Indirectly, however, concerns over value appropriation also play a role. Parties that have committed themselves to sharing proprietary knowledge may experience reduced opportunities to appropriate value from their knowledge, for example, owing to the fact that it is no longer privately held, and because the other party may attempt to capture value from this knowledge as well. When this eﬀect induces a focal organization not to include a provision on the sharing of proprietary knowledge in the contract, concerns over value appropriation diminish, but the likelihood that value is being discovered and created diminishes as well, thereby indirectly reducing value appropriation. As the example shows, future research on this topic is requisite.

CONCLUSION In this chapter, I have discussed the key ﬁndings and most signiﬁcant implications of this study on the role of contracting and trust in interorganizational relationships. A red thread that has been weaving its way through the discussion is that contracting and trust are multifaceted concepts, which deserve to be investigated from multiple perspectives. The integrative framework that has been presented in this study should oﬀer them a fertile basis from which to develop and enrich their thinking.

NOTES 1. 2.

Value appropriation has been labelled variously as value capture, allocation or distribution (Priem, 2007). Lepak et al. (2007: 188) deﬁne an isolating mechanism as ‘any knowledge, physical, or legal barrier that may prevent replication of the value-creating new task, product or service by a competitor’. Examples constitute time compression diseconomies to imitation (Dierickx

Discussion and conclusion

3.

4.

5.

6. 7. 8.

9.

10.

11.

261

and Cool, 1989), causal ambiguity prohibiting copying by competitors (Lippman and Rumelt, 1982) and resources that are valuable, rare, inimitable and nonsubstitutable (Barney, 1991). Observe that, in the majority of studies on interorganizational collaboration, scholars have ‘tended to emphasize either the cooperative, or the competitive side, failing to pay suﬃcient attention to the complex interactions between cooperation and competition’ (Zeng and Chen, 2003: 587). This suggests that investments in relation-speciﬁc assets comprise an endogenous variable in managing and governing interorganizational relationships (Ghosh and John, 1999; Jap, 1999; Kim and Mahoney, 2006) instead of an exogenous variable that determines governance forms (Williamson, 1985). In fact, Kim and Mahoney (2006) propose that mutual relation-speciﬁc investments may substitute for vertical integration (i.e. a change in governance mode as a ﬁrst-order eﬀect) and lead to the use of a smaller number of suppliers (i.e. a change within a governance mode as a second-order eﬀect). Or, as Williamson (1996: 135) contends, ‘reciprocity can serve to equalize the exposure of the parties’ transforming a unilateral relationship into a bilateral one. Ultimately, these reciprocal investments increase the dependence of parties on each other. They can function as a pledge for commitment and they may serve as signals for continuity and trust (Poppo et al., 2008: 12). By engaging in mutual sunk-costs investments, partners can thus lower transaction costs and increase relational rents (see Dyer and Singh, 1998). Note that this concern becomes invalid when the returns from speciﬁc investments are suﬃciently large, so that they ‘bond’ the receiver and discourage opportunistic actions. In this case, unilateral speciﬁc investments may entail a self-enforcing mechanism for the investor, due to the returns that they create for the receiver (Rokkan et al., 2003). The problem becomes less pronounced as well, if investments in relation-speciﬁc assets are reciprocal (performed by both parties). This enables parties to cooperate in valuecreating activities that are diﬃcult to contract. In this case, the reciprocity of the investments provides a credible assurance for both parties that their counterparts will not take advantage of a hold-up situation. It also leads to greater perceptions of continuity (Poppo et al., 2008). Mizik and Jacobson (2003) suggest that, on an intraorganizational level, investments in R&D primarily stimulate value creation, whereas investments in advertising primarily augment opportunities for value appropriation. The existence of problems and awareness of such problems is generally assumed. Few researchers have studied the processes in which managers engage themselves to discover and choose problems (Nickerson et al., 2007). In this respect, Nickerson and Zenger (2004) proclaim that participants in interorganizational relationships frequently cannot specify a priori the knowledge that they wish to obtain, because they do not know what to look for (i.e. unknown unknowns), or because the knowledge may not exist yet. Foss (2001: 373), for example, developed a notion of leadership deﬁned as ‘the taking of actions that coordinate the complementary actions of many people through the creation of knowledge (or belief) conditions that at least approximate common knowledge and where these actions characteristically consist of some act of communication directed as those being led’. This sheds new light on the debate as to ‘whether collective outcomes are the result of the individuals who make up an organization, or whether something else, emergent, is realized (not reducible to individuals)’ (Felin and Hesterly, 2007: 205). It shows that it is sometimes more fruitful to embrace seemingly contradictory perspectives and focus on their interdependence instead of trying to determine which perspective reigns over the other. The question that one may raise, more generally speaking, is whether it is valuable to ascertain which of two perspectives should predominate if both make sense. A contingency approach or a focus on interdependencies between both perspectives seems more beneﬁcial. I focus on discovery by partners that are already engaged in collaborative relationships. One could also investigate to what extent ﬁrms are capable of discovering and acting

262

12. 13.

14.

Contracts and trust in alliances upon new alliance opportunities (i.e. opportunity sensing and response capabilities) (see Sarkar et al., 2006). Fréchet (2007) deﬁnes a psychological contract as the set of expectations that an individual develops in the course and within the framework of an agreement, between himself and another individual or an organization. More speciﬁcally, Grandori (2007: 5) contrasts procedural contracts with more ‘applied, substantive, detailed rules [. . .] specifying which actions to perform under what circumstances’. She claims that only high-level, procedural, constitutional rules, specifying how to make decisions, are capable of coordinating under uncertainty. These contracts should not be seen as more incomplete. Grandori (2006: 131) observes that ‘the fundamental form of these contracts is rather like that of a complete contract, stating that these commitments are taken “no matter what” the contingencies will be, and no matter what speciﬁc actions will be selected’.

Appendices APPENDIX A

MAT-95 DATABASE

The data set is composed of survey data from a large stratified sample of IT transactions by small- and medium-sized enterprises, consisting of five to 200 employees. It has been developed by researchers from Utrecht University, in cooperation with the Federation of Dutch IT (FENIT), the Institute of Small- and Medium-Sized Enterprises (IMK), and the Association for Society and Business (SMO) (Batenburg and Raub, 1995). The sample was drawn from a data-file of Directview, a commercial Dutch organization specialized in the marketing of data from the IT branch. Advantages of this data-file were that (1) it contained an estimated 80 per cent of all Dutch organizations; (2) its data were checked on accuracy and completeness at least once a year; and (3) it captured detailed information on the organization’s IT situation (see Rooks, 2002). The survey developers randomly selected firms until at least 15 cases were identified for each of 36 cells in a stratified research design. The 36 (4 3 3) cells represented unique combinations of three theoretical dimensions: four product groups representing two IT product types, each with two levels of complexity (i.e., software versus hardware, and standard versus complex products), three levels of network embeddedness (i.e., weak, modest, and strong inter-firm relations) and three levels of the buyer’s expertise (i.e., having one or more full-time IT specialists, only part-time IT employees, or no IT employees) (Anderson and Dekker, 2005). In an additional sampling effort, five industries were selected, namely: (1) food- and stimulants, (2) basic metal products, (3) means of transport industry, (4) wholesale, and (5) transport and storage. Respondents consisted of key informants in the buying firm, usually IT managers responsible for the organization’s automation. They were first approached in a CATI interview, to solicit cooperation. When a respondent was willing to cooperate, a transaction was 263

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selected that met the stratification criteria. In total,1239 questionnaires were distributed among Dutch small- and medium-sized IT buyers. After three reminders, 971 questionnaires were returned by respondents, resulting in a ‘response rate’ – calculated as the number of useful responses divided by the sum of the number of useful, non-useful, and non-responses (see Groves, 1989) – of 78.4 per cent. When corrected for the refusals to cooperate during the telephone interview, the cooperation rate still equalled 58.8 per cent (see Rooks, 2002), which is relatively high compared to other research on interorganizational cooperation. The maximum number of transactions with a single supplier (IBM) is 30 and only four suppliers accounted for more than 10 transactions each. Approximately 25 per cent of the suppliers were part of a larger firm, leaving 75 per cent of the suppliers independent firms. Nonresponse analyses were performed to check for systematic differences between response- and non-response groups. No significant differences were found in the responses per industry and geographical region (Batenburg, 1997). After eliminating responses with too many missing values, 911 observations remained.

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APPENDIX B MEASURES USED IN QUANTITATIVE STUDIES Antecedents Relation-specific investments are measures by three indicators (consistent with Poppo and Zenger, 2002; Reuer and Ariño, 2007), reflecting the costs related to switching to another supplier. Questionnaire items for this variable are concerned with the damage in terms of time and money that the buyer would face if the product had to be replaced owing to malfunctioning. The individual items refer to the need to ‘purchase a new product’, ‘reeducate personnel’ and ‘re-enter data’. Jointly, these indicators provide an indication of the magnitude of the buyer’s hold-up problem (see Dekker, 2003). Cronbach’s alpha for this scale amounts to 0.75, which is slightly above the guideline of 0.7 for modest composite reliability (Nunnally, 1978). Complexity of the exchange relates, among others, to the scope of a transaction (Oxley and Sampson, 2004), the number of partners involved, and the degree of technological or organizational interdependency between the partners (Kumar and Van Dissel, 1996). Researchers have argued that complexity needs to be controlled through rules, scheduling or plans (Steensma and Corley, 2000), and that higher degrees of complexity call for more coordination (Gulati and Singh, 1998), implying that governance costs and administrative overheads rise (Williamson, 1985). Congruent with Dekker (2003), I measure complexity by two indicators. First, I develop a count-measure of the number of products involved in a transaction. Many transactions comprise the purchase of multiple products. Eighteen product categories are distinguished (e.g., standard software, network-configurations, mainframes and support activities). The number of products is then calculated as the sum of the values for each product category. In order to obtain a normal distribution, I take the square root of this value. The second indicator results from subdividing the 18 product types into five different product categories, each entailing a different degree of interdependency between the partners. The lowest value for this scale consists of standard products, which include standard software packages, personal computers, workstations and peripheral equipment such as cables and accompanying devices. The highest level of complexity consists of tailor-made software and

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design activities. A Guttmann-type scale is then developed in which the level of complexity is determined by taking the maximum complexity levels present in a transaction. Finally, the overall complexity of an exchange is measured by both the number of products transacted and the complexity level involved with the transaction. Cronbach’s alpha for this measure is 0.71. Prior relationships between the same partners are measured by the existence of a dummy variable (consistent with previous studies of, amongst others, Dekker, 2003; Kale et al., 2000; Oxley and Sampson, 2004), indicating whether the buyer and the supplier had undertaken business with each other before or not (0 no prior relationship, 1 prior relationship). I recognize that this is a very crude indicator, but believe it suffices its purpose here. Size of buyer firm The majority of studies presuppose a positive relationship with formalization (Oxley, 1997). Following previous research (Heide, 2003; Heiman and Nickerson, 2004; Muthusamy and White, 2005), I measure size of the buyer firm by two indicators. The first indicator consists of the number of employees of the buyer organization before the transaction. As this measure is highly skewed, the logarithm of these values is taken (see Davila, 2005). The second indicator consists of the turnover of the buyer before the transaction (see Heide, 2003). As the distribution of this item is highly skewed, the logarithm is taken of these values. Cronbach’s

for the scale containing both items equals 0.73. Financial volume With respect to financial volume, transaction cost economists suggest that organizations deal more cautiously with transactions involving greater investment commitment (Chi, 1994; Williamson, 1985), as they generally involve higher dependency of an organization on its transaction partner and higher risks (Heide and John, 1988). Financial volume is therefore proposed to be positively associated with the degree of formalization (Batenburg et al., 2003; Blumberg, 2001; Yan and Gray, 2001). It is measured as the volume of payments from the buyer to the supplier organization (see Heide, 2003), excluding payments for extra work (response categories: 1 <€ 11.363, 2 € 11.363 to € 22.726, 3 € 22.726 to € 45.455, 4 € 45.455 to € 90.909, and 5 more than € 90.909). Antecedents Size of supplier firm may influence the need to contract, as larger suppliers possess more bargaining power, and as the relative

Appendices

267

degree of dependence of the buyer on the supplier is likely to become greater. This variable is measured by one indicator consisting of the number of employees at the supplier before the transaction. The response categories are divided into five value ranges (1 less than 5; 2 5–9; 3 10–19; 4 20–49; and, 5 more than 50). Measurability of inputs, outputs or behaviour in a relationship often connects to high uncertainty (Poppo and Zenger, 2002). It has been suggested to complicate the design of appropriate contracts (Blumberg, 2001; Ouchi, 1979; Ouchi and Maguire, 1975; Eisenhardt, 1989b). After all, ‘even though management defines bureaucratic measures as both legitimate and effective, it may, nevertheless, be unable to implement these patterns’ (Gouldner, 1954: 146). At the same time, others put forward that, if necessary, managers ‘try to find decision rules, information sources, and structural designs that provide adequate understanding’ to cope with low measurability and uncertainty (Daft and Lengel, 1986: 555). The influence of measurability on governance decisions has therefore remained ambiguous. It is captured by three items, referring to how difficult it was for the respondent’s organization ‘to compare this product with similar products’, ‘to compare the price–quality ratio of potential suppliers’ and ‘to evaluate the quality of this product at the time of delivery’. Responses follow a five-point Likert-scale (1 ‘very easy’, 5 ‘very difficult’). As the ability to contract is a construct with a positive orientation, the scales were reverse-coded. Cronbach’s alpha for this scale equalled 0.79. Firm reputation refers to a focal organization’s knowledge of the partner’s likely behaviour, and of its capabilities and resources (Hill, 2001a). As reputation reduces the likelihood that partners behave opportunistically, it is believed to reduce the need for relying on complex and costly contracts (Eggleston et al., 2000). Congruent with Carson et al. (2006), the items I use refer to the importance of ‘the reputation and reliability of the supplier’, ‘the reputation and reliability of the product’, and ‘the general impression of the supplier and its employees’. The resulting scale has a Cronbach’s alpha of 0.73. Alternative options increase one’s ‘ability to exit from existing relations’ Palay (1996: 49), thereby offering an alternative to contractual safeguards. Cooper and Slagmulder (2004: 17) offer an example of Isuzu, an Asian car manufacturer, which ‘used direct competition between its major suppliers to ensure that the suppliers were as innovative as possible. When a supplier failed to

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remain competitive, Isuzu punished that firm by awarding it slightly less volume than in previous years’. In these cases ‘interests were secured because of the existence of potential alternatives and not necessarily because of actual recourse to those substitutes’ (Masten, 1996: 50). Consistent with Jap and Ganesan (2000), I measure alternative options by two indicators referring to ‘the number of alternative suppliers that could have arranged a similar IT solution’ and ‘the number of alternatives for this product’ (1 ‘minimal’, 5 ‘very high’). Cronbach’s alpha for this scale equals 0.72. Perceived dependence was measured by one indicator, described as ‘the respondent’s estimation, before the transaction, of the buyer’s dependence on the supplier’. The response categories ranged from 1 ‘very small’ to 5 ‘very large’. First user group describes whether the buyer belonged to the first group of users of the product in its industry (1 belonged to the first user group, and 0 did not belong to the first user group). Age of supplier and age of respondent measure the number of years the supplier is active in the IT branch, and the age of the person answering the questionnaire, respectively. Organization-level variables influencing governance decisions consists of the buyer’s legal expertise, the buyer’s expertise concerning the transacted goods or services, and expertise derived from other relationships. For example, as buyers with legal expertise are likely to be better able to negotiate and contract, their possession of legal expertise is proposed to increase the extensiveness of negotiations and the completeness of contracts. Buyers with legal experts are further assumed to be aware of the downsides of standard contract usage, which reduces the likelihood that those are used. Antecedents and Governance Mechanisms This resonates with findings from Leiblein and Miller (2003), from their study on 469 make-or-buy decisions of 117 semiconductor firms, which show that organization-level characteristics, like experience with a certain domain, influence governance decisions. Buyers may differ in their ability to select attractive sourcing partners, negotiate, and enforce supplier contracts, design systems to manage relationships outside of the hierarchy, or to monitor and enforce contractual compliance (e.g., Anand and Khanna, 2000a; Ring, 2002), and they might be more or less capable of interacting

Appendices

269

with other companies or in creating value in interorganizational relationships (Dyer et al., 2001; Lorenzoni and Lipparini, 1999). ●

●

●

Buyer’s legal expertise is measured as a dummy variable indicating whether the buyer has employees or departments with legal expertise or not (0 no, 1 yes). Buyer’s IT expertise (i.e., expertise concerning transacted goods or services) is measured by a dummy variable indicating whether the buyer has employees or departments with IT expertise or not (0 no, 1 yes). Buyer’s experience with managing interorganizational relationships is proxied by the extent to which it has few or many connections with other organizations (Hoang and Rothaermel, 2005). It is measured by a question indicating whether the buyer has any relationships or cooperative agreements with other organizations with respect to R&D, purchasing & sales, or transport (0 no, 1 yes).

Ability to contract I measure the ability to contract in terms of three items, referring to how difficult it was for the respondent’s organization ‘to compare this product with similar products’, ‘to compare the price–quality ratio of potential suppliers’ and ‘to evaluate the quality of this product at the time of delivery’. Responses follow a five-point Likert-scale (1 ‘very easy,’ 5 ‘very difficult’). As the ability to contract is a construct with a positive orientation, the scales were reverse-coded. Cronbach’s alpha for this scale equalled 0.79. Construct validity was assessed by analysing the scale’s correlation with the focal organization’s relative experience with automation compared to other organizations in the same industry. Pearsons’ correlation statistic is equal to 0.30 (p0.00), indicating that organizations which are relatively more experienced with automation possess a higher ability to contract, something which strongly reinforces my confidence in this measure. Need to contract was not measured explicitly. Instead, I measure the actual degree of contract complexity. In case the relationships between each of the four antecedents, the actual degree of contractual complexity and the ability to contract exhibit signs in opposite directions, I infer that their effects on the need and the ability to contract must differ. If a higher level of asset-specificity, for example, leads to a lower ability to contract, but also to a higher degree of contractual complexity, I infer that asset-specificity must have a positive influence on the need to contract. Hence, I propose

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that the effects that antecedents have on the need to contract can be derived from their effects on the degree of contract complexity and the ability to contract. Contractual complexity The measure for contractual complexity is constructed from the respondents’ answers regarding the presence or absence of 24 contract clauses, including ones on price determination; liability of the supplier; restrictions on product use; price levels; force majeure; nondisclosure by the buyer; updating; arbitration arrangements; settlement of R&D costs; joint management; technical specifications; termination periods; price changes; warranties; insurance by the supplier; payment terms; quality (norms); service periods; sanctions for late payment; intellectual property rights; the reservation of spare parts; delivery times; protection of the product; and maintenance periods. Individual contract terms receive a value of one when the respondents indicated that they were included as a clause in the contract, whereas they are coded zero when the subject was not arranged or only arranged verbally. Subsequently, the degree of formalization is calculated as a count measure of the contractual agreements on the 24 financial, legal and operational issues that were actually covered by the contract. Governance Mechanisms and Interorganizational Performance Information processing and sensemaking activities are measured as the number of men-days the respondent and his/her colleagues jointly spent on drawing up the contract and negotiating with the supplier. This conforms to previous research in which measures of data search have been proposed as proxies for ‘mindful’ versus ‘mindless’ cognitive processing (e.g., Dunegan, 1993). To obtain a positive normal distribution, I take the log of this measure. Partner selection efforts. Most empirical inquiries regarding partner selection have focused on the type of selection criteria organizations apply in different contexts (e.g., Hitt et al., 2000; Nielsen, 2003). However, since interorganizational relationships vary as to the contexts and settings in which they take place, the tasks concerned, and the organizations involved, attempting to identify a universal list of criteria that organizations should employ when seeking an appropriate partner seems futile (Hitt et al., 2000). To secure a higher external validity of the findings, I use the number of men-days spent by a buyer on the selection and comparison of suppliers and their products as a proxy for selection

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271

efforts. The distribution of responses in terms of this indicator ranges from zero to three hundred days and is highly peaked and skewed. Most buyers had only spent a day or two on supplier and product selection, while a few invested a substantial amount of time. The variable is therefore subjected to a double square root transformation, rendering a normal distribution (see also Dekker, 2003). Exhaustiveness of negotiations between buyers and suppliers was measured by the extent to which 24 financial, legal and operational issues were discussed by the buyer and supplier during negotiations on the transaction on a three-point scale (1 little, 2 normal, 3 a lot). Issues included were price determination; liability of the supplier; restrictions on product use; price levels; force majeure; nondisclosure by the buyer; updating; arbitration arrangements; settlement of R&D costs; joint management; technical specifications; termination period; price changes; warranties; insurance by the supplier; payment terms; quality (norms); service periods; sanctions for late payment; intellectual property rights; the reservation of spare parts; delivery times; protection of the product; and maintenance periods.The variable consists of a count measure for all terms, implying that a minimum value of 24 and a maximum value of 72 could be obtained. Standard contract. The decision to apply a standard form contract or a tailor-made contract is measured by a dummy variable (0 tailor-made contract, 1 standard form contract). Advance payment. The decision as to whether or not to pay a supplier in advance is measured by a dummy variable (0 no advance payment, 1 advance payment). Interorganizational performance is measured by two proxies. The first pertains to the extent to which 11 different types of problems have occurred within relationships (i.e., exceeding delivery period; exceeding price / budget; product incomplete; product too slow / too limited; deviance of agreed on specification; incompatibility with other products; installation too quick / careless; support too summarily; service too slow / late; necessary adaptations slow or late; insufficient / unclear documentation. Response categories: 1 ‘not’, 5 ‘into a large extent’). The occurrence of problems is then calculated as the maximum value respondents give to one of the problem categories. Similar to Rooks (2002) and Rooks et al. (2006), the validity of the measure was assessed by regarding its relationship with other performance variables, such as report marks for the supplier, and the degree to which a buyer would

272

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recommend the supplier to others, which were all negative, confirming confidence in the validity of this measure. Corresponding with prior work by Rooks and Snijders (2001), the second proxy for interorganizational performance refers to the extent to which buyers take corrective measures to alleviate or mitigate problems (i.e., deliberate with supplier; refer to agreements made; contact higher management; inform other clients of supplier; postpone payment period; postpone payment; claim damage; call for arbitration; other juridical steps; finish relationship; defer agreement. Response categories: 0 ‘no’, 1 ‘yes’). The final measure is then constructed which consists of a count-measure of the number of actions that buyers took in reaction to problems emerging in their relationships with suppliers. Similar to the first dependent variable, I assessed the validity of this measure by examining its correlations with alternative performance measures, which were negative and significant here as well.

273

Appendices

APPENDIX C

STRUCTURAL EQUATION MODEL

e27

e1

e2

Contract

Specs

e3 e26

Actions CONTRACT COMPLEXITY

PERFORMANCE e25

Problems

e23

Meas 1

e22

Meas 2

e21

Meas 3

e19

Asset 1

e24

MEASURABILITY

e20

E18

Asset 2

e17

Asset 3

E4

ASSET SPECIFICITY

SIZE CLIENT

e16

e15

Rep 2

e13

Rep 3

E5

Employ

E6

Supplier

E7

Product

E8

e9

Rep 1

e14

Turnover

ALTERNATIVE SUPPLY

REPUTATION

TRANSACT. COMPLEXITY

Numpsqrt

Comall

e12

e11

e10

274

1. Financial volume 2. Complexity 3. Asset-specificity 4. Measurability 5. Size buyer 6. Size supplier 7. Legal expertise 8. Other relationships 9. IT expertise 10. Importance reputation 11. Alternative options 12. Perceived dependence 13. First user group 14. Age supplier 15. Age of the respondent

1.22

0.48

1.22 8.81

2.60

0.35

2.91 38.5

0.17

0.04

0.09 0.03

0.06 0.03

1.00

11

0.13 0.08

0.14 0.26

0.05

1.00

10

0.15

1.00

12

1.00

13

14

15

0.55 0.02 0.05 0.03 0.15 0.12 0.17 0.05 1.00 0.11 0.02 0.05 0.04 0.00 0.05 0.06 0.06 0.10 1.00

0.08 0.04

0.17 0.23

9

0.18 1.00 0.07 0.00

1.00

8

0.02 0.02 0.00

0.25 0.06

1.00 0.05

7

0.14 0.05

0.04

0.25 0.21

0.29 0.05 0.07 0.06 0.28 0.07 0.01 0.01 0.02 0.03

0.16

0.26

0.30

1.94 0.22 0.21 0.24

5.33

0.06 0.17

1.00 0.05 0.01

6

0.26 0.11 0.11

0.16 0.02

0.00 0.01 0.07 0.19 0.21 0.00

0.41 2.09

0.78 11.3

0.11 0.21

1.00 0.27 0.13 0.05

5

2.02 0.43 1.00 3.04 0.37 0.40 1.00 2.67 0.28 0.30 0.39 1.00 0.87 0.42 0.09 0.05 0.01 1.47 0.38 0.13 0.17 0.07 0.40 0.08 0.02 0.02 0.04 0.50 0.08 0.07 0.03 0.04

4

5.32 8.66 9.40 5.79 3.40 0.20 0.49

1.00

3

1.46

2

2.54

1

CORRELATION MATRIX

Mean S.D.

APPENDIX D

275

7.86

40.2

10.7

0.35

0.24

0.50

0.35

0.20

0.31 0.04 0.09

0.11 0.11 0.33 0.15

5.84

0.42

0.35

0.32 0.22 0.11

0.09 0.16

0.22

0.37 0.28

0.46 0.24 0.16 0.07

0.44

0.26

0.70

0.71

0.00

0.17

0.50 0.06 0.09 0.15

1.58

0.50 0.10

0.06

0.09

0.07 0.03

0.00 0.01

0.07 0.08

0.01 0.03

0.35

0.06

0.09 0.03

0.08

0.24

0.12

0.16

0.07 0.040.04

0.04 0.01 0.01

0.12 0.08 0.02

0.01 0.02 0.15 0.00

0.24 0.17

0.25

0.08 0.18 0.05

0.03 0.08 0.10 0.030.02

0.33 0.13

0.06 0.07

0.23 0.13

0.07

0.04 0.05 0.03 0.01 0.05

0.16

0.04 0.03

0.22

0.09

Correlations with binary variables consist of Kendall’s tau-b. Correlations higher than 0.072 are significant at the 0.05-level, whereas correlations higher than 0.085 are significant at the 0.01-level.

16. Familiar partner 17. Selection eﬀorts 18. Advance payment 19. Negotiation eﬀorts 20. Standard contract 21. Contract completeness

276

Contracts and trust in alliances

APPENDIX E ANTECEDENTS OF SIX GOVERNANCE MECHANISMS (1) Familiar partner

(2a) Selection eﬀorts

(2b) Selection eﬀorts

(3a) Advance payment

Financial volume Complexity Asset-specificity Measurability Importance reputation Alternative options Perceived dependence First user group Size buyer Size supplier Legal expertise Other relationships IT expertise Age supplier Age of respondent Familiar partner Selection eﬀorts Advance payment Ext. negotiations Standard contracts

n.s. n.s. 0.89 (0.005) 1.10 (0.046) 1.11 (0.062) 1.11 (0.083) 1.28 (0.010) 0.61 (0.039) n.s. n.s. n.s. n.s. n.s. 1.40 (0.003) n.s. – – – – –

0.32 (0.000) n.s. 0.14 (0.004) 0.18 (0.000) 0.11 (0.010) n.s. n.s. n.s. n.s. n.s. n.s. 0.09 (0.039) n.s. 0.09 (0.094) n.s. – – – – –

0.30 (0.000) n.s. 0.11 (0.021) 0.17 (0.000) 0.13 (0.002) n.s. n.s. n.s. n.s. n.s. n.s. 0.09 (0.038) n.s. n.s. n.s. 0.20 (0.000) – – – –

1.48 (0.000) n.s. n.s. n.s. n.s. n.s. 1.20 (0.075) n.s. n.s. n.s. n.s. n.s. n.s. 0.71 (0.008) n.s. – – – – –

Number observations R2 – Adjusted* Correctly predicted %

420 0.130 (0.174) 65.0

459 0.307 –

406 0.332 –

417 0.103 (0.148) 74.8

277

Appendices

(3b) Advance payment

(3c) Advance payment

(4a) Ext. negotiate

(4b) Ext. negotiate

1.47 (0.001) n.s. n.s. n.s. n.s. n.s. 1.23 (0.053) n.s. n.s. n.s. n.s. n.s. n.s. 0.73 (0.014) n.s. n.s. – – – –

1.43 (0.002) 0.14 (0.020) 0.13 (0.032) n.s. 0.12 (0.014) 0.11 (0.022) n.s. 0.12 (0.017) 0.10 (0.044) n.s. n.s. n.s. n.s. 0.24 (0.000) 0.25 (0.000) n.s. n.s. n.s. 1.21 (0.079) 0.15 (0.002) 0.16 (0.001) n.s. n.s. n.s. n.s. n.s. n.s. n.s. 0.11 (0.035) 0.11 (0.033) n.s. n.s. n.s. 0.66 (0.093) n.s. n.s. n.s. n.s. n.s. 0.72 (0.011) 0.12 (0.025) 0.10 (0.064) n.s. 0.08 (0.073) 0.08 (0.057) n.s. – 0.12 (0.010) n.s. – – – – – – – – – – –

0.417 0.107 (0.153) 75.1

405 0.104 (0.149) 74.3

(4c) Ext. negotiate

(4d) Ext. negotiate

n.s. 0.09 (0.056) n.s. n.s. 0.22 (0.000) n.s. 0.16 (0.001) n.s. n.s. 0.10 (0.059) n.s. n.s. n.s. n.s. 0.09 (0.045) 0.08 (0.094) 0.23 (0.000) – – –

n.s. 0.09 (0.065) n.s. n.s. 0.22 (0.000) n.s. 0.16 (0.001) n.s. n.s. 0.10 (0.055) n.s. n.s. n.s. n.s. 0.09 (0.043) n.s. 0.24 (0.000) n.s. – –

419 0.247

419 0.258

0.406 0.287

404 0.289

–

–

–

–

278

Contracts and trust in alliances

APPENDIX E (continued)

Financial volume Complexity Asset-specificity Measurability Importance reputation Alternative options Perceived dependence First user group Size buyer Size supplier Legal expertise Other relationships IT expertise Age supplier Age of respondent Familiar partner Selection eﬀorts Advance payment Ext. negotiations Standard contracts

(5a) Standard contracts

(5b) Standard contracts

(5c) Standard contracts

(5d) Standard contracts

(5e) Standard contracts

0.75 (0.009) 0.86 (0.040) n.s. n.s. n.s. n.s. 0.81 (0.041) n.s. 0.63 (0.005) 1.47 (0.000) n.s. n.s. n.s. n.s. n.s. – – – – –

0.75 (0.010) 0.86 (0.041) n.s. n.s. n.s. n.s. 0.80 (0.040) n.s. 0.63 (0.005) 1.47 (0.000) n.s. n.s. n.s. n.s. n.s. n.s. – – – –

0.78 (0.032) 0.85 (0.032) n.s. n.s. n.s. n.s. 0.82 (0.059) n.s. 0.64 (0.009) 1.47 (0.000) n.s. n.s. n.s. n.s. n.s. n.s. 0.65 (0.032) – – –

0.79 (0.043) 0.86 (0.042) n.s. n.s. n.s. n.s. 0.83(0.080) n.s. 0.64 (0.008) 1.48 (0.000) n.s. n.s. n.s. n.s. n.s. n.s. 0.67 (0.047) n.s. – –

0.79 (0.050) 0.87 (0.063) n.s. n.s. n.s. n.s. n.s. n.s. 0.62 (0.006) 1.51 (0.000) n.s. n.s. n.s. n.s. 0.97 (0.080) n.s. n.s. n.s. 0.96 (0.036)

Number observations 396 396 384 382 382 R2 – Adjusted* 0.139 (0.193) 0.139 (0.193) 0.152 (0.210) 0.152 (0.210) 0.162 (0.224) Correctly predicted % 73.0 72.7 73.7 73.6 73.0

279

Appendices

(6a) Contract complete 0.23 (0.000) 0.08 (0.092) n.s. 0.10 (0.039) 0.16 (0.000) 0.08 (0.074) n.s. 0.08 (0.072) n.s. 0.30 (0.000) 0.09 (0.028) n.s. n.s. n.s. n.s. – – – – – 419 0.309 –

(6b) Contract complete

(6c) Contract complete

(6d) Contract complete

0.22 (0.000) 0.16 (0.005) 0.12 (0.137) n.s. n.s. n.s. n.s. n.s. n.s. 0.08 (0.078) n.s. n.s. 0.17 (0.000) 0.14 (0.002) 0.13 (0.003) n.s. 0.09 (0.062) 0.08 (0.68) 0.09 (0.057) 0.09 (0.050) .08 (0.081) n.s. n.s. n.s. n.s. n.s. n.s. 0.31 (0.000) 0.29 (0.000) 0.29 (0.000) 0.09 (0.027) 0.08 (0.047) 0.09 (0.023) n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. 0.14 (0.002) 0.09 (0.053) 0.07 (0.087) – 0.22 (0.000) 0.23 (0.000) – – 0.16 (0.000) – – – – – – 419 0.325 –

406 0.350 –

404 0.373 –

(6e) Contract complete

(6f) Contract complete

0.10 (0.061) 0.11 (0.048) n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. n.s. 0.25 (0.000) 0.25 (0.000) 0.08 (0.046) 0.08 (0.036) n.s. n.s. 0.07 (0.076) 0.07 (0.095) n.s. n.s. 0.07 (0.060) 0.07 (0.85) n.s. n.s. 0.37 (0.004) 0.12 (0.013) 0.14 (0.000) 0.15 (0.000) 0.40 (0.000) 0.41 (0.000) – n.s. 404 0.486 –

381 0.463 –

* For the logistic regressions, odds ratios are presented, while for the multiple regressions standardized betas are displayed. The figures between brackets are significance values. Instead of R2–Adjusted, Cox & Snell R2 (Nagelkerke R2 between brackets) are presented for the logistic regressions.

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Index Abbott 2 ability to contract antecedents of contracting 67–75, 80–84 definition 15 future research 81–4 information processing 75–8, 251 methodology of study 35–6, 37 quantitative measures used 269 research findings 78–80, 233–4 research framework 65–7 research theme 23–4 Accenture 4, 5, 8 actionable understandings 115–16 Adler, P. 14 administration 171 advance payments decision correlation analysis 217–18, 219–23, 275, 276–9 factors influencing 212–13 governance trajectories 206, 210, 225, 226, 228, 229 quantitative measures used 271 adverse selection 50, 53 age of partner organization decision correlation analysis 274, 276–9 governance trajectories 220, 222, 223–4, 226 quantitative measures used 268 agency theory 52–5, 66, 110, 150, 152, 157 Ahuja, G. 227 Aisin 69 alliances see interorganizational relationships Allison, Graham T. 33 alternative options decision correlation analysis 274, 276–9 governance trajectories 220, 224, 226

quantitative measures used 267–8 and standardization 194–8 structural equation model 273 Alza 97, 127, 134 American Institute of Architects (AIA) 187 Anand, B. 225 Anderson, E. 69, 94, 100 Anderson, S.W. 9, 28, 31, 195 antecedents and complexity of contracts 192–201, 226 decision correlation analysis 276–9 and governance 23–4, 225–9 and governance trajectories 210, 215–17, 225–9 information processing 75–8 need vs. ability to contract 67–75, 80–84 quantitative measures used 265–70 research findings 78–80 research framework 65–7 sensemaking 75–8 antecedents–governance–performance model benefits of contracting 106 formalization 151 governance trajectories 206 integrative perspective 19–20 need vs. ability to contract 65–7 research themes 21–2, 232–40 standardization 181 tenability of 250 trust 86–7 Argyres, N.S. 8, 56, 61, 71, 72, 91, 108, 123, 140, 214 Ariño, A.M. 5, 18, 47, 48, 73, 74, 95, 108, 145, 257, 258 Arrow, K.J. 243 articulation 112, 124–5, 135 assessment 121 327

328

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assets see relation-specific assets asset-specificity decision correlation analysis 274, 276–9 definition 51 governance trajectories 220–21, 222, 223–4, 226 research findings 78–80 and standardization 194–8 structural equation model 273 associational contracts 83–4 AstraZeneca 2 authority 43 automobile producers 56, 94, 123 Avadikyan, A. 108, 123, 155 Aventis 2 Azevedo, J. 34 Baden-Fuller, C. 2 Bagley, C.E. 8, 256 Balogun, J. 156, 159 Bamford, J.D. 105–7 bargaining 213 see also negotiation bargaining game 245–6 Barnard, C.I. 130 Barthélemy, J. 71 Bechky, B.A. 118, 132 behaviour interpretation 88, 89, 96–100, 103 behavioural theory of the firm 74–5 benevolence 15 Bensaou, B. 69 Berdrow, I. 6 Beta Trading 137 bias 112, 127, 135 Bies, R.J. 108, 155, 173 Blomqvist, K. 120 Boeing 4 Borys, B. 14 bounded rationality 49, 57 bounding 54 BP 2 Bristol-Myers Squibb 2 Byrne, B.M. 195 Canada Post 6 capabilities 60–61, 114, 200–201 see also ability to contract

Cardinal, L.B. 229–30 Carson, S.J. 23, 102, 267 case studies 34–5, 160–74 Castañer, X. 155 Chalos, P. 141, 227 Chaserant, C. 98 chemicals 202 Chia, R. 37 Child, J. 46, 137 China 141 Chrysler 56 Chu, W. 93 Ciba Geigy 97, 127, 134 civil law 187 Clegg, S. 155 Cloodt, M. 18 Coase, R. 34 Coca-Cola 125 codification of contracts 11–12 coercive formalization 14 coevolution 167 cognition cognitive limitations 71–2, 88, 114, 138–9, 145–6, 256 and formalization 155, 158, 169–70, 176 cognitive psychology 255 collaborative relationships see interorganizational relationships Colombo, M.G. 9, 108, 215, 216, 228 commitment, and cooperation 120–21 common law 187 communication 155, 163 completeness 112, 127, 135, 155, 156, 159 of contracts 210, 214–15, 218, 223–5, 226, 228, 229, 275 complexity decision correlation analysis 274, 276–9 of the exchange 69, 70–72, 78–80, 81, 265–6 and formalization 168 and standardization 194–8 of transactions 273 complexity of contracts and antecedents 192–201, 226 as attribute of contracting 12

Index decision correlation analysis 220, 223–4, 225 governance trajectories 205–7, 214 and interorganizational performance 192–201 quantitative measures used 270 structural equation model 273 congruent understandings 115–16, 130–31 consistency 112, 127, 135, 155, 186–7 constitutional contracts 83–4 construal processes 257 consultancy 41 context 135–9, 166, 188 contract completeness 210, 214–15, 218, 223–5, 226, 228, 229, 275 contract incompleteness 256 contract theory 150 contracting agency theory 54 antecedents 67–75 capabilities 60–61, 200–201 context 135–9 and control 48, 141–2, 145–7 coordination in 55–6, 141–2, 145–7 costs 51 cross-disciplinary research 255 definition 10–11 and governance 105–13, 249–50 governance trajectories 209, 210, 213–14 integrative perspective 19–21 in interorganizational relationships 10–14, 89 interpretation of partners’ behaviour 96–100 manager’s role 251–3 and mindlessness 190–92 and motivation 99 negative eﬀects 133–5 partnership asymmetries 142–3 research themes 21–8 role of 232 and sensemaking 111, 112, 119–28, 139–42, 251 and standardization 179–82, 188–9, 198–202 time, eﬀect of 135–9 typology 11–14 and understanding 112, 139–42, 247

329

contracts completeness 210, 214–15, 218, 223–5, 226, 228, 229, 275 content of 257–8 see also complexity; standardization control antecedents 215–17 and contracting 48, 141–2, 145–7 and coordination 61 and formal governance 108–13, 249 and formalization 141–2, 155, 157, 168, 176 and governance 25–6, 46–55, 62, 208 methodology of study 35–6 and motivation 88 role of 232 and trust 85–7 see also formal control Cooper, R. 267 cooperation 42, 120–21, 211 see also prior cooperation Cooray, J. 155 coordination antecedents 215–17 and cognitive limitations 88 and contracting 55–6, 141–2, 145–7 and control 61 and formal governance 108–13, 249 and formalization 141–2, 155, 156–7, 168, 176 and governance 46–7, 55–62, 208 QUICK–STEADY case study 163 role of 232 see also formal coordination cost 51, 184 creativity 166 Cronin, M.A. 115 Crossan, M.M. 6 cross-disciplinary research 255–6 cruise ships 202 crystallized goals 53 cultural regimes 101, 102–3, 114, 144–5 Dacin, M.T. 155 Daft, R.L. 76 Davila, T. 74 De la Torre, J. 145 De Rond, M. 17

330

Contracts and trust in alliances

decontextualization 199–200 Deeds, D.L. 198 Dekker, H.C. 9, 28, 31, 195, 265 deliberation 112, 124–5, 135 Delmar, F. 155 Delmestri, G. 66 dependence, perceived 220, 222, 223–4, 226, 268, 274, 276–9 detail of contracts 11–12 Dewar, R.D. 108, 155 distrust combined governance forms 93–5 expectancy disconfirmation 95–6 and formal control 89–91 and formal coordination 89–91 in interorganizational relationships 100–104 interpretation of partners’ behaviour 96–100 and performance 18–19, 91–3 and trust 87–9 division of labour 130, 155 documents 123 domain of contracts 12–14 Douwe Egberts (DE) 83 Dow Chemical 2 Doz, Y.L. 100, 127, 134 Drucker 2 drug companies see pharmaceutical companies duality of formalization 26–7, 35, 149–51, 154–60, 174–7, 233, 237–8 duration of relationships 40 Dyer, J.H. 8, 47, 93, 221 dynamic capabilities 23–4, 58–63, 70–72 dynamic transaction costs 134 Ebers, M. 21 economic activity 28–30, 101–2 eﬃciency 183–4, 188 Einstein, A. 133 Eli Lilly 2, 4 enabling formalization 14, 141 enforcement 11–12, 156, 159 enforcement costs 51 entrepreneurship 62, 156, 159 equity exchange see advance payments Ernst, D. 8

Esthétique 127 exchange 166 exchange complexity 69, 70–72, 78–80, 81, 265–6 exchange eﬃciency 183–4 execution 121 expectancy disconfirmation 95–6 experience 60, 247, 269 experimental research 254 explicit coordination 147 exploitation 135–9 exploration 135–9 External Management of Automation, The [MAT95] database 35–6, 263–4 Faems, D. 13, 14, 83, 97, 143, 257 Falk, A. 156 familiar partners 276–9 see also partner selection; prior cooperation Fehr, E. 156 Feldman, M.S. 146 ferries 202 Ferrin, D.L. 103 financial volume 220, 223–4, 226, 228, 266, 274, 276–9 firm size decision correlation analysis 274, 276–9 governance trajectories 220, 223–4, 226, 228 need vs. ability to contract 69, 74–5, 78–80 quantitative measures used 266 structural equation model 194–8, 273 First Clinical Research 184 first user group 220, 222, 224, 226, 268, 274, 276–9 flexibility 166 flight operations 202 focusing attention 112, 123–4, 135 FoodCom 221–2 Ford 56 formal control combined governance forms 93–5 expectancy disconfirmation 95–6 and formal coordination 87–9

Index in interorganizational relationships 100–104 interpretation of partners’ behaviour 96–100 and performance 91–3 and trust 89–91 see also control formal coordination expectancy disconfirmation 95–6 and formal control 87–9 in interorganizational relationships 100–104 interpretation of partners’ behaviour 96–100 and performance 91–3 and trust 89–91 see also coordination formal governance 105–13, 248–9 see also governance formalization case study 35, 160–74 coercive 14 and cognition 155, 158, 169–70, 176 and complexity 168 and control 141–2, 155, 157, 168, 176 and coordination 141–2, 155, 156–7, 168, 176 definition 254 degree of 166–7 dialectic perspective 151–4 duality of 149–51, 174–7 dysfunctions of 156, 159–60, 170–71, 172 enabling 14 functions of 154–8, 168–70, 172, 176–7 future research 177, 254–5 and governance trajectories 225 and learning 155, 158, 169–70, 176 and legitimacy 141–2, 155, 157–8, 169, 176 manager’s role 149–51, 251, 252 negative eﬀects 133–5 in organizations 57–8 research findings 233, 237–8 research theme 26–7

331

and sensemaking 111–13, 119–28, 140–42, 158 tensions 171–4 Foss, K. 156 Foss, N.J. 25, 108, 130, 245 Fréchet, M. 142–3, 257 Freund, J. 189 Fryxell, G.E. 136 Fuji Xerox 125 fundamental transformation 221 Furlotti, M. 68, 83, 185 future research cross-disciplinary research 255–6 experimental research 254 formalization 177, 254–5 governance trajectories 229–30 need vs. ability 81–4 pluralistic approach 250–51 pre- and post- contracting processes 256–7 sensemaking 142–7 standardization 199, 201–2 trust, and contracts 101–4 Gainey, T.W. 72, 224 Ganesan, S. 156, 217, 268 General Motors–Fisher Body Case 64 Germany 102, 186, 201 Geyskens, I. 256 Ghosh, M. 59 Gioia, D.A. 34 Gittell, J.H. 31, 32 GlaxoSmithKline 2, 4 Gluck, G. 189 Glynn, M.A. 105 Goldfarb, N. 184 Gouldner, A. 155, 156 governance and antecedents 23–4, 225–9 combinations of forms 93–5 and contracting 105–13, 249–50 as control mechanism 25–6, 46–55, 62, 208 as coordination mechanism 46–7, 55–62, 208 decision correlation analysis 274–9 decision interrelationships 214–15, 233, 240, 252 formal governance 105–13, 248–9

332

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inseparability 202 integrative perspective 19–21 and interorganizational relationships 1, 7–10, 46–7, 204–7 manager’s role 248, 252–3 quantitative measures used 268–72 role of 105–13, 248–9 and standardization 188 theory 207–9 and value 258–60 see also antecedents–governance– performance model governance trajectories antecedents 210, 215–17, 225–9 decision correlation analysis 217–25, 274–9 decision interrelationships 214–15, 249–50 definition 205, 209 and formalization 225 future research 229–30 and interorganizational relationships 204–7 manager’s role 252 methodology of study 37 multiple regression analyses 223–5 and negotiation 209, 210, 212–13 research findings 233, 240 research theme 28 stages of 209–14 Grandori, A. 9, 32, 66, 68, 83, 185, 258 Grant, R.M. 2 GRAPH (imaging company) 13–14, 96, 97, 143–4 Grimaldi, R. 155 Gulati, R. 47, 56, 57, 73, 108 Hagedoorn, J. 18, 38, 42, 56, 258 Håkansson, H. 31 Hargadon, A.B. 118, 132 Hatch, M.J. 25, 150 HCL technologies 4 Hearst 2 Heide, J.B. 50, 208, 228 Heiman, B.A. 215, 243 Henderson, R. 145–6 Hendry, J. 115, 156 Herbig, P. 155 Hesen, G. 56, 258 Hill, C.A. 120, 201, 202

Hoecht, A. 93 Hoelter, J.W. 196 Hoetker, G. 221 hold-ups 51, 61, 64, 156 Hsieh, C. 29 implicit coordination 147 incompleteness 112, 127, 135, 156, 159 see also completeness inconsistency 112, 127, 135, 186–7 Infeld, L. 133 information 50, 82 asymmetries 143, 157, 185, 256 processing 75–84, 251, 270 see also knowledge; learning innovation 135–9, 241, 247 institutional environments 102–3 institutional theory 110, 157 integrity 15 intentions 12, 14, 103 interaction 112, 126, 135 interorganizational performance 192–201, 210, 270–72 interorganizational relationships contracting 10–14, 89 control in 46–55, 100–104 coordination in 46–7, 55–62, 100–104 duration 40, 41 empirical basis of study 37–40 failure of 7–8 forms of 31 and governance 1, 7–10, 46–7, 204–7 growth of 2–4 integrative perspective 19–21 and intraorganizational relationships 31–2 joint ventures 39 methodology of study 33–7 motivation 5–7 performance 16–19 purpose 38 research themes 21–8 scope of study 28–33 and sensemaking 110–13 stages of 204–5 and trust 14–16, 89, 100–104, 251 interpretation of contracts 186–7 interpretation of partners’ behaviour 88, 89, 96–100, 103

Index intraorganizational relationships 31–2 Ireland, D. 8, 156 Isuzu 267–8 Italy 6 IT expertise 220, 224, 226, 269, 274, 276–9 Jap, S.D. 94, 100, 108, 156, 217, 268 Jemison, D.B. 82 JET (inkjet technology firm) 13–14, 96, 97, 143–4 John, G. 59, 208 Johnson, G. 156, 159 Johnson & Johnson 2 judgement errors 112, 127, 135 Kaghan, W.N. 120 Kahn, R.L. 12, 155, 156 Kale, P. 108, 155 Kang, N.H. 2 Kaplan, S. 145–6 Katz, D. 12, 155, 156 Kerr, J.L. 56–7, 108 Ketokivi, M. 155 Khanna, T. 225 King, C. 201, 202 Kirsch, L.J. 208–9 Klaas, B.S. 72, 224 Klein, B. 28, 34, 108, 156, 208 Klein, P.G. 228 Klein Woolthuis, R. 25, 26, 200, 221, 225 knowledge and ability to contract 70 and formalization 158 protection 141 sharing 260 value creation 241, 243–4 value discovery 245, 247 see also information; learning known means–ends relationships 53 Kogut, B. 21 Kotabe, M. 155 Koza, M. 172 Kreps, D.M. 156 Krishnan, R. 102, 137, 138 Lane, P.J. 221 Langer, E. 180

333

Langfred, C.W. 88, 94 Langley, A. 155 Langlois, R.N. 134 language 144–5, 155, 186–7 Lassar, W. 56–7, 108 Lavie, D. 3, 244 law studies 255 Lazzarini, S.G. 86, 156 learning 155, 158, 169–70, 176 see also information; knowledge legal expertise 220, 224, 226, 228, 269, 274, 276–9 legal regimes 101, 102–3 legitimacy and contracting 141–2 and formal governance 108–13, 249 and formalization 141–2, 155, 157–8, 169, 176 and standardization 186 Leiblein, M.J. 60, 214, 268 Lengel, K.J. 76 Lepak, D.P. 241, 259 Lerpold, L. 5 Lewicki, R. 87 Lewin, A. 172 licence agreements 41 Liebeskind, J.P. 214 life-cycle of interorganizational relationships 205–7 Lind, J. 31 Lindenberg, S.M. 108 Lipparini, A. 6 Lockett, A. 9 L’Oréal 127 Lorenzoni, G. 6 Lounsbury, M.D. 120 Lubatkin, M. 221 Lui, S.S. 155 Lumineau, F. 257 Luo, Y. 49, 73, 212 Macaulay, S. 98 MacCallum, R.C. 195 Madhok, A. 8, 59, 73, 108, 202, 215, 228 Makadok, R. 46, 145 manager’s role in contracting 251–3 dialectic perspective 151–4

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and formalization 149–51, 251, 252 future research 81–2 governance 248, 252–3 managerial cognition 256 tensions in formalization 171–5, 176 understandings 114, 145 manufacturing 38, 41 March, J.G. 57–8, 62, 108, 110, 155 Marcy, R. 105–7 Marginson, D. 156 market transactions 28–30 marketing 38 Martin, S.S. 180 Masten, S.E. 9, 108, 155, 156, 228 MAT-95 Database 35–6, 263–4 Mayer, K.J. 8, 56, 61, 71, 91, 108, 120, 123, 257 Mayer, R. 15 McDaniel, R.R. 133 McGahan, A.M. 216 measurability decision correlation analysis 274, 276–9 governance trajectories 220, 221, 222, 223, 224, 226, 227, 228 quantitative measures used 267 structural equation model 194–9, 273 meeting of minds 179, 180, 188–9, 239, 252 Meindl, J.R. 109 Merck 2 Mesquita, L.F. 95, 103 Meyer, J. 25, 108, 155, 171 Milewicz, J. 155 Miller, D.J. 60, 268 Miller, P. 155 mindfulness 180, 190–92, 200, 201, 239, 270 see also sensemaking mindlessness 179, 180, 189–92, 233, 252, 270 Mintzberg, H. 18, 134, 155, 156 monitoring 48, 51, 54 moral hazard 50, 53 motivation 5–7, 88, 99, 156, 159 see also need to contract Nadler, D.A. 79 NASA 137

need to contract antecedents of contracting 67–75, 80–84 future research 81–4 information processing 75–8, 251 methodology of study 35–6, 37 quantitative measures used 269–70 research findings 78–80, 233–4 research framework 65–7 research theme 23–4 negotiation context, eﬀect of 135–9 exhaustiveness of 206, 210, 213, 226, 228–9 future research 142–7 and governance 105–13, 208 governance trajectories 209, 210, 212–13 methodology of study 35–6, 37 and mindlessness 190–92 negative eﬀects 133–5 research findings 233, 236–7 research theme 25–6 and sensemaking 111, 112, 116–28, 139–42, 251 and standardization 179–82, 188–9, 192–202 time, eﬀect of 135–9 and understanding 114–16, 139–42, 247 value creation 128–33 see also bargaining negotiation eﬀort decision correlation analysis 275, 276–9 governance trajectories 206, 210, 213, 218, 223–5, 226, 228–9 quantitative measures used 271 Ness, H. 120 Nestlé 125 network eﬀects 187–8 Ngo, H.-Y. 155 Nickerson, J.A. 29, 132, 133, 215, 241, 243 non-compliance 43 Nooteboom, B. 15 Norway 120 Novartis 2 novel understandings 131–2, 247 nuclear plants 202

Index O’Connor, N.G. 141, 227 Ogden, S. 156 Olekans, M. 82 Oliver, A.L. 21 Olsen C.P. 109 Oneworld 6 opportunistic behaviour 49–50, 69–72, 74, 83, 208, 211 organizational behaviour theory 57–8, 62 organizational characteristics 144–5, 166, 268–9 organization-level antecedents 216, 268 Osborn, R.N. 38, 42 Ouchi, W.G. 47, 53 outcome performance 17–18 outcome-based contracts 53–4 outsourcing 3 Oxley, J.E. 71, 74, 108, 137, 155, 257 Palay, T.M. 74, 267 Park, S.H. 7 Parkhe, A. 257 partner selection decision correlation analysis 217–18, 222, 274 governance research 208 governance trajectories 206, 209, 210–12, 225, 227, 228–9 partnership asymmetries 142–3 quantitative measures used 270–71 value creation 244 perceived dependence 220, 222, 223–4, 226, 268, 274, 276–9 performance expectancy disconfirmation 95–6 and formalization 172 integrative perspective 19–21 interorganizational relationships 16–19 interpretation of partners’ behaviour 88, 89, 96–100 and standardization 194–8 structural equation model 273 and trust 18–19, 91–3 see also antecedents–governance– performance model Pfizer 2 pharmaceutical companies 2, 8, 257

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Philips 83 philosophy 114 Pietroforte, R. 187 Pitre, E. 34 politics 143 Poole, M. 36 Poppo, L. 15–16, 155, 258 post-contracting processes 256–7 power 143 prairie travellers 106–7 pre-contracting processes 256–7 Priem, R.L. 241 prior cooperation governance trajectories 210, 218–23, 226 need vs. ability to contract 23–4, 69, 72–4, 78–80 quantitative measures used 266 see also cooperation; familiar partners prior experience 60, 247, 269 process performance 17–18 process-based contracts 53–4 processes 11, 123 Processor 221–2 Quélin, B.V. 71 QUICK (financial services organization) 35, 160–77 R&D (research and development) 38, 41, 60, 96, 97, 102, 143–4 Rands, G. 109, 122 Ratnatunga, S. 155 reflection 112, 124–5, 135 relational-level antecedents 216 relationship mortality 16–17 relationships 31, 54, 220, 226, 274, 276–9 relation-specific assets governance trajectories 221, 222, 223, 227, 228 need vs. ability to contract 68–70, 78–80, 83 and negotiation 141 quantitative measures used 265 value creation 242–3 reputation decision correlation analysis 274, 276–9

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governance trajectories 220, 223–4, 226 quantitative measures used 267 structural equation model 194–8, 273 resource asymmetries 143 resource-based view 58–63 retailing industry 120 Reuer, J.J. 9, 28, 47, 48, 73, 74, 95, 215, 227, 228, 257, 258 Richardson, G.B. 30 Rico, R. 115 Rindfleisch, A. 228 Ring, P.S. 40, 79, 108, 109, 120–21, 122, 137, 236, 257 risk 54, 94–5, 170–71, 184–5, 211 robustness 184–5 Roche 2 Rooks, G. 271, 272 Rose, N. 155 Roth, N. 98 Rothaermel, F.T. 198 Rousseau, D.M. 14–15 routinized behaviour 189–90 Rowan, B. 25, 108, 155, 171 Ryall, M.D. 56, 73 Sakai, K. 2 sales and marketing 41 Salomon, R.M. 61 Sampson, R.C. 9, 30, 56, 60, 71, 73, 155 Sandberg, J. 115 Sarkar, M.B. 60 Saussier, S. 9 Schifrin, M. 3 Schoorman, F.D. 103 Schrader, S. 9, 109 Schweitzer, M.E. 156 search costs 51 selection eﬀort decision correlation analysis 275, 276–9 governance trajectories 206, 210, 211–12, 217–18, 223–5, 226 semiconductor firms 60 semi-structure 171–2 sensebreaking context 135–9 and contracting 111, 119–23, 251

definition 118–19 factors influencing 145 and formal governance 249 research findings 233, 236–7 and standardization 189 value creation 128–33 sensedemanding context 135–9 and contracting 111, 119–23, 251 definition 118 factors influencing 145 and formal governance 249 research findings 233, 236–7 and standardization 189 value creation 128–33 sensegiving context 135–9 and contracting 111, 119–23, 251 definition 117–18 factors influencing 145 and formal governance 249 research findings 233, 236–7 and standardization 189 value creation 128–33 sensemaking context 135–9 and contracting 111, 112, 119–28, 139–42, 251 and cooperation 120–21 factors influencing 145 and formal governance 108–13, 249 and formalization 111–13, 119–28, 140–42, 158 future research 142–7 in interorganizational relationships 110–13 meaning of 117, 119 need vs. ability 76–7, 78–84 and negotiation 111, 112, 116–28, 139–42, 251 quantitative measures used 270 research findings 233, 236–7 and standardization 189 triggers 201 and understandings 112, 237 value creation 128–33 see also mindfulness Serva, M.A. 103 services organizations 37–8 Shane, S. 155

Index Shane, S.A. 108, 132 Shapira, Z. 9 Sharps, M.J. 180 Shaw, J. 173 Shelanski, H.A. 228 Shenkar, O. 155 Shook, C.L. 198 Siggelkow, N. 34 signals 103, 155 Simon, H.A. 12, 13, 34, 49, 57–8, 62, 108, 109, 110, 155 Simonin, B.L. 155 Simons, R. 25, 26, 109, 155 Singh, H. 8, 9, 47, 57, 108, 109, 155, 221 Singh, K. 155 Sitkin, S.B. 82, 98, 101, 108, 155, 173 size of organization decision correlation analysis 274, 276–9 governance trajectories 220, 223–4, 226, 228 need vs. ability to contract 69, 74–5, 78–80 quantitative measures used 266 and standardization 194–8 structural equation model 273 Slagmulder, R. 267 Smith, P.L. 82 Snijders, C. 272 Sobrero, M. 9, 109 social networks research 72–4 social relations 144–5 Soda, G. 9 software firms 2, 3 Sony 2 specialization 130 specificity of contracts 11–12 speed 184–5 spillovers 44 standard contracts decision correlation analysis 217–18, 219–23, 275, 276–9 governance trajectories 206, 209, 210, 213–14, 225, 226, 228, 229 quantitative measures used 271 standardization advantages 182–8 disadvantages 183, 188–90

337

future research 199, 201–2 in interorganizational relationships 179–82, 198–202 methodology of study 37 and mindlessness 190–92, 252 and negotiation 179–82, 188–9, 192–202 research findings 233, 238–9 research theme 27 structural equation model 192–8, 273 Starbucks Coﬀee 4 STEADY (retailer) 35, 160–77 Stickel, D. 101 Stinchcombe, A.L. 12, 13, 155 strategic blindness 138–9 strategic cooperation 41 strategic knowledge accumulation 243–4 strategic management 255 structural equation model 192–8, 273 structures 11, 114 Stuart, T.E. 244 survey method 35–6, 263–4 Swedberg, R. 54–5 Takeishi, A. 215 Targama, A. 115 tensions in formalization 171–5, 176 terminology 114 Thatcher, D. 9 Thomas, J.B. 76, 82 Thompson, J.D. 53 3M 137 time 135–9, 184–5 Torissi, S. 155 Toyota 69 trade-oﬀs 26–7, 35, 149–51, 153, 176, 233, 237–8 transaction complexity 273 transaction cost economics control function 110 formalization 150, 151–2, 157 governance theory 49–52 need vs. ability to contract 23–4, 66, 68–70, 81 Trevino, L.K. 76, 82 trust combined governance forms 93–5 and control 85–7, 89–91

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and coordination 89–91 definition 14–15 and distrust 87–9 expectancy disconfirmation 95–6 and formalization 157 future research 101–4 integrative perspective 19–21 in interorganizational relationships 14–16, 89, 100–104, 251 interpretation of partners’ behaviour 96–100 methodology of study 35–6 partner selection 211 and performance 18–19, 91–3 repair 103 research findings 233, 234–5 research themes 21–8 role of 232 and sensegiving 138–9 and standardization 185 typology 15–16 violation 103 Tushman, M.L. 79 uncertainty 48, 101–2 understandings and contracting 112, 139–42, 247 and cooperation 120–21 development of 114–16 manager’s role 114, 145 and sensemaking 112, 237 value creation 128–33, 247 Ungson, G.R. 7 Unisource 99 United Kingdom (UK) 102 United States (US) 3, 141, 186, 187, 201 value 20–21, 258–60 value appropriation 241–4, 259

value creation 128–33, 135–9, 240–48, 259 value discovery 244–8, 259 Van de Ven, A.H. 36, 109, 120–21, 236 Van Marrewijk, A. 99 vertical integration 29–30, 48 vertical quasi-integration 29–30 Vieira da Cunha, J. 150 Villalonga, B. 216 violation of trust 103 Vision3D 142 Vlaar, P.W.L. 83, 155 Volberda, H.W. 156 Walsh, J.P. 108, 155 Wathne, K.H. 50 Weber, M. 64 Weick, K. 33, 109, 111, 113, 117, 122, 123, 133, 134, 155, 236 Weingart, L.R. 115 Weiss, L. 31, 32 Williamson, O.E. 28, 31, 49, 50, 51, 70, 81, 101, 108, 155, 156, 216, 221 Witt, U. 109, 130 Wright, M. 9 Xerox 125, 241 Yin, R.K. 34 Zaheer, A. 15 Zajac, E.J. 109 Zand, D.E. 100 Zeira, Y. 155 Zenger, T. 155 Zenger, T.R. 29, 61, 258 Zollo, M. 9, 109, 137, 155, 215, 221, 228