How incomplete contracts foster innovation in inter-organizational relationships

R. Sumo, Wendy van der Valk, A.J. van Weele, Geert Duijsters

Research output: Contribution to journalArticleScientificpeer-review

Abstract

Relative to relational governance, research into the use and effects of formal governance is scarce. Recent contributions suggest that a specific type of contract that has intentionally been left incomplete, the performance-based contract (PBC), fosters innovation. However, it is unknown how this effect occurs. To address this gap, we draw on transaction cost economics and agency theory to develop propositions on how PBCs affect innovation. PBCs are characterized by low term specificity and rewards that are tied to performance. We propose that low term specificity, that is, not stipulating how the focal firm's partner should deliver the performance and which resources to use, enhances the partner's autonomy, which in turn fosters innovation. However, excessive low term specificity inhibits innovation, since it may lead the partner to display opportunistic behavior. We furthermore propose that performance-based pay incentivizes the partner to engage in innovation. This suggests that linking rewards to performance attenuates the negative relationship between term specificity and innovation when the former is very low. Finally, we propose that a more risk-averse partner will engage in fewer innovative activities as such a partner will be less sensitive to the pay-for-performance clause.
Original languageEnglish
Pages (from-to)179-192
JournalEuropean Management Review
Volume13
Issue number3
Early online date18 May 2016
DOIs
Publication statusPublished - Oct 2016

Fingerprint

Incomplete contracts
Innovation
Interorganizational relationships
Specificity
Reward
Innovative activity
Relational governance
Resources
Governance
Transaction cost economics
Opportunistic behavior
Pay-for-performance
Agency theory
Autonomy
Economic theory
Risk-averse

Keywords

  • inter-organizational relationship
  • innovation
  • incomplete contract
  • transaction cost economics
  • agency theory
  • term specificity
  • pay for performance
  • risk-averseness

Cite this

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title = "How incomplete contracts foster innovation in inter-organizational relationships",
abstract = "Relative to relational governance, research into the use and effects of formal governance is scarce. Recent contributions suggest that a specific type of contract that has intentionally been left incomplete, the performance-based contract (PBC), fosters innovation. However, it is unknown how this effect occurs. To address this gap, we draw on transaction cost economics and agency theory to develop propositions on how PBCs affect innovation. PBCs are characterized by low term specificity and rewards that are tied to performance. We propose that low term specificity, that is, not stipulating how the focal firm's partner should deliver the performance and which resources to use, enhances the partner's autonomy, which in turn fosters innovation. However, excessive low term specificity inhibits innovation, since it may lead the partner to display opportunistic behavior. We furthermore propose that performance-based pay incentivizes the partner to engage in innovation. This suggests that linking rewards to performance attenuates the negative relationship between term specificity and innovation when the former is very low. Finally, we propose that a more risk-averse partner will engage in fewer innovative activities as such a partner will be less sensitive to the pay-for-performance clause.",
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How incomplete contracts foster innovation in inter-organizational relationships. / Sumo, R.; van der Valk, Wendy; van Weele, A.J.; Duijsters, Geert.

In: European Management Review, Vol. 13, No. 3, 10.2016, p. 179-192.

Research output: Contribution to journalArticleScientificpeer-review

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