Do formal contracts and relational governance function as substitutes or complements?

TLDR

Relational exchange arrangements based on trust are often viewed as substitutes for complex contracts, yet formal contracts are also argued to undermine trust and encourage opportunistic behavior. The study develops and tests an alternative perspective that formal contracts and relational governance function as complements. Empirical analysis of information service exchanges shows that managers pair customized contracts with high relational governance, and this interdependence improves exchange performance, with distinct determinants reinforcing their complementary role. © 2002 John Wiley & Sons, Ltd.

Abstract

Abstract Relational exchange arrangements supported by trust are commonly viewed as substitutes for complex contracts in interorganizational exchanges. Many argue that formal contracts actually undermine trust and thereby encourage the opportunistic behavior they are designed to discourage. In this paper, we develop and test an alternative perspective: that formal contracts and relational governance function as complements. Using data from a sample of information service exchanges, we find empirical support for this proposition of complementarity. Managers appear to couple their increasingly customized contracts with high levels of relational governance (and vice versa). Moreover, this interdependence underlies their ability to generate improvements in exchange performance. Our results concerning the determinants of these governance choices show their distinct origins, which further augments their complementarity in practice. Copyright © 2002 John Wiley & Sons, Ltd.