How do Internal and External Contracts Differ? Evidence from the Semiconductor Industry

Abstract

Firms often use internal formal contracts between organizational units to govern transactions within firms. However, there is little empirical evidence of what is included in internal contracts and how they differ from contracts used between firms. Using a novel data set of internal and external formal contracts from firms in the semiconductor industry, we empirically investigate their contents using topic modeling. The results indicate that internal contracts focus more than external contracts on enforcement and property rights. In contrast, external contracts place more emphasis on the specification of terms and deliverables, compensation, and contingencies. This study demonstrates how the use of formal contracts in transactional governance differs within and between firms, an understanding of which is critical to managers given the ubiquity of internal transactions and the prevalence of internal formal contracts.