Organizations as Relational Contracts: Lessons from a New Workshop Series

By Giorgio Zanarone

As I announced in an earlier post, on September 23-24, 2016, CUNEF hosted the second workshop on relational contracts in Madrid. The first workshop was held in 2015 in Munich, and the third one will take place this year at Kellogg. In this post, I briefly summarize a few takeaways from the second relational contracting workshop, which I think speak directly to SIOE and its scholarship.

The first lesson, more than fifty years down the road, is that Stewart Macauley was right: relational contracts—agreements that are too routed in the parties’ ongoing collaborations to be enforced by courts—are ubiquitous, and they are essential to understand business not only in countries with weak institutions, but also in advanced economies. The empirical evidence presented at the workshop indicates that informal enforcement mechanisms are used to solve as diverse organizational problems as coffee chain governance in Rwanda (Macchiavello & Morjaria), movie rotation policies of exhibitors and distributors in Spain (Barron, Gibbons, Gil & Murphy), slot exchanges and flight rescheduling between U.S. major and regional airlines (Gil, Kim & Zanarone), and political lobbying in Hungary (Szeidl & Szucs).

The second lesson is that Williamson’s (and Klein’s) “calculative trust”—i.e., the trust that partners will cooperate for fear of terminating a valuable collaboration—is key to relational contracting. Macchiavello & Morjaria show that coffee mill owners and farmers in Rwanda cooperate more when there is less competition between mills, and hence the fallback option in case their relationship breaks down is less attractive. Gil, Kim & Zanarone show that U.S. major airlines assign bad weather routes, where conflicts with regional partners on flight rescheduling and slot exchanges are more frequent, to regional airlines with whom they have more valuable collaborations. As a result, regional networks with worse weather routes were more resilient to the 2008 economic crisis. Finally, Szeidl & Szucs show that under Hungarian right-wing governments, state-owned firms tilted advertising to connected media, but following a public fallout between the government and a media owner (a breakdown of calculative trust), coverage of governmental corruption in the formerly connected newspaper increased to the level of opposition newspapers.

The third lesson is that relational contracts require clear communication, because misperceived breach may lead to the premature termination of valuable collaborations. The paper by Krüger and Friebel documents that after a German personnel search firm homogenized incentive pay across divisions, employees in the division whose pay policy was changed, and who anticipated to lose from the new scheme, punished the firm by severely reducing their performance, despite the change in expected compensation being modest.

Fourth, as emphasized by Bob Gibbons and Bentley MacLeod in their keynote lectures, there are wide avenues for future research on relational contracting, both theoretical and empirical. The static repeated-game models traditionally used to operationalize calculative trust, and to which most existing evidence relates, cannot capture the clarity problem and the dynamics of coordination and information disclosure in informal relationships. Some of the theoretical papers presented at the workshop move in the direction of filling this gap. For instance, Ganuza & Gomez model scorecards and objective performance metrics as mechanisms that coordinate the definition of breach among contracting parties, thus preventing misunderstandings and inefficient breakdowns. Their model can explain the use of detailed formal agreements in the absence of court enforcement, as documented in the recent Bozovic and Hadfield (2015) “scaffolding” paper. In contrast, in the model developed by Li, Mukherjee & Vasconcelos, an employer (or client) may want to maintain ambiguity on which dimensions of performance are most valuable in order to prevent the employees (or suppliers) from strategically shirking.

Let me wrap up. There is evidence that relational contracts solve a variety of problems in diverse institutional settings, both between firms and within. And there are empirical puzzles on the internal dynamics of relational contracts that call for enrichment of existing theoretical models, which in turn calls for more thorough empirical tests. Not surprisingly given these premises, research on relational contracts is attracting considerable attention across multiple fields, to the point that we now have a regular workshop series on this topic. We may well be looking not at another subfield, but at a powerful pair of glasses to look at institutions and organizations.