The Effects of Relational Contracts on Procurement: Evidence from Information Technology Outsourcing

Abstract

We augment existing studies of spot procurement contracts by introducing relational contracting. We first show that at intermediate interest rates, the form of procurement contract affects the parties' reneging temptation on a given relational contract, and hence affects the best relational contract that is sustainable. Using a novel data set on information technology outsourcing contracts, we find that lower reneging temptation, measured by narrowly varying alternative vendors' modification costs, favors relational fixed-price contracts. Second, we find that a vendor with high reputation capital in fair bargaining (cost-cutting) is more likely to be awarded a fixed-price (cost-plus) contract. Lastly, we find that relational contracting makes fixed-price contracts less complete and complexity matters less in the choice between fixed-price versus cost-plus contracts with relational contracting. JEL Codes: D2, D86, L24, M15