Uncertainty, Opportunism and Governance: The Effects of Volatility and Ambiguity on Formal and Relational Contracting

Abstract

Volatility and ambiguity are generally thought to create exchange situations more conducive towards opportunism. We examine the effectiveness of contractual and relational governance in constraining opportunism under volatility and ambiguity. We hypothesize that relational contracts will be robust to volatility but not ambiguity, whereas formal contracts will be robust to ambiguity but not volatility. The hypotheses are supported using data from 125 interorganizational relationships involving R&D for new product development. Our findings suggest that formal and relational contracts each may have advantages and disadvantages relative to the other in specific situations, so that they are not simply substitutes. The results have important implications for transaction cost and relational contracting theory, and challenge the view that relational contracts are not so susceptible to opportunism. A revised comparative governance schema is theorized for future research.

Keywords: Contracts, R&D, alliances and partnerships, transaction costs, governance

JEL Classification: D23, L14, L22, L23