The Governance of Multiple Transactions: Discriminating Alignment and Performance Implications

Transcription

1 The Governance of Multiple Transactions: Discriminating Alignment and Performance Implications PRELIMINARY DRAFT: PLEASE DO NOT CIRCULATE Erik A. Mooi Vu University Amsterdam Kersi D. Antia School of Business, University of Wisconsin-Madison Mrinal Ghosh Eller College of Management, University of Arizona 1

2 The Governance of Multiple Transactions: Discriminating Alignment and Performance Implications The effective governance of interorganizational relationships is a critical and much sought capability, and has caused a great deal of managerial and academic interest. In this paper, we seek to understand the performance impact of governance deviations - a comparison between observed and expected levels of contract completeness as based on governance theories. The context of 376 Dutch buyer-supplier relationships reporting on 848 purchases of IT products allows us to disentangle relationship- and transaction-specific governance deviations using an error components model. Thus we can shed light on how governance deviations - a lack of discriminating alignment across individual and multiple transactions impact ex post transaction cost, a measure of nonperformance based on a set of 11 transaction problems, weighted by buyer perceived severity. We also posit and find supporting evidence for the influence of such deviations on ex post costs to vary, depending on the length of the relationship between the contracting parties and the extent of measurement ambiguity. Our findings speak to the persistence of governance across the multiple transactions that firms undertake and its performance implications. Key words: Governance; Contracts; Alignment; Relationships 2

3 1. Introduction Governance the effective initiation, maintenance, and termination of interorganizational relationships has been identified as a key firm capability (Dyer and Singh 1998), and has engendered an impressive body of research built on Williamson s (1985) transaction cost economics (TCE) paradigm, the relational exchange paradigm (Macneil 1980), and agency theory (Eisenhardt 1989). Acknowledging the double jeopardy of opportunism and the inevitable incompleteness of contracts, governance logic centers on the discriminating alignment hypothesis, whereby firms are posited to align transactions (which differ in their attributes) with governance structures (which differ in their costs and competencies) in a discriminating (mainly transaction cost economizing) way (Williamson 1996, p46). Broadly, governance work thus remains focused on providing safeguards well matched to the dangers of opportunism and its attendant transaction costs the costs of planning, adapting, and monitoring task completion under alternative governance structures (Williamson 1985, p2). In recent years, there has been growing acknowledgment of the potential governance role of contracts, and particularly of contractual completeness the degree to which numerous relevant clauses are codified in the contract (e.g. Anderson and Dekker 2005, Ghosh and John 2005). Relatively complete contracts are posited to serve as benchmarks for performance verification, and to reduce the leeway for opportunistic acts (Kashyap, Antia, and Frazier 2012). There also appears to be an emerging consensus that it is not so much the absolute level of contractual completeness that matters, as much as its level relative to what might be expected, keeping transactional hazards in mind (Bercovitz et al. 2006, Mooi and Ghosh 2010, Wang et al. 2010). 1 Recent research provides intriguing evidence of the validity of this relative viewpoint, 3

4 both with respect to contractual safeguards in particular (Mooi and Ghosh 2010) as well as governance more generally (Wong, Kayande, and Jap 2010). If optimal contracts are efficient in that they result in lower transaction costs, then it follows that deviations from optimality whether reflected in over- or under-provision of safeguards should be associated with higher transaction costs (cf. Mooi and Ghosh 2010). Interestingly, although the notion of protecting against inadequate safeguards and their consequent transaction costs lies at the very heart of TCE, agency theory, and the relational exchange perspective alike (Eisenhardt 1989, Macneil 1980, Williamson 1985), very little empirical evidence exists regarding the impact of undersafeguarding that is, deploying a less complete contract than the situation would warrant. Even less is known about the impact of oversafeguarding deploying more complete contracts than would be called for. On the one hand, it may be argued that more is better (Lusch and Brown 1996). The more complete the contract, the greater the contracting parties ability to plan for anticipated contingencies, and the lesser the degrees of freedom available for potential opportunism (Wuyts and Geyskens 2005). On the other hand, writing overly complete contracts calls for anticipating an overwhelming number and variety of contingencies, undertaking costly negotiations, and reduces both parties ability to adapt as necessary (Mooi and Ghosh 2010). The consequences of deviations from optimal safeguards remain an under-explored issue, one with critical implications for the success of the interorganizational relationship. The present study seeks to address this gap in our understanding of interorganizational relationship governance. Building on an integration of TCE- and relational contracting-informed logic, we attribute governance deviations to two distinct causes a generalized relationshipspecific propensity, and a more localized transaction-specific component. Whereas the former 4

5 may manifest itself across the many transactions the partners undertake, the latter is reflected in a level of contractual completeness that differs from what would be warranted for the particular transaction. We propose that the attribution of governance deviation to the relationship or the transaction matters when considered in juxtaposition with situation- and relation-specific contingencies. One situational exigency commonly identified in prior research is measurement ambiguity the extent to which the firm is unable to verify its partner s performance of stipulated obligations (Mooi and Ghosh 2010). Prior governance-related studies adopting a relational contracting perspective have also identified the firm s relational history with its partner the cooperation and interaction over the length of the prior relationship as a relevant relation-specific consideration ( Heide and Miner 1992, Wuyts and Geyskens 2005). Whereas both relationship- and transaction-attributed governance deviations are hypothesized to impact transactional efficiency similarly, we also expect differential performance outcomes, depending on the particular over-safeguarding attribution s (mis) match with transactional realities or relational expectations. We test our hypotheses in the context of a matched set of 376 Dutch buyer-supplier relationships across 848 purchases of IT hardware and software products. Our ability to observe multiple transactions between the same buyer-supplier dyad facilitates our effort (the first, to the best of our knowledge) to disentangle relationship- and transaction-specific governance deviations. In the section that follows, we introduce the notion of governance deviation as a comparison between observed and expected levels of contract completeness. We then distinguish between relationship- and transaction-attributable deviations, and elicit the rationale underlying our baseline hypothesis that regardless of the particular attribution, over (under)safeguarding is 5

6 associated with fewer (more) ex post problems, i.e., lower (higher) transaction costs. This is followed by a discussion of how partners specific attributions of governance deviations, in combination with measurement ambiguity and the partners relational history, will likely result in differential performance outcomes. We then describe our data, construct measurement, and model specification approaches, and the results of the corresponding estimation. We conclude with a discussion of the implications of our findings. 2. Conceptual Background Our research focuses on the completeness of explicit contracts ex ante and takes a buyer s perspective in a vertical exchange setting. Consistent with Macneil (1980), we argue that contracting parties cannot anticipate all contingencies nor make complete plans. Our focus is therefore on the relative completeness of contracts. Firms use contracts for a variety of reasons related to transactional attributes. Such reasons include creating mutual understanding, helping safeguard transactions, planning for uncertainty through contingencies, and mitigating appropriation concerns (Williamson 1991). There is a growing recognition of the fact that contracts are impacted by the relationship between the transacting parties (Vanneste and Puranam 2010, Wuyts and Geyskens 2005). For example, drafted contracts may codify shared sets of rules, procedures, responsibilities, and expectations across transactions (Gilson 1984). Contracts also specify the rights and obligations of both parties across multiple transactions, thereby improving coordination across such transactions (Mayer and Argyres 2004). As firms strive to balance multiple objectives while deploying contractual safeguards, it is possible and indeed likely that they would overshoot or undershoot to varying degrees that is, specify more or less complete contracts, relative to the requirements of the particular 6

7 transaction. We refer to this discrepancy between the observed and expected levels of contractual completeness as governance deviation. Prior work on contracting and the literature on incomplete contracts in particular ascribe governance deviation to a variety of reasons evolving (inter) organizational routines (Mayer and Argyres 2004), inertia or persistence (Mayer and Bercovitz 2008), managers being ill informed or mistaken (Masten 1993), or other sources of unobserved heterogeneity. The present study takes note of these underlying drivers of governance deviation, and explicitly accounts for any or all of them occurring, even while remaining agnostic about the particular cause. We decompose the total extent of governance deviation into a relationshipspecific component, and a transaction-specific component. Whereas the former accommodates the possibility of routines, persistence, as well as any unobservable characteristics of the relationship between the contracting parties, the latter allows for the simultaneous possibility of managerial error or any unobserved other situational characteristics. Our emphasis is not so much on identifying the particular causal factors underlying governance deviation, as much as it is on the need to account for any or all of them when assessing their efficiency-related consequences. Governance deviation poses critical implications for both contracting parties. Undershooting with respect to contractual completeness opens both parties to honest misunderstandings, unrequited expectations, and even opportunism by their partner. Under the right conditions, however, incomplete contracting does facilitate efficient adaptation (Ghosh and John 2005). In much the same manner, overshooting brings with it a mixed bag of potential consequences. Whereas overspecifying contracts might be prohibitively expensive (Mooi and Ghosh 2010), breed mistrust (Jap and Ganesan 2000), may cause the opportunism it was 7

8 designed to mitigate (Ghoshal and Moran 1996), and impede adaptation to unforeseen contingencies (Ghosh and John 2005), it may also help clarify both parties performance obligations (Mayer and Argyres 2004). Which of these outcomes obtain is the central question of concern to us. The present study attempts to reconcile these divergent viewpoints with respect to the performance implications of governance deviations. Specifically, we build on prior research positing ex post transaction costs to vary systematically with the acceptance or reactance of the target of the focal firm s governance efforts (Brehm 1968; Heide, Wathne, and Rokkan 2007). Such acceptance or reactance is hypothesized to be a function of (a) the attribution made by the supplier firm to the buyer firm s governance deviation, and (b) the (mis) match thereof with relational and situational constraints. Figure 1 provides a stylized representation of our a priori expectations. As can be seen in the diagram, we hypothesize a direct correspondence between governance deviation and ex post transaction costs, no matter the ascribed source of such deviation (Hypotheses 1A, 1B). This main effect is hypothesized to be orthogonally impacted by relational (relationship length, hypotheses H2, H3) and situational (measurement ambiguity, hypothesis H4, H5) moderators. Our conceptual framework is based on the expectation that it is governance deviation (i.e., the contrast between observed and expected level of contractual completeness) and its match or mismatch with relationship- and situation-driven considerations that explains target firms responses to the focal firms governance efforts. We now discuss the specific hypotheses in turn. 3. Hypotheses We expect that deviating from the expected level of contractual completeness impacts performance. Such deviations, whether relationship-specific or transaction-specific, should help 8

9 buying firms reduce ex post transaction costs. In the next paragraphs, we line out the expected effect of such deviations on ex post transaction costs. 3.1 Transaction specific governance deviations Crafting more complete contracts beyond the expected level helps anticipate future contingencies and both transacting parties actions in response for that transaction (Lusch and Brown 1996). The specification of parties mutual obligations facilitates planning, and the resulting understanding of mutually agreed roles facilitates more efficient adaptation to foreseeable conditions (Wuyts and Geyskens 2005). Greater coordination is also achieved, as parties know their roles and plans are in place. Greater contract completeness also implies that appropriate performance benchmarks are specified, resulting in easier verification of the partner firm s performance against explicitly specified benchmarks. Control is therefore facilitated as well. Supplier violation of more complete contracts could also trigger legal or informal enforcement of terms, thereby reducing quasi-rent appropriating behaviors of the supplier such as failing to provide proper implementation. The control afforded to the buyer thus curbs deviant behavior of the supplier. Conversely, crafting safeguards below the expected level might adversely impact the sellers ex ante ability and incentives to adjust the transaction to buyers needs. For example, failing to specify critical aspects of interoperability or implementation requirements of IT systems reduces the ability of the seller to incorporate these issues and, as rewards for adaptation are not in place, will also not have the incentive to do so. Control and coordination are also reduced and ability of the buyer to verify performance against agreed standards is reduced. In sum, we expect that as contracts become more complete (incomplete), relative to the expected, ex post transaction costs will be reduced (increased): 9

10 H1A: The greater the transaction-specific contractual over (under) safeguarding, the lower (higher) the ex post transaction costs. 3.2 Relationship specific governance deviations. When oversafeguarding is attributable to the relationship, the supplier and buyer know what to expect of each other as specific terms are kept consistent across transactions. These consistencies create a common language in which to do business and represent a meeting of the minds between parties. Relation-specific deviations represent a codification of mutual understanding between parties on how they interact and deal with each other (Lusch and Brown 1996). For example, outlining communication modes during implementation (e.g. orally or in writing) could help smoothen implementation as joint understanding is present. Such relationship-specific deviations are likely particularly effective as they are expected and have likely been drafted or used before, reducing uncertainty as to how these terms function. Such relationship-specific deviations should therefore reduce transaction problems. The ambiguity in interpreting contracts should also be lower when contractual deviations are consistent across transactions and organizational forgetting is avoided (Mayer and Argyres 2004). Such deviations can also represent knowledge repositories, which are known to promote efficient exchange between parties (Mayer and Argyres 2004). Parties which consistently oversafeguard likely have a higher goal congruency, which reduces incentives for opportunism, as parties have a greater understanding of the direction and nature of the relationship (Jap and Anderson 2003). On the other hand, undersafeguarding persists in some relationships. This undersafeguarding could be due reasons including corporate policy, managerial biases, an emphasis on ex post revision to the deal. From prior governance literature, it is well known that such undersafeguarding could invite opportunistic behaviors. We go beyond this by expecting 10

11 that undersafeguarding, when this is expected, increases opportunism, ceteris paribus. When parties know each other s vulnerabilities the ability to be opportunistic increases (Wathne and Heide 2000). Moreover, the incentive to be opportunistic increases. The expected payoff of such actions increase due to a an increasing difficulty of being caught as appropriate performance levels are more difficult to verify. Therefore we posit: H1B: The greater the relationship-specific contractual over (under) safeguarding, the lower (higher) the ex post transaction costs. 3.3 Moderating role of Relationship Length The effect of transaction and relationship-specific deviations on ex post transaction costs is likely modified by the prior length between the transacting parties. From the relational literature we know that over the course of repeated transactions, parties form, test, and (dis)confirm expectations of one another (Heide and John 1992). Such expectations could be based on good or bad past experiences and relate to the mode of conducting business, includes contractual safeguarding. Thus, when relationship-specific oversafeguarding occurs, the over-safeguarding is ascribed to a common expectation. As such, reactance is unlikely because there is no apparent threat from such oversafeguarding. Moreover, parties likely perceive such oversafeguarding as legitimate as parties have had time to establish their viewpoints and are well aware of them. Such legitimacy avoids reactance (Brehm 1966). As the parties relational history increases, oversafeguarding may be more effective as formal contracts and the relational exchange (likely fostered by prior interaction) serve as complements in enhancing performance (Poppo and Zenger 2002). In fact, prior work suggests that when contracts are expected (i.e., communalities exist over time, beyond the idiosyncracies of the transaction) trust is promoted, ceteris paribus 11

12 (Mayer and Argyres 2004). Such additional trust help purchasing outcomes (Heide and John 1992). Conversely, as the buyer firm s propensity to under-safeguard becomes known over time and repeated interactions, it opens itself up to the possibility of ex post opportunism (Wathne and Heide 2000). As the relationship ages, shirking or evasion of obligations becomes easier as the counterpart would have knowledge on what to exploit and how to appropriate quasi rents. Therefore we expect: H2: The negative (positive) influence of relationship-specific contractual over(under)safeguarding on ex post transaction costs will be strengthened, the greater the relationship length between transacting parties. Parties with prior relational history form expectations about each other and their mutual relationship. In contrast to the situation where over-safeguarding is ascribed to a common expectation, the party facing levels of contract completeness that exceed particular transaction hazards is likely to foster reactance. The legitimacy ascribed to such oversafeguarding is likely low as this safeguarding is beyond what may be expected on the basis on transactional hazards. A perceived lack of legitimacy likely fosters reactance on the part of the seller (Brehm 1966). Such reactance may manifest itself through for example an evasion of obligations, which would increase transaction cost to the buying party (Wathne and Heide 2000). On the other side, undersafeguarding, particularly in the presence of a long prior relationship, may hurt outcomes to the buyer. The performance enhancing effects of relational exchange fostered by prior interaction, are likely low as the critical formal contracting complement is lower, relative to expected. This results in subpar purchasing outcomes (Poppo 12

13 and Zenger 2002). Over the course of a long relationship length, norms develop expectations of behavior from one another, held by both buyer and supplier. Therefore: H3: The negative (positive) influence of transaction-specific contractual over(under)- safeguarding on ex post transaction costs will be weakened, the greater the relationship length between transacting parties. 3.4 Moderating role of Measurement Ambiguity Measurement ambiguity is the buyer s perceived difficulty of defining ex ante and verifying ex post the products procured in the contract (Anderson and Dekker 2005). The effects of relation- and transaction-specific oversafeguarding on ex post transaction costs likely depend on the level of measurement ambiguity of the buyer. Generally, over-safeguarding is likely to help parties coordination and control efforts. However, the difficulty of verifying performance creates friction. Adapting to changing circumstances is thus difficult, especially when verification of changes is difficult or ambiguous (Lusch and Brown 1996). The presence of a oversafeguarding, specifically if such oversafeguarding is kept consistent, may provide little flexibility to both parties. Moreover, compared to low ambiguity, the oversafeguarding over a series in transaction likely does not synchronize with the specific demands of that transaction. Moreover, oversafeguarding specific to the relationship may foster opportunistic behavior of the seller. When the seller knows such oversafeguarding takes place, loopholes may be anticipated and the difficulty of being caught due to opportunistic behaviors is low as appropriate performance levels are more difficult to verify. Whereas over-safeguarding hitherto served coordination and control objectives, it is discordant with the reality of inadequate verification ability brought about by measurement ambiguity. The result is that coordination and control is significantly 13

14 diminished, and ex post transaction costs significantly increased, under conditions of measurement ambiguity. Although, on the face of it, an inadequately complete contract would likely result in increased ex post transaction costs, such frictions are likely to be tempered further downwards by the reality of measurement ambiguity. That is, the damaging consequences of inadequate contractual completeness are likely lower relative to the situation where relatively lax contractual safeguards are deployed with regard to situations where verification of effort were possible. H4: The negative (positive) influence of relationship-specific contractual over (under)safeguarding on transaction costs will be weakened, the greater the measurement ambiguity of the transaction. Writing more complete contracts beyond warranted may signal distrust as it constraints partners behavior (Jap and Ganesan 2000). If firms see a need to over safeguard transactions under measurement ambiguity, beyond what is expected due to that measurement ambiguity, such oversafeguarding may be attributed to perceived opportunistic tendencies of the supplier. The signal of distrust is thus likely even stronger, which could create the opportunism the more complete contract was designed to mitigate. Moreover, because distrust likely furthers distrust of the counterpart, the relationship may sour as a climate of suspicion and retaliation emerges (Wuyts and Geyskens 2005). The threat of formal or informal enforcement is also less credible as problems of verifiability increase (Williamson 1975). Suppliers could anticipate the greater costs of enforcement brought through nonverifiability and thereby discount its credibility. When transaction specific undersafeguarding occurs, sensemaking is substantially harder for the counterpart. Specifically, the counterpart may not be able to interpret why, under 14

15 hazardous conditions, the exchange partner chooses to undersafeguard. A lack of sensemaking constrain action of the counterpart, leading to maladaptation (Weick et al. 2005). In sum, we expect that: H5: The negative (positive) influence of transaction-specific contractual over (under)safeguarding on ex post transaction costs will be weakened, the greater the measurement ambiguity of the transaction. 4. Method 4.1 Research Context We test our hypotheses in the context of 848 IT (hardware and/or software) product purchases by 376 Dutch firms over a twenty-year period. The data originate from the External Management of Automation project and are made available through the Steinmetz Archive and the data collectors (Batenburg and Raub 1995). This data collection is an effort of the department of sociology of Utrecht University aimed at examining how buying firms manage their IT transactions (Buskens, Raub, and Weesie 2000). Complex transactions are deliberately oversampled to increase the precision of the estimates for such transactions. As such, sample descriptive statistics might not be representative of the population. The data collectors contacted 1,798 companies by telephone, and identified the individuals responsible for IT transactions in each firm as potential key informants. The data collectors asked the key informants to list their firms IT purchases over the prior decade and to indicate their satisfaction with each purchase. From the IT transactions thus identified, the data collectors selected one transaction at random and confirmed the key informants degree of knowledge of the specific transaction. They then asked the qualified key informant to participate 15

16 in a survey on the selected IT transaction. Each informant was given a choice of on-site versus mail-based administration of the survey; 574 opted for the on-site option, whereas 214 responded by mail. Each of the 788 willing and competent key informants reported on a single transaction. About 95% of the informants had ten or more years of tenure at the company they reported on, and about ten years of IT experience, suggesting a high level of informant competence. Upon completion of the original survey, informants were asked if they were willing to answer the same set of questions about a second transaction. 183 informants agreed and participated in a second survey on another IT transaction, selected randomly from the list of transactions they had listed earlier. The first wave therefore comprises 971 transactions conducted by 788 buyer firms with 561 unique suppliers. Three years later, the data collectors contacted the 788 informants that had participated in the original study and asked them to list the IT transactions conducted since they were last contacted. 281 of the original 788 firms responded, and consistent with the first survey administration, were asked to report on a single transaction randomly selected from those they identified. Across both data collection occasions, 304 buyer firms reported on a second transaction with the same supplier, and an additional 80 reported on three transactions with the same supplier partner. Our analysis focuses on these 384 repeatedly observed buyer-supplier dyads and the 848 transactions they reported on. The buying firms span a broad spectrum of industries, such as logistics, parts production, and wholesaling. On average, they employ 86 full-time employees. Further descriptives of these firms are included in Table 1. We checked for potential response bias by comparing the response rates across industries and regions and by testing for significant differences in satisfaction by survey participation status and method of survey administration (on-site versus mail). Recall that 16

17 survey participants and non-participants alike had been asked to list multiple IT transactions and their levels of satisfaction with each transaction. The average levels of satisfaction reported by respondents and non-respondents were not statistically significant (6.9 versus 6.8 on a 10-point scale, respectively). As well, satisfaction levels with the supplier did not systematically vary across the two methods of data collection (7.2 and 7.2 respectively, p>.05). Satisfaction with the supplier also did not vary across the three waves (7.1, 7.2, and 7.2 respectively, p>.05). We therefore infer little possibility of response bias nor structural differences between the various waves of data collection. 4.2 Measures Table 2 lists the measures we use in our study, along with information on their specific indicators and evidence of reliability, where relevant. Ex post transaction costs are measured as a composite index of eleven possible problems that might have occurred in a specific transaction. Informants were asked to indicate whether each of the possible problems occurred. For each problem they indicated as having occurred, they were then asked to rate the problem s severity on a five-point scale ranging from very little to very much. Contract completeness is also a composite index reflecting which, if any, of 24 specific contractual terms were included in the formal written contract. The specific items comprising this measure were arrived at in consultation with several IT managers and lawyers, and reflect commonly included stipulations regarding financial, legal and operational issues (Rooks, Raub, and Tazelaar 2006). 17

18 Relationship length refers to the number of years the buyer reported doing business with the supplier. Measurement ambiguity reflects the degree of difficulty faced by the buyer in defining ex ante and verifying ex post the products/services transacted. This three-item reflective scale taps into the difficulty faced by the buyer organization in judging the quality of the product/service at the time of delivery, in comparing the focal product/service with other products, and in judging the price/quality ratio of potential suppliers products/services. Control variables. Transaction size refers to the total price for all products and services comprising the focal transaction as indicated in the contract, and is measured using a single ordered categorical variable - less than US$15,000, between $15,001 and $30,000, between $30,001 and $60,000, between $60,001 and $120,000, and more than $120,000. Transaction complexity refers to the scope of the deal and the extent of coordination and interaction required between the buyer and seller for the product and service, and is measured by the sum of two indicators. The first indicator relates to the scope of the product and is a simple count of up to 18 specific products and services transacted. The second indicator comprises an ordered categorical variable reflecting the need for coordination and interaction between the buyer and seller. Two experts rated each of the 18 products and services as belonging to one of five categories - Category one represents the least need for coordination and interaction whereas category five the most. Categories 1, 2, and 3 represent standard and more advanced products and services, respectively. Category 4 represents specialized, and category 5 tailored, products or services. If multiple products were included in the same transaction, the highest category score was used to rate the complexity. The two indicators of transaction complexity correlate (r=.69); 18

19 yet the fact that the correlation is far from unity indicates they tap into different aspects of complexity. Buyer lock-in refers to the difficulty faced by the buyer in switching or replacing products or suppliers (Dutta et al. 1995). This four-item scale considers the magnitude of costs in terms of time and money the buyer would incur if the focal supplier s product were to be replaced. These costs relate to purchasing another product, (re) training the buyer s personnel, new data and information entry, and idle production. We measured the importance of the transaction with a two-item, five-point Likert scale reflecting the value of the transacted products or services to the buyer. The items measure the perceptions of the buyer on the importance of the products/services to the automation and profitability of the buying organization. The buyer s dependence on the supplier was also measured with a single-item 5-point scale soliciting the buyer s evaluation of its own dependence on the supplier, prior to purchasing the product. We also used two dummy variables (hardware and software) to control for whether the focal transaction was limited solely to a hardware or software purchase. The baseline category represents the case where the transaction involved both hardware and software elements. The binary variable IT/legal expertise took on the value 1 if the buying firm had employees dedicated to IT or legal affairs, and was coded as 0 otherwise. The ordered categorical variable Wave controls for the particular wave of data collection (first, coded as zero, second coded as 1, third coded as 2), so as to capture possible differences between the data collection efforts. Finally, we 19

20 also included industry controls, using dummy variables based on the first digit of the Dutch SBI industry classification code. Measurement Validity We subjected the reflective multi-item measures to a confirmatory factor analysis (CFA). The measurement model includes the observed indicators of measurement ambiguity, complexity, and lock in. The fit statistics provide confirmatory evidence of acceptable model fit (χ 2 = , p <.05, CFI=.961, TLI=.947, RMSEA=.056). All factor loadings are high and statistically significant, indicating high convergent validity. The inter-construct correlations exceeded the squared average variance extracted for each reflective multi-item scale, providing evidence of discriminant validity (Fornell and Larcker 1981). All in all, the CFA provides confidence in our construct measures. 4.3 Model Specification Our main interest lies in explaining varying performance outcomes of relationship- and transaction-specific governance deviations in combination with relational and situational exigencies. As such, our proposed model must enable us to (1) predict the level of contractual completeness commensurate with the level of anticipated transacting hazards, (2) compute the governance deviations between the predicted and actually observed levels of contractual completeness, (3) partial out the total governance deviations to relationship- and transactionspecific attributions, and (4) assess the impact on ex post transaction costs of particular combinations of each attributed source of governance deviation with relationship- and situationspecific factors. We undertake a two-step model specification approach that enables us to achieve all four aims. In the first step, we specify a regression model that builds on extant governance logic to 20

21 predict the level of contractual completeness given the particular hazards of the transaction. The difference between the predicted and observed levels of contractual completeness, governance deviation, is then ascribed to relationship- and transaction-specific components using standard residual decomposition techniques developed for panel data analysis (Baltagi 2005). In the second and subsequent step, each component is then interacted multiplicatively, corresponding to each of the four cells in Figure 1. Our proposed strategy allows us to leverage the unique information available from the consideration of multiple transactions between buyer and seller, and has the added advantage of accounting explicitly for the endogeneity of firms contracting choices. We now describe each step in detail. Step 1: Matching governance to circumstances. Prior governance theory calling for more completely specified contracts in the face of contracting hazards has found significant support (For a meta-analytic overview of governance predictions, see Geyskens et al. 2006). Building on these governance-related arguments and past empirical work, we first estimate a baseline model that predicts the expected level of contractual completeness for a specific transaction (Anderson and Dekker 2005, Mooi and Ghosh 2010, Vanneste and Puranam 2010). This model is a function of a set of previously identified and well-acknowledged considerations - relationship length, measurement ambiguity, transaction complexity, buyer lock-in, importance of the transaction, and buyer dependence, along with context-specific control variables (whether the transaction only featured hardware or software components, the buying firm s IT and legal expertise, the data collection wave, and industry dummies). The inclusion of an extensive set of theoretically relevant predictors helps specify a robust model, estimated using a random effects, Generalized Least Squares (GLS) regression with panel-robust standard errors to account for possible heteroskedasticity. 2 The first-stage model is specified as follows: 21

22 (1) Contract completeness=α+x it β+υ i +ε it where α is the intercept and β is a the vector of the aforementioned predictor variables. The random effects model decomposes the residuals into components υ i and ε it. Residual υ i represents governance deviations that are specific to the buyer-seller relation and remains constant over each buyer-seller dyad s repeated transactions. In contrast, residual ε it reflects transaction-specific governance deviations and varies over the repeated transactions observed. It is also worth noting that each residual component may take on positive or negative values; the former would reflect oversafeguarding, whereas the latter would indicate undersafeguarding. Step 2: Performance outcome. We retain the two residuals from step 1 as predictors of ex post transaction costs, using their corresponding coefficient estimates to test hypotheses 1A and 1B. Pairwise multiplicative interactions of each residual with relationship length and measurement ambiguity are also included in this second-stage regression so as to uncover their contingent performance effects, as are the predictors featured in equation (1) above. 3 This results in the following outcome model: (2) Ex post transaction costs=α+υ i +ε it +υ i.relationship length+ε it.relationship length +υ i.measurement ambiguity+ε it.measurement ambiguity + X it β+υ i +ε it Econometrically, the approach we propose parallels the two-stage approach of Garen (1984, 1988), wherein the effects of a set of antecedents on a continuous choice variable (i.e. contract completeness) are estimated in the first stage, and the subsequent stage calls for the estimation of the impact of the first-stage choice variable on the outcome (i.e. ex post transaction costs), controlling for the first-stage residuals. The modification we make to the Garen approach is to include the relationship- and transaction-specific residuals as explanatory variables. 22

23 4.4 Results Table 3 reports the results of the first stage regression of contractual completeness on its anticipated predictors, as specified in Equation (1). We find relationship length and the buyer s dependence on the seller to be associated with lower levels of contractual completeness (b = -.055, p <.10; b = -.529, p <.01 respectively). In contrast, and consistent with transaction cost logic, measurement ambiguity, transaction complexity, and larger transactions lead to significantly higher levels of contractual completeness (b =.137, p <.10; b =.238, p <.01; b = 1.280, p <.01, respectively). With respect to the control variables, dedicated hardware or software purchases and higher levels of legal expertise each result in greater contractual completeness (b = 1.237, p <.01; b = 1.237, p <.05; b = 1.051, p <.10, respectively). We then retained the relationship- and transaction-specific residuals of contractual completeness based on the coefficient estimates in Table 3. The latter were then included, along with the other predictors specified in Equation (2), in the second-stage regression of ex post transaction costs. Three variants of this regression were specified, and their corresponding coefficients displayed in Table 4. The first variant includes just the main effects of the two residual components; the second variant further included their pairwise interactions with relationship length and measurement ambiguity; the third variant is the full model, including the residuals, their interactions, and the first-stage predictors. As can be seen from Table 4, the parameter estimates appear consistent in terms of their valence and levels of statistical significance. Furthermore, the variance explained continues to increase significantly across the three variants specified and estimated, thereby suggesting that the inclusion of the full set of predictors is justified. We test our hypotheses using the estimates from the full model, listed in the fourth column of Table 4. 23

24 Consistent with hypothesis H1A, relationship-specific governance deviations result in lower ex post transaction costs (b = , p <.01). A similar negative impact of transactionspecific governance deviations on ex post transaction costs is evident, consistent with hypothesis H1B (b = -.556, p <.05). We now turn to the results pertaining to the hypothesized contingent effects of relationship length (hypotheses H2 and H3) and measurement ambiguity (hypotheses H4 and H5). Hypothesis 2 posits that the effects of relationship-specific deviations on ex post transaction costs is strengthened, the greater the relationship length between transacting parties. We find evidence in support of this hypothesis (b = -.067, p <.01). Hypothesis 3 posits that the negative effect of transaction-specific governance deviations on ex post transaction costs is weakened, the greater the relationship length between transacting parties. This hypothesis finds support as well (b =.021, p <.05). Hypothesis 4 suggests a weakening of the influence of relationship-specific governance deviations on ex post transaction costs, the greater the measurement ambiguity of the transaction. We find strong support for this hypothesis (b =.091, p <.05). We find no support for Hypothesis 5. Of the control variables included, only buyer dependence and dedicated hardware purchases have any significant impact on ex post transaction costs (b = -.642, p <.01; b = , p <.01, respectively). 4.5 Robustness checks We assessed a series of alternate specifications so as to evaluate the robustness of our substantive findings to assumptions regarding the presence/absence of autocorrelation and potential asymmetric and threshold effects of the computed residuals, as well as distributional assumptions. We examine these issues in turn. Presence of autocorrelation: The presence of serial correlation could bias the standard errors (Baltagi 2005, p136). We test for this possibility using Wooldridge s test for 24

25 autocorrelation in panel data (Wooldridge 2001). The results (p >.05) suggest that autocorrelation is not a significant factor to incorporate. 2 Sensitivity of results to linear residual specification: the effects of over (under) safeguarding could be nonlinear in their effect on ex post transaction costs. To investigate this possibility, we assessed several alternate transformations of the residuals. Specifically, if the effect of oversafeguarding is different from for undersafeguarding, a split of the residual into positive and negative residuals should be able to detect forms of nonlinearity. We therefore constructed a variable, which took on the value of the positive residual when present, or was given the value of zero in case of a negative residual. A corresponding variable was created for negative residuals which took the absolute value of the negative residual when present, and the value of zero else (cf. Bercovitz, Jap and Nickerson 2006). The results of this specification suggest (conform H1A and H1B) that the main effect of transaction specific safeguarding and relationship-specific safeguarding are linear. That is, transaction-specific over safeguarding reduces ex post transaction costs while transaction-specific under-safeguarding increases such costs. We find the same pattern to hold for relationship-specific under- and over-safeguarding. The effect of governance deviations on ex post transaction costs might also be subject to an unknown threshold. That is, slight deviations from expectations might matter much less than large deviations. We test for this possibility by including additional quadratic terms for the transaction- and relationship-specific residual terms (see Wang, Kayande, and Jap )Neither of the quadratic terms is significant, whereas the untransformed variables keep their original sign and significance levels. 25

26 Sensitivity of results to distributional assumptions: So as to assess the sensitivity of our inferences to distribution-related assumptions, we estimated both first- and second-stage regression models using bootstrapping. Specifically, we ran 1000 replications and compared the direction and significance of the models. A direct comparison of the signs and significance of the standard errors estimated via random effects GLS and bootstrapping yielded strong evidence of robustness; the standard errors and their associated significance levels were relatively invariant. 5. Discussion The present study builds upon and extends the governance-informed notion of a discriminating alignment between governance efforts and the features of the particular transaction. We leverage the unique features of a dataset comprising repeated transactions between 376 Dutch IT buying firms and their suppliers to assess the effects of deviations from such a discriminating alignment. Consistent with a nascent yet growing body of research on the perceptions and related consequences of governance relative to expectations, we propose that firms governance efforts are contrasted with what might be expected given prior interactions and/or present conditions. Given that parties governance efforts are more likely to overshoot or undershoot to varying degrees rather than exactly match the optimal level of governance, it is important to assess the performance implications of such governance deviations. Our research represents the first attempt, to the best of our knowledge, to explicitly measure the extent of such over- or undersafeguarding within and across transactions, and which relates to subsequent performance outcomes. Our central premise is that the performance outcomes achieved are not only a function of the extent of governance deviation. Rather, it is the attribution of the governance deviation to relationship- or transaction-specific characteristics, in combination with relational and situational 26

27 constraints, which determines subsequent performance. We find over (under)safeguarding to be associated with a reduction (increase) in ex post transaction costs, regardless of whether such governance deviation is attributed to the particular relationship or specifically to the transaction. Our finding of more is better when it comes to governance efforts is significantly tempered, however, depending on the particular attribution-constraint combination considered. Thus, we propose that it is not only the content of the term that matters, but also where such terms are attributed to (transaction or relation). The longer the relationship between buyer and seller, the greater the opportunity for relationship-specific routines and procedures to develop and become known, and the greater the likelihood of both partners having expectations of the appropriate conduct of the relationship. To the extent that governance deviations occur and are attributed to relationship-specific routines and constraints, the parties heightened cognizance of such relational idiosyncrasies gained from repeated interactions with each other aids in their sense making of the governance deviations. The result is an amplification of the negative (positive) effect of over- (under-)safeguarding on ex post transaction costs. This consistency between relationship-specific ways of doing things and the expectations developed over the long term stands in stark contrast to the mismatch between the latter expectations and transaction-specific attributions of governance deviations. Whereas over-(under-)safeguarding is generally observed to result in lower (higher) ex post transaction costs, the attribution of such governance deviation to unique features of the transaction flies in the face of relational expectations. The result is an attenuation of the main effect of over-(under-)safeguarding. As is evident from the preceding discussion, relationship length serves to strengthen or weaken the performance impact of governance deviation, contingent on the particular attribution made. 27

28 Our study provides evidence of a similar contingent effect with respect to the situational constraint imposed by measurement ambiguity. The parties inherent difficulty in verifying each other s performance increases the likelihood and severity of ex post transaction costs, and dampens the beneficial effects of relationship-attributed over-safeguarding. No such moderation is observed to occur, however, when the governance deviation is attributed to transactionspecific concerns. 6. Managerial Implications Our findings pose important implications for the managers of firms undertaking interorganizational relationships. Given the greater likelihood of governance deviations rather than a perfect match with optimal contractual safeguards, perhaps the first point to note is that regardless of the attribution, over-(under-)safeguarding leads to reduced (increased) ex post transaction problems. This would suggest that managers would be well advised to be safe rather than sorry with respect to their governance efforts. Our prescription for increased safeguards must be made, however, with a few important caveats. First, when deploying a contract within the context of a long-term relationship, cognizance of the attribution made to over- or under-safeguarding is critical. If governance deviations are perceived by the focal firm s partner to be attributable to the normal state of affairs in this relationship, the partners knowledge of each other over the course of the longterm relationship helps to make sense of the deviation as but one more instance of confirming evidence. In such an instance, relationship length facilitates the strengthening of the beneficial effect of over-safeguarding, and a corresponding weakening of the negative effect of undersafeguarding. If, however, over-safeguarding is deemed idiosyncratic to the current transaction, the stark contrast with the repository of prior interactions creates cognitive dissonance in the 28