Integrating Economic and Organization Theory
Edited by Anna Grandori
Chapter 5: Contracts: coordination across firm boundaries
Contracts between firms involve a projection over the future. In this chapter I analyze some of the problems that arise in contractual relationships and some of the mechanisms that parties have developed to cope with these problems. An overarching problem is what has been labeled opportunism and, in particular, the problem of hold-up. While the contractual interaction might be as simple as a straight-forward promise to deliver some well-defined commodity at a future date, the more analytically interesting contracts involve adaptation as new information becomes available. Contracts often involve a form of ‘real option’; that is, rather than spell out what should happen in all future contingencies, the contract gives one or both parties the option to make decisions (including abandonment or termination) as new information becomes available. One governance device is to give one party the power to make decisions as new information arrives. The party that values flexibility the most would be given the power to make the decision and it would be confronted with a ‘price’ reflecting the counterparty’s reliance. While economists often model contracts in a principal–agent form with the agent posing a problem of moral hazard, the more interesting problems concern double-sided moral hazard. That is, the outcomes depend on the behavior of both parties.
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