Putting "Calculative" In "Trust": How to Engender Relational Governance Within Formal Contracts

Interfirm contracts are often plagued by opportunism arising from exchange hazards such as uncertainty and relation-specific investments. Relational mechanisms, evoked in the spirit of Williamson’s “calculative trust” can assist contracting parties to overcome concerns about opportunism and grow joint surplus from exchange. We investigate how relational governance can be fostered within the structures of a formal contract to limit losses from exchange hazards. We identify and empirically examine two relational mechanisms, the possibility of a future contracting horizon and bilateral reputation capital for cost containment. We use as a context, two of the most commonly occurring formal contract governance regimes, namely fixed-price (FP) and cost-plus (CP). Using contract data from settings where the supplier can engage in deliberate obfuscation through unverifiable actions that increase adaptation cost, we predict that relational mechanisms reduce cost inefficiency hazards and increase the likelihood of cost-plus contracts. Empirical tests using textual analysis of 149 SEC material contracts (averaging $49.1 million in value), supplemented with hand-collected trade and industry data, provide results consistent with predictions.