The Role of Relationship Scope in Sustaining Relational Contracts in Interfirm Networks

Nicholas Argyres (Washington University in St. Louis)
Janet Bercovitz (University of Colorado Boulder)
Giorgio Zanarone (CUNEF)

Abstract : A key strategic decision for many firms is the breadth of its relationships with its partners. Whether those partners are suppliers, commercial buyers or complementors, firms must decide how many different activities to include in their transactions with them. Existing economic theories of relationship scope are limited in that they do not consider the implications of the fact that most firms transact within networks of partners. They focus on dyads only. In addition, those theories tend to consider one-sided moral hazard only, whereas many partnerships involve two-sided moral hazard. Organization theory, on the other hand, tends to rely on the notion of emotion- or norm-based trust to explain relationship scope, though such is not present and hard to establish in many settings. We develop a general theory of partnership scope in interfirm networks that addresses these deficiencies. We show how, by broadening the scope of business it conducts with a partner, a firm can sustain a self-enforcing exchange relationship with that partner (a “relational contract”) in which both parties cooperate with each other repeatedly, thereby maximizing the value created by the relationship. We provide numerous examples of empirical settings in which our model applies, including franchising, supply chains, and platform-based ecosystems.

Recall and Response: Relationship Adjustments to Supply-chain Shocks

Emek Basker (U.S. Census Bureau)
Fariha Kamal (U.S. Census Bureau)

Abstract : We study changes in firms' sourcing behavior following negative shocks to their supply chains. We identify the impact of shocks to relationships between U.S. buyers and their foreign suppliers using recalls of consumer products for health or safety reasons. Compared to a control group, U.S. firms that source a recalled product from an unaffiliated supplier are more likely to discontinue orders from the supplier subject to the recall and increase their reliance on alternative suppliers. In contrast, buyers that are vertically integrated with the suppliers of recalled products maintain their reliance on the same suppliers. We interpret these findings using a model of buyer-supplier relationships, in which firms with larger market sizes benefit more from vertical integration and find it optimal to maintain these integrated relationships in the face of adverse shocks.

Sustaining Informal Contracting in Reinsurance

Sadie Blanchard (Notre Dame Law School)

Abstract : This paper examines the surprising persistence of informal economic exchange in the reinsurance industry. Remarkably in light of their risk level, stakes, and complexity, reinsurance contracts were for most of their history concluded very informally, including by handshake, scribbles on a napkin, or a “slip” of a couple of pages. This form of contracting continued substantially well into the Twentieth Century, with contract documents leaving key terms “to be agreed” or entirely unspecified. The industry historically governed itself under an “utmost good faith” norm for business relationships, and disputes were arbitrated by industry experts under this remarkably general standard. Today, by contrast, reinsurance contracts are often recorded in documents of over 100 pages. This paper will describe the network structures, the social and business practices, and the economic characteristics of the business that allowed the reinsurance industry to maintain such informality in contracting for such a long time, including as insured risks grew more valuable and complex over the Twentieth Century.