The Effect of Contract Detail and Prior Ties on Contract Change: a Learning Story

Abstract: While much is known about how firms design their contracts, we know less about how they change and amend those contracts during execution of the transaction. This is important since a decision to modify an existing contract is likely to have a significant impact on the performance of the exchange. We examine when firms decide to change their contracts and analyze the drivers of that choice. Drawing on work on contracts and learning, we develop and empirically test the role of initial contract detail and prior ties between the parties on the amount, content and direction of changes to the contract. Specifically, we show that when firms take the time to add more initial details, then the need to change the contract will decrease. On the other hand, the more frequently firms have worked together in the past, the more likely they are to make changes to the contract, in part because the cost of making such changes decreases as the parties learn to work together. Finally, more prior ties also affect the content of change by leading to a preference for changes to the enforcement provisions in the contract more so than to the coordination provisions in the contract; while contract detail influences the direction of change by driving towards less removing or weakening existed provisions in the initial contract. We test our ideas using a sample of 128 international joint ventures (involving Chinese and foreign firms) and find support for all the hypotheses