Microfoundations of Value Creation and Relational Contracting in B2b Relationships: the Role Cross-understanding

Abstract: This paper develops the construct of cross-understanding in interorganizational relationships to further our understanding of how firms create value and solve the problem of clarity in relational contracting. Whereas much interorganizational research considers the problem of credibility – how the parties to a relationship can convince each other that they will honor the relational contract–, we examine the problem of clarity – how the parties can reach a joint understanding of their relational contract. We argue that cross-understanding, the accuracy with which the parties’ understand each other’s mental models, helps the parties to solve the problem of clarity. We test our hypotheses on a sample of 214 relationships between small and medium-sized manufacturing firms and their suppliers. This study is one of few studies that examine the effects of relational contracting, measured using subjective survey scales, on firm-level profitability measured objectively about one year later than the initial survey. We validate the cross-understanding measure using data from both sides of the dyad. We find that both the effect of cross-understanding on firm profitability and it’s complementarity with relational contracting increases with product complexity and technological uncertainty. Relational contracting can have negative performance effects if the parties fail to match product complexity and technological uncertainty with appropriate levels of cross-understanding.