Restoring Interfirm Relationships Following Contract Violations: a Tce Perspective

Abstract: We augment work on Transaction Cost Economics (TCE) and contract violations with insights from psychological work on conflict management to examine the causes and consequences of contract violations in repeat exchange relationships. We argue that contract violations occur not only because of bounded rationality or self-interest seeking behavior with guile (opportunism), but also from simple self-interest seeking behavior without guile, and that this distinction is important in understanding how future contracts are written in response to violations. Furthermore, we propose that following contract violations, effective governance in repeat exchange relationships depends on the non-violating party’s beliefs about 1) whether expectations were aligned between the exchange partners and 2) the violating party’s intent. We develop propositions on the underlying causes of different types of violations, concerns raised by each violation, as well as the mechanisms by which exchange partners can improve the design of subsequent contracts to reduce the likelihood of future conflict(s). In doing so, we add to the extant literature on the micro-foundations of strategy by providing a comprehensive picture of the different types of contract violations as well as the future governance changes required to maintain exchange relationships.