Detailed Contract Drafting in Industrial Buyer-supplier Relationships: Strategic Consequences of Misaligned Contractual Governance

Abstract: Only a handful of studies have examined the performance consequences of formal contracting while accounting for endogeneity. In this paper, the authors investigate the relationship between detailed contract drafting (DCD) and two major dimensions of overall relationship performance—cost reductions (CR) and end-product enhancements (EPE). These outcomes, respectively, contribute to implementing cost leadership and differentiation strategies. The authors test their hypotheses on survey questionnaire data from 305 long-term industrial buyer-supplier relationships in the wood industry using control function and instrumental variable estimators. Provided the parties align DCD with transaction attributes, DCD positively affects both CR and EPE outcomes. However, deviating from the expected levels of DCD reduces both CR and EPE out-comes. CR and EPE outcomes differ on three accounts. Firstly, DCD has a diminishing (inverted u-shape) effect on EPE outcomes, because they are more difficult to specify contractually ex ante compared to CR outcomes. Secondly, and for the same reason, the effect of DCD on EPE outcomes increases with the level of ex ante relational norms. Finally, EPE seems more sensitive to misalignments.