Management Control for Market Transactions: The Relation Between Transaction Characteristics, Incomplete Contract Design, and Subsequent Performance

Using an unusually comprehensive database on 858 transactions for information technology products and accompanying services, we study how close partners who are exposed to opportunistic hazards structure and control a significant transaction. We analyze data on the terms of contracting to determine whether transaction and supplier characteristics that generate opportunistic hazards are related to the formal management control structure. We also examine whether misalignment between transaction and supplier characteristics and the control structure is associated with ex post performance problems. Characteristics associated with hazards are found to be positively related to contract extensiveness. Factor analysis of the use of 24 contract terms reveals four groups of contract terms that are commonly used in combination. We interpret these factors as “dimensions of management control” and label them: assignment of rights, product and price, after-sales service, and legal recourse. Characteristics associated with hazards are positively related to the use of all four dimensions of management control, with different hazards associated with different controls. We then examine the relation between transaction characteristics and ex post transaction problems, demonstrating that even in the presence of mutually agreeable contracts, hazards remain. We conclude that costs of contracting are associated with increased use of contract terms on assignment of rights, after-sales service, and legal recourse. Finally, we present evidence that management control structures that are better aligned with transaction hazards mitigate subsequent performance problems, though at a nontrivial cost of contracting.