The Impact of Technological Interdependency on Contracting Complementarities: Evidence from Automobile Product Development

This paper examines the impact of contracting complementarity across product development systems in the automobile industry. While most empirical research on contracting assumes that each governance choice is independent of each other, cross-system integration and incentive problems within product development suggest the potential for complementarities across contracting choices within the firm. This paper develops and implements an instrumental variables estimator which allows us to distinguish contracting complementarity from firm-level fixed effects in governance choice. Taking advantage of system-level determinants of vertical integration to calculate instruments for system-to-system contracting complementarity, we establish three findings. First, contracting choices are “clustered”: the probability of vertical integration for each automobile system increases in number of other systems that are vertically integrated. Second, instrumental variables and reduced-form estimates suggest that contracting complementarity, rather than unobserved firm-level factors, are the drivers of this correlation. Finally, the degree of correlation in governance is sensitive to the underlying contracting and technology environment, and contracting complementarity seems to be highest for those interactions where integration and coordination are most critical. While we interpret these findings cautiously, the results suggest that assuming away contracting complementarity may be problematic in contexts where coordination activities are both important and difficult to monitor.