The Effects of Relational Contracts on Procurement: Evidence from Information Technology Outsourcing∗

We augment existing studies of spot procurement contracts by introducing relational contracting. We first show that at intermediate interest rates, the form of procurement contract affects the parties’ reneging temptation on a given relational contract, and hence affects the best relational contract that is sustainable. We also show that relational contracts make contracts less complete and complexity plays a lesser role in the choice between fixed-price versus cost-plus contracts with relational contracting. Using a novel data set on information technology outsourcing contracts, we find that lower reneging temptation, measured by narrowly varying alternative vendors’ modification costs, favors relational fixed-price contracts. Second, we find that a vendor with high reputation capital in fair bargaining (cost-cutting) is more likely to be awarded a fixed-price (cost-plus) contract. Lastly, we find that complexity matters less in the choice between fixed-price versus cost-plus contracts with relational contracting. JEL Codes: D2, D86, L24, M15 ∗We would like to thank participants of seminars at University of Washington and the 2008 SOLE meeting for helpful comments. All remaining errors are our own. Correspondence can be addressed to [email protected] or [email protected].