Contractual Adaptation and the Evolutionary Perspective of Contracting Strategy

Abstract

Unlike organizational or institutional adaptation, contractual adaptation is a transaction-level response to continual evolution of the economic environment. To understand the underlying dynamics, we examine a spectrum of abstractions of environment and their corresponding optimal contracting strategies given firm-specific characteristics (combination of resources and capabilities). Our analysis shows that under continual evolution of the environment an adaptive contract which is temporarily renegotiation-proof benefits from inter-temporal, Pareto-improving updates - voluntary renegotiation. The efficiency advantage of contractual adaptation over static contracting alternatives, including spot transaction, long-term contract, and multiple short-term contracts, arises from the balance between flexibility and precision. We also detail the optimal adaptation strategy in relation to firm-specific characteristics. In extending to long-term transaction in continually evolving environment, we introduce the evolu...