Now You See It, Now You Don't: Explicit Contract Benefits In Extralegal Exchanges

Abstract

To enhance performance, buying firms often use supplier governance mechanisms, such as explicit contracts, to coordinate efforts. Yet, it is unclear how these governance mechanisms would perform in extralegal exchanges, whereby suppliers may renege on the contract with little or no legal recourse. Furthermore, there is a paucity of studies examining these extralegal exchanges in the presence of an external market willing to pay higher prices, thus tempting suppliers to renege on existing agreements. Accordingly, we seek insight into the effectiveness of implicit and explicit contracts juxtaposed with the evolving payoff for a supplier's reneging. We do so with a dataset from a buying firm and its suppliers in the for‐hire trucking industry. Our results reveal that implicit contracts do, indeed, enhance performance (i.e., suppliers reject business offerings less often), eventhough the buying firm has no viable legal recourse for rejected business offerings. Likewise, we find that explicit contracts (i.e., providing more specificity to the supplier) further enhance performance; yet, as the external market conditions change in the supplier's favor, more explicit contracts’ effectiveness drastically weakens. Indeed, when external market prices reach their highest, our results suggest that explicit contracts’ benefits virtually disappear. Overall, our results provide a rare look into implicit and explicit contracts’ outcomes in an extralegal exchange when suppliers’ reneging becomes more/less threatening, thereby offering insight for researchers and managers.