Overcoming contract incompleteness: evidence from long-term supply relationships

Abstract

This paper explains how firms address contract incompleteness in long-term supply relationships. For firms, it is practically impossible to assess all future eventualities, draft complete and fully contingent contracts, observe and verify the agreed performance. Based on an empirical investigation of long-term supply relationships between agribusiness and farms in India, we present evidence that under certain conditions overcoming contractual incompleteness is possible. We argue that firms are better able to deal with contract incompleteness when they specify contract clauses that regulate (1) recurrent interaction, (2) relational frame and (3) nonlegal enforceability. These three mechanisms of contract clauses enable firms to preserve the substance of how they wish to relate to each other and simultaneously allow them to remain sufficiently flexible to embrace new opportunities.