Based on Research By Balaji R. Koka

When It Comes To Contracts, Relationships Matter Most For The Weaker Party

  • You can’t plan for everything. All legal contracts are, in the end, incomplete.
  • The quality of the relationship governs inevitable contract gaps.
  • The factor of relationship governance has measurable value, but only to the more risk-exposed party.

The best laid plans of mice and men often go awry. Poet Robert Burns articulated the idea concisely in 1785. John Steinbeck invoked it in the title of his melancholy 1937 novella. We still repeat the adage today.

Contract lawyers, however, would beg for a revision. The best laid plans always go awry. Hence the art form known as the contract, designed to anticipate every which way an accord might possibly go. In the end, though, legal agreements are always incomplete. No one can foresee all possible outcomes. No number of billable hours can predict the future.

So as vendor and client proceed with their contract and nuanced situations arise, what happens? What shapes the exchange when written words are not enough?

The relationship itself.

Yes, even in contracts–perhaps especially in contracts–subjective factors such as trust, reciprocity and flexibility shape the final interaction. Handshake deals may linger mainly among Texas wildcatters, but the power of interpersonal relationships, known as “relational governance,” is still integral to the study of contracts. And the research presumes that this power has real, monetary value.

Until now, most scholars have pronounced the value of those relationships as roughly equal for both clients and vendors. But a study by Balaji R. Koka, a professor at the business school, and coauthor Anandasivam Gopal of the Robert H. Smith School of Business, University of Maryland, shows that in contracts, as in most relationships, someone still has the upper hand.

To look at the value of relational governance from the vendor’s perspective, the researchers studied data on 105 projects completed by a leading Indian software services firm. First they designated each project as either “fixed price” or “time and materials.” In a fixed price contract, the vendor’s revenues were fixed. Any unforeseen issues on the project were likely to endanger the vendor’s bottom line. By comparison, time and materials contracts were more flexible, with the vendor bearing less risk.

The findings showed just how important the power relationships in contracts are. Using project profitability as the measure of value, the scholars showed that relational governance indeed has measurable benefit to vendors. But the profit increase to the vendor was only significant in higher risk situations–in other words, the fixed price projects. In the less risky time and materials projects, the software firm did not materially benefit from relational governance.

The formal, written powers of traditional governance, in other words, boosts value for both parties when contracts are complex. But this value is only significant for the more vulnerable partner.

So for a vulnerable mouse scurrying in an open field, it’s worth it to smile at others higher up on the food chain. It could pay off in a conflict. The bigger mammals like humans have less reason to bother with pleasantries. All they need is a good lawyer.

Balaji R. Koka is an associate professor of strategic management at Jones Graduate School of Business at Rice University.

To learn more, please see: Gopal, A., & Koka, B. R. (2012). The asymmetric benefits of relational flexibility: evidence from software development outsourcing. MIS Quarterly, 36(2), 553-576.