Department of Management Information Systems, University College Dublin, Dublin 4, Ireland; College of Management, 7 Rabin Boulevard, Rishon Le-Zion, Israel
This paper examines multiple contract design choices in the context of transaction and relational attributes and consequent ex ante and ex post transaction costs. It focuses on two understudied themes in the IT outsourcing literature. First, while the literature is predominantly concerned with opportunism and consequent ex post hazard costs that contracts can safeguard against, parties to a contract also economize on ex ante transaction costs by their choice of contract type and contract extensiveness. Second, the literature studies the aggregate extensiveness of contracts rather than of distinct contract functions: safeguarding, coordination, and adaptability. Against this backdrop, our research model portrays a nuanced picture that is anchored in the following theoretical interpretation: transaction and relational attributes have implications on specific ex ante and ex post transaction costs, and these implications can be balanced by respective choices in both contract type and the extensiveness of specific contract functions. These two contract design choices complement and substitute for each other in their ability to economize on specific transaction costs. Our analysis of 210 software development outsourcing contracts finds that explanatory power increases when analyzing the extensiveness of individual contract functions rather than the aggregate contract extensiveness, highlighting subtle competing influences that are otherwise masked by an aggregate measure. Our analysis also shows that a preference for time-and-material contracts counteracts the effect of certain transaction attributes on contract extensiveness, and even cancels it out in the case of transaction uncertainty.
This study examines the role of business familiarity in determining how software development outsourcing projects are managed and priced to address risks. Increased business familiarity suggests both more prior knowledge, and hence reduced adverse selection risk, and increased implied trust about future behavior, and hence implied reduced moral hazard risk. Preferring high business familiarity partners may also alleviate concerns about incomplete contracts. By reducing these risks, higher business familiarity is hypothesized to be associated with higher priced projects, reduced penalties, and an increased tendency to contract on a time and materials rather than a fixed price basis. These hypotheses were examined with objective contractual legal data from contracts made by a leading international bank. Integrating trust theory into agency theory and into incomplete contract theory and examining unique contract data, the contribution of the study is to show that the premium on business familiarity and the trust it implies is not in directly affecting price, but, rather, in changing how the relationship is managed toward a tendency to sign time and materials contracts. Implications about integrating trust into agency theory and incomplete contract theory, as well as implications regarding trust premiums and software development outsourcing, are discussed.
Recently, an option-based risk management (OBRiM) framework has been proposed to control risk and maximize value in information technology investment decisions. While the framework is prescriptive in nature, its core logic rests on a set of normative risk-option mappings for choosing which particular real options to embed in an investment in order to control specific risks. This study tests empirically whether these mappings are observed in practice. The research site is a large Irish financial services organization with well established IT risk management practices not tied to any real options framework. Our analysis of the risk management plans developed for a broad portfolio of 50 IT investments finds ample empirical support for OBRiM's risk-option mappings. This shows that IT managers follow the logic of option-based risk management, although purely based on intuition. Unfortunately, reliance on this logic based on intuition alone could lead to suboptimal or counterproductive risk management practices. We therefore argue that managerial intuition ought to be supplemented with the use of formal real option models, which allow for better quantitative insights into which risk mitigations to pursue and combine in order to effectively address the risks most worth controlling.