Relational Contracts, Growth Options, and Heterogeneous Beliefs: A Game-Theoretic Perspective on Information Technology Outsourcing

Author List: Li, Xiaotong;
Journal of Management Information Systems, 2014, Volume 31, Issue 2, Page 319-350.
More companies have realized that information technology (IT) outsourcing, once viewed as a cost reduction tool, could facilitate and even enable the transformation of their core business processes. The benefits from a potential outsourcing relationship expansion have strategic implications for relational incentive provision. Modeling “information poaching” in IT outsourcing as an incentive problem with contractibility constraints, our analysis shows that this problem could be mitigated in a repeated game where the outsourcing client and the service provider agree on a relational contract. When the two partners share the belief that they can potentially benefit from a future relationship expansion, they are more likely to behave cooperatively during the early stages of their relationship. However, when they disagree about the likelihood of the future relationship expansion, they will have different preferences on a set of otherwise equivalent relational bonus contracts. Specifically, they will adopt a relational contract with large but infrequent bonuses when the client is more optimistic than the service provider about the potential of their relationship. Because these results hold even when the sourcing partners’ beliefs are very close to each other, our analysis sheds fresh light on the issue of equilibrium selection in relational contract theory. In the context of IT outsourcing, the results of this study suggest that, because salient forms of relational bonuses are often not adopted, relational incentive provision is likely more pervasive than what we can observe.
Keywords: contractibility;equilibrium selection;growth options;heterogeneous beliefs;IT outsourcing;outsourcing contracts;relational contracts;repeated games
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List of Topics

#25 0.213 relationships relationship relational information interfirm level exchange relations perspective model paper interpersonal expertise theory study effects literature role social identify
#70 0.161 contract contracts incentives incentive outsourcing hazard moral contracting agency contractual asymmetry incomplete set cost client parties examine effort structures double
#47 0.102 outsourcing vendor client sourcing vendors clients relationship firms production mechanisms duration mode outsourced vendor's effort activities in-house managing technology domestic
#48 0.073 dimensions electronic multidimensional game transactions relative contrast channels theory sustained model predict dimension mixture evolutionary results unique traditional likely finite
#246 0.073 strategic benefits economic benefit potential systems technology long-term applications competitive company suggest additional companies industry operating costs difficult substantial total
#267 0.072 options real investment option investments model valuation technology value analysis uncertainty portfolio models using context intuitive managerial regret uncertain case
#213 0.069 assimilation beliefs belief confirmation aggregation initial investigate observed robust particular comparative circumstances aggregated tendency factors examine stages uncertainty instead confidence
#211 0.056 service services delivery quality providers technology information customer business provider asp e-service role variability science propose logic companies especially customers