The Effect of Contracts and Trust on Partnership Performance

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The Effect of Contracts and Trust on

Partnership Performance

Empirical Analysis on the Effect of Contractual Complexity in Interaction with Trust, Opportunistic Behavior, and Commitment on the Success of Interfirm Relationships

by Jan Sitterberg

S3247643

j.sitterberg@student.rug.nl

MSc. BA - Organizational & Management Control University of Groningen

Faculty of Economics and Business

January 22, 2018

Supervisor: A. Rehman Abbasi Second Assessor: Dr. D.B. Veltrop

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Abstract

The goal of this study is to better understand the effects contract complexity has on trust and opportunistic behavior in interfirm relationships and how this ultimately influences the performance achieved. To this effect, a comprehensive model was developed that was an-alyzed in three separate sub-models testing hypotheses that were developed from assump-tions that follow from previous literature and bring clarity to some of the debated points in the relationship between control, trust, and performance. Surprisingly, contract complexity at high levels may cause opportunistic behavior to occur more often rather than curbing it. But the unexpected absence of an inverted U-shape relationship between contract complexity and trust seems to show that the negotiation partners are careful to avoid overly complicated con-tracts, leading to the fact that they seem to rarely exist in practice. The results also showed that contract complexity alone does not seem to play a major role in affecting partnership performance, but rather causes changes in opportunistic behavior which, in turn, decreases the commitment to the relationship, worsening its performance. The results also suggest that IOR Trust and Contract Complexity are two separate, unrelated constructs both affecting partnerships performance in their own ways. Identifying IOR Trust as an independent factor in the Contract Complexity – Partnership Performance research arena suggests including trust in a different role in a serially mediated relationship with control variables, e.g., as a moderating variable, could provide additional insights into this complex of variables influ-encing each other.

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Tables

Table 1: Reliability and Validity Measures ... 15

Table 2: Regression Results H1... 19

Table 5: Regression Results H4 ... 24

Figures

Figure 1: Research Model ... 6

Figure 2: Sub-Model 1 ... 6 Figure 3: Sub-Model 2 ... 8 Figure 4: Sub-Model 3 ... 9 Figure 5: Sub-Model 4 ... 10 Figure 6: Summary H1 ... 20 Figure 7: Summary H2 ... 21 Figure 8: Summary H3 ... 22 Figure 9: Summary H4 ... 25

List of Abbreviations

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Introduction

Problem Statement

As markets grow and globalization occurs, interfirm relationships have attracted sig-nificant attention from accounting researchers; particularly the management accounting and control practices in these relationships. Since risk of failure is a critical concern in interfirm relationships, appropriate governance structures, including management control systems and the development of trust, pose a special interest in this context (Das and Teng, 2001; Speklé, 2001). However, there has been only limited attention to the form of management control systems that are suited for strategic alliances. (Langfield-Smith & Smith, 2003).

Because these relationships tend to involve long-term cooperation, the issue of control and trust is a central point that needs to be considered since “contractual safeguards and trust are important control mechanisms that reduce risk and facilitate cooperation in a partnership” (Lui & Ngo, 2004, p.474), therefore ensuring success.

Most of past literature has researched control and trust in interfirm relationships with the result of them being either substitutes or complements (Dekker, 2004). The studies con-sider the inverse relationship between control and trust or their relationship of being mutually supporting, respectively. Van der Meer-Koistra and Vosselman have further expressed that control and trust interact with each other instead of merely being substitutes or complements (2009).

They name a research gap in that research could focus on “the contents of contractual agreements” and “the consequences of excess control” (2009, p.281). This view aligns with Lumineau’s work, stating that “a debate has ensued to determine how contracts and trust in-fluence each other” (2017, p.1554). The role that a contract plays in interfirm relationships, therefore, is a central factor of success and needs further research since contracts are the often the base of interfirm relationships (Meira et al., 2010). Furthermore, the details of a contract can be easily controlled and are graspable measures that affect the more abstract concepts of trust and relational signaling.

This study aims to contribute to the discussion on the relationship between trust and control with emphasis on the contractual agreement between partners and its effect on trust and performance. It does so by empirically testing the effects of the complexity of a contract in these relationships with regards to both building trust and interfirm relationship perfor-mance. It shows results that are interesting to both academics and practitioners.

Purpose. The goal of this study is to better understand the effects of contract design

regarding complexity and provide new insights into what impact it has on successful or un-successful interfirm cooperation.

Significance of the study. Even though firms consider collaboration a key strategy to

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can be considerable, ranging from 30% to 70% (Tjemkes et al., 2012). Furthermore, even though their value is recognized, many alliances’ results disappoint actors, compared to ex-pectations. There are no indisputable reasons yet that explain these failures.

This research aims to investigate connections in relationships so that firms can address causes of failure and improve interfirm alliances by bringing more stability towards them.

Problem statement and research questions.

High failure rates demonstrate the need for indicators to establish and manage inter-firm alliances.

Based on the identified literature gap of the role contracts play in the success of inter-firm relationships, the following two research questions were developed:

The first question addresses the control-trust nexus and aims at finding out how con-tractual agreements affect trust building in interfirm partnerships:

RQ1: What are the effects that a contract has on trust and opportunistic behavior in interfirm relationships?

The second question focuses on the relationships between a contract, trust, and oppor-tunistic behavior and their effect on performance:

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Literature Review

Trust and Control Theory

An essential characteristic of alliances is the mutual dependence between formerly in-dependent organizations. Agreeing to engage in alliances, therefore, causes several concerns: mixed feelings of general uncertainty about the course of events, the dependence on and the potentially opportunistic behavior of unfamiliar partners, and contingent risks. All of which can significantly impact the performance of alliances and even cause failure (Krishnan et al., 2006). Alliances are said to be “characterized by a high level of dissatisfaction with their actual outcomes relative to expectations and, correspondingly, a high rate of failure” (Madhok & Tallman, 1998, p.326).

These failure rates make it necessary for firms to deal with coordination problems and calls for governance mechanisms that provide direction and security and “management control practices used to mitigate risk and enhance cooperation” (Anderson et al., 2009) that provide direction and security.

Consequently, issues of alliance governance have attracted the attention of researchers and “literature has established a significant interest in studying the governance architecture for safeguarding alliances” (Krishnan et al., 2006, p.2).

Literature mostly agrees that the governance of interfirm alliances consists of two gen-eral mechanisms: formal and relational governance.

• “Formal governance is defined as the set of structural mechanisms to safeguard the alliance [against opportunism and conflict], often written down in a formal contract”. • “Relational governance refers to the relational processes underlying interorganiza-tional relationships with trust between the parties as the central” regulating mechanism (Mollona et al., 2016, p.1682).

As both kinds of governance mechanisms co-exist in alliances, a debate has ensued to determine how contracts and trust influence each other.

Contractual Governance. Traditionally, when talking about governance of alliances,

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to be performed, procedures for monitoring and penalties for noncompliance, and rewards for outcomes attained” (Goo & Nam, 2007, p.2).

Trust. One of the most frequently accepted and studied critical factors in business

re-lationships that involve collaboration is trust. Trust is a form of behavior or a personal char-acteristic or trait (Naef & Schupp, 2009). It describes the “expectation that an exchange partner will not behave opportunistically, even when such behavior cannot be detected by the victim (Mayer et al., 1995)” (Mollona et al., 2016, p.1682). It is also the willingness to accept a certain behavior of others as being able to rely on it and judge the risk of disappointment as low (Sommerlatte, 2016).

According to Transaction Cost Economics, trust is the ability to be sure that a partner will behave in accordance to both parties’ interests and allows for smooth and stimulating cooperation as the partners rely on mutual agreements and are committed without further ver-ification and safeguard (Sommerlatte, 2016). This allows the implementation of systems which grant freedom to choose without trying to process more information about the world than necessary (Tomkins, 2001).

Interorganizational Commitment. “The commitment–trust theory argues that

com-mitment is the key construct for understanding interorganizational relationship performance, and that a firm's commitment leads it to engage in cooperative behavior (Leonidou et al., 2008; Morgan & Hunt, 1994)” (Liu et al., 2010, p.846). Therefore, commitment represents a long-term interest in the partner which makes the firm more likely “to invest more resources, deci-sions, and operations in that relationship (Mavondo & Rodrigo, 2001)” (Pesämaa, 2015, p.30).

Opportunistic Behavior. Opportunistic behavior plays a central role in the relationship

between control and trust. According to Moeller, opportunism “arises when a partner’s behav-ior differs from that of the other partners’ implicit or explicit understanding of their contract” (Moeller, 2010, p.33)

Opportunism can be passive or active. The passive form entails lack of dedication in performing to the best of one’s competences. The active form of opportunism, which is cov-ered in this study, entails that actors primarily pursue their personal interests and “will disre-gard the interests of their partners if they can get away with it”. Some researches find “that relational norms, e.g., trust, challenge this assumption and mitigate opportunistic behavior” (Judge & Dooley, 2006, p.26).

Partnership Performance. There is much ambiguity about the deciding factors of

al-liance performance in literature.

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must be the organization’s financial performance, e.g., the long-term return on investment (Porter, 2001). However, alliances usually do not report financial performance, which would, in any case, tend to be biased by partners’ accounting preferences. Also, it would be difficult to objectively attribute the fair share in the alliance success to the participating companies.

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Hypothesis Development

Based on the identified literature gap of the role contracts play in the success of inter-firm relationships, a comprehensive model was developed and analyzed in three separate sub-models:

Figure 1: Research Model

Hypothesis 1

The first sub-model was of the mediator relationship of Contract Complexity, IOR (In-terorganizational Relationship) Trust, and Partner Performance:

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Contract and Performance. There is an ongoing debate over which roles contracts and

trust play regarding performance. Literature cannot settle on the discussion if contracts elimi-nate risks and improve performance or if they have an intimidating effect on partners which would make business relationships less successful. However, researchers agree that contracts play a central role, whether the effect is positive or negative (De Jong & Klein Woolthuis, 2004). Fehr et al. see a possible impact that control through a contract on performance may have, for example through being more or less flexible (2008).

Contract and Trust. Zahir-ul-Hassan and Vosselman argue that “formal control

sys-tems can result in positive expectations about the behavior of a partner in the future by provid-ing apparently objective evidence of performance and by helpprovid-ing in coordinatprovid-ing between partners” (2012, p.11).

Lumineau further states that “contracts can have both positive […] and negative influ-ences” on trust in an interfirm relationship (Lumineau, 2017, p.1566). Additionally, there is no consensus on whether trust and control act as substitutes or complements.

Especially highly detailed contracts can be detrimental to trust development. They can be interpreted as a sign of distrust between exchange partners by emphasizing control and legal rules, thus encouraging opportunistic behavior (Klein Woolthuis et al., 2005; Cavusgil et al., 2004). Van der Meer-Koistra and Vosselman also see a literature gap in the studies of excess control (Vosselman & van der Meer-Kooistra, p.281, 2009). Dekker suggests that the relationship between formal control and trust may, to a certain point, be nonlinear which could explain the previously mentioned researcher’s findings (2004).

Trust and Performance. Trust is seen as an essential element of organizational

perfor-mance (Hartmann & Slapnicar, 2007). It can reduce transaction, coordination and monitoring costs and facilitate coordination (Zaheer et al. 1998). An important benefit attributed to trust is its ability to enhance performance. Partners in a relationship with a high degree of trust are willing to invest more in the relationship to achieve better results and success in the relation-ship (Poppo et al., 2016).

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In the context of these factors, it was hypothesized:

H1: There is a significant relationship between Contract Complexity and

Partner-ship Performance mediated by IOR Trust.

To further test if a nonlinear relationship is reflected in the data, the following hypoth-esis was developed:

H1a: The relationship between Contract Complexity and IOR Trust is an inverted

U-shape.

Hypothesis 2

The next partial model that was analyzed shows the mediator relationship between contractual completeness, opportunistic behavior, and partnership performance:

Figure 3: Sub-Model 2

Contract and Opportunistic Behavior. Uncertainties about the environment and the

potential opportunism of partners make contractual safeguards and trust between partners par-ticularly important for successful outcomes. (Lui & Ngo, 2004). Formal contractual provisions can control the communication and actions in a partnership. Therefore, contracts are seen as effective mechanisms for mitigating opportunism through details and contract application (Faems et al., 2008).

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costlier to violate contracts that include penalties for opportunistic behavior (Cavusgil et al., 2004).

Opportunistic Behavior and Performance. Transaction Cost Economics predicts a

negative relation between opportunistic behavior and performance “because the success of a relationship and its competitive advantages rely on the joint efforts of the partners” (Lui et al., 2009, p.2). Furthermore, if “a party seeks its own gain and acts opportunistically by breaching the contract, withholding or distorting information, shirking obligations, or grafting joint earn-ings, the other party will suffer” (Lui et al., 2009, p.2).

Based on the relations between these constructs, it was hypothesized:

H2: There is a relationship between Contract Complexity and Partnership

Performance negatively mediated by Opportunistic Behavior.

Hypothesis 3

Trust may not have a direct effect on partnership performance but rather an indirect effect, mediated by interorganizational commitment. To study this relationship, the following sub-model was analyzed:

Figure 4: Sub-Model 3

Trust and Commitment. Trust does not necessarily influence the success of a

relation-ship directly. The influence is often indirect in connection with another variable which then influences success. Studies have shown that trust has a positive impact on collaboration, com-mitment and conflicts in relationships (Kwon & Suh, 2004; Morgan & Hunt, 1994); these factors then indirectly influence the success of a relationship.

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worthwhile striving to keep it” (Martins et al., (2017), p.49). Morgan and Hunt (1994) as well Cote and Latham (2006) found a positive relationship between trust and commitment.

Commitment and Performance. “Commitment-trust theory conceptualizes that

suc-cessful business relationships need relationship commitment” (Ashnai, 2013, p.50). Consistent with previous findings in the literature, it is predicted that “the partners not only communicate more and openly […], but are also willing to share more resources with a higher commitment to the relationship” (Vivek & Richey, 2013, p.366). Moeller also found support that commit-ment is related to better perceived performance in a relationship (2010).

This leads to the following hypothesis:

H3: There is a positive relationship between IOR Trust and Partnership Performance

mediated by Interorganizational Commitment.

Further Questions and Hypothesis 4

Since the relationship between Contract Complexity and IOR Trust is arguable and may prove not to provide significant results, an alteration to the overall model was conceptu-alized to display serial mediation of opportunistic behavior and commitment on the relation-ship of contractual complexity and performance to look like this:

Figure 5: Sub-Model 4

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To support this, Wang and Yang find that opportunistic behavior in interorganizational relationships has an impact on partnership performance through factors like commitment, con-flict, satisfaction, and trust. Commitment is the major influence in this case (2013). This is supported by Wang and Yang’s findings that show a relation between opportunistic behavior and commitment, explaining that opportunistic behavior reduces commitment, therefore less-ening satisfaction and trust in the relationship and causing conflict, “resulting in reduced or-ganizational performance” (p. 146, 2013).

This leads to the following hypothesis:

H4: There is an indirect relationship between Contract Complexity and Partnership

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Methodology/Research Design

In this study, a theory testing approach was followed. This was to test hypotheses that were developed from assumptions that follow from previous literature and bring clarity to some of the debated points in the relationship between control, trust, and performance. After defining the conceptual model, data was collected and analyzed to evaluate results and their theoretical and practical implications, as well as limitations of the study and suggestions for further research.

Data Collection

The goal of this study was to shed light on the effects of Contract Complexity, as well as the relationship with IOR Trust, Interorganizational Commitment, and Opportunistic Be-havior, and provide new insights on its impact on the success of interfirm cooperation.

For this purpose, a survey was conducted that was provided by the thesis supervisor. This survey was carried out at firms in Germany and the Netherlands which regularly operated in interorganizational partnerships. To minimize any misunderstandings and ensure a large collection of data, the survey was conducted in German and Dutch respectively and included numerous questions that measured the specified constructs.

The survey was done in person after firms were contacted via e-mail or phone, asking for their help by emphasizing the importance of the study and offering to share study results afterward. This resulted in the survey being conducted with 34 managers who were usually employed in the procurement department as these managers had day-to-day experience in working with other firms on a contractual basis, like in buyer-supplier relationships. These managers were located at 22 firms in Germany and the Netherlands. After contacting 188 firms, this means there was an effective response rate of 11.70%. The data entries were then pooled with entries from last year’s data collection, resulting in a dataset of 78 entries to analyze.

Construct Operationalization

The variables collected in the survey either precede, cause or "shape" the construct (formative measurement model) or the indicator variables are caused by the construct and only reflect the underlying concept (reflective measurement model).

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Measurement

The questions in the survey were adopted from previous literature to secure a useful and valid collection of data. Most items were measured on a Likert scale, with a value of 1 representing “Strongly Disagree” and a value of 7 representing “Strongly Agree”.

Consistent with Poppo and Zenger (2002), contractual complexity was measured by asking respondents for their level of agreement on a 7-point scale with the following statement “The formal contract of the employees is highly customized, which requires considerable legal work”. The survey also asked for the “length of the contract (in pages), which previous work has shown to be an indicator of contractual complexity (Joskow, P.L. (1990)” (Poppo & Zenger, 2002, p.717).

The five items used to measure IOR Trust were adopted from Zaheer et al. who de-signed their measurement “to tap trust in close, personal relationships rather than a more gen-eral trusting orientation”. They used “items designed to measure the fairness component of trust […] in an exchange context”, and “ensured that items corresponding to all three forms of trust - cognitive, behavioral, and emotional - were represented in the scales” (1998, p.147). Most items are based on integrity and are formative. One item (trustworthiness) reflects an understanding of benevolence and is also formative.

Several dimensions of commitment were covered: loyalty, affective and calculative commitment, confidence in and the willingness to invest in the long-term stability of the rela-tionship. This was done with seven items adapted from Bianchi (2006), which focused on how important the partnership is to the firm and how much effort goes into maintaining it.

Opportunistic behavior was measured with six items adapted from Cote & Latham (2006), Carson et al. (2004), and Rokkan et al. (2003). These were questions about how the respondents estimated the possibility of opportunistic behavior by the partner, regarding the keeping of promises, acting only towards their own benefit, or simply being uncooperative. All variables used are reflective.

Since financial performance measures of alliances are usually not available, partner-ship performance was measured with four reflective items adapted from Poppo & Zenger (2002), Ren et al. (2009), and Das & Teng (2003). They concerned how satisfied respondents were with the partnership, regarding cost, quality of products or services, responsiveness of the partner, and the achievement of goals. Such subjective performance indicators have been criticized (Richard et al., 2009), however, Krishnan et al. report strong correlations between subjective and objective measures of alliance performance (2006).

Several control variables were also collected including company location, company size, and previous partnership history.

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History was measured by asking how often the firms had worked together before using steps from “never” to “very regularly”.

The location operationalized by splitting the entries into firms from the Netherlands and other countries, creating a dummy variable of 0 or 1. The employee count was transformed using natural logarithm due to the large differences in answers and to ensure a bell shape in the data.

Data Analysis

To make sure that there was a solid base of items for analysis, items were checked and verified. Negatively worded items were reverse-coded. Linearity between items was visually checked with scattergrams; skewness and kurtosis of the items were also analyzed.

Since the length of contract pages showed a skewness of +8.5, a natural logarithm transformation was applied to shift the data for this item closer towards the normality assump-tion and a bell shape as well as to avoid heteroscedasticity problems. This means that larger values move closer together in the data distribution and differences between smaller values gain more importance. Logarithmic transformations like this are commonly used in literature (Schilke & Cook, 2015).

This process of analyzing the data showed that one outlier concerning the item “con-tract length” was with “1000 to 2000” pages on average ten times higher than the next largest response at 150 pages. In the literature, values that deviate more than 2- or 3-times the standard deviation from the mean are often eliminated (Dolci, 2014). If the distribution of the variable deviates considerably from a normal distribution, this threshold should be set at 4-times the standard deviation from the mean (Lohninger, 2008). According to these thresholds, a contract length of 1000 pages would be considered an outlier. Since parameters like average and stand-ard deviation are sensitive towstand-ards such outliers, they could compromise regression coefficient estimates, p-values, and confidence intervals (Preacher & Kelley, 2011). Furthermore, the value seems questionable since it should be possible to indicate contract length more precisely. Therefore, the response entry which contained this outlier was removed from the data pool. With three entries being removed for missing values, the final sample size consisted of 74 cases.

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Afterwards, factor analyses were conducted to identify the factors of Contract Com-plexity, IOR Trust, Opportunistic Behavior, Commitment, and Partnership Performance re-garding the previously stated hypotheses using the SPSS routine FACTOR. Exploratory factor analysis is normally used when a yet unknown structure is looked for in a dataset. In this study, however, the items provided were already grouped and, due to theoretical considerations, as-sociated with the constructs to be examined. In this respect, a reassignment of items to factors due to statistical correlation relationships seemed to be redundant. The results of a factor anal-ysis with all items also showed no meaningful attribution of the items to the components.

Instead of the complete set of variables, therefore, the associated variables for each theoretical construct were analyzed separately to discover the underlying latent factors (similar to a confirmatory factor analysis). It was assumed that each variable only represents one factor. With Likert items, the average values of the variables that load up to one factor are often additively combined into a factor score. Here, this approach encounters difficulties be-cause the variable Contract Length (in pages) was measured at a completely different scale than the other variables and cannot be averaged with Previous Partnership History (measured on a Likert scale). In this study, all variables were therefore standardized, and the factor values were calculated using the routine implemented in SPSS, which combines variables into opti-mal factor scores by best reproducing the item correlation matrix.

Running factor analysis, the SPSS routine FACTOR first provides test scores for the Kaiser-Meyer-Olkin (KMO) measure of sampling adequacy where the KMO score should be higher than 0.5 or 0.6 and Bartlett’s test which should be significant at 0.05. These tests check if the internal correlation between the items and in the correlation matrix as a whole is suffi-cient to run meaningful factor analyses. The KMO scores for all variables exceeded 0.7 except for Contract Complexity. However, since this is a formative construct, the KMO scores are not as important for this construct and can be accepted like this since it assumes internal cor-relation. Furthermore, all Bartlett’s tests came with an outcome of p that was 0.000, therefore being significant. These results show that factor analysis is adequate.

Finally, in addition to Harman’s single factor test, several reliability and validity measures were calculated:

Table 1: Reliability and Validity Measures

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To analyze reliability, Cronbach’s Alpha was calculated. Cronbach’s Alpha is most widely applied in research settings like this where the measurement results are gathered in a one-time survey. It estimates the internal consistency of the measured items, i.e., the extent to which measures are positively correlated. Thus, Cronbach’s Alpha is based on the idea of re-flective constructs.

There is no binding threshold value above which the estimated reliability is regarded sufficient. Often, a reliability score of 0.7 measured through Cronbach's alpha is regarded as being ‘sufficient’, above 0.8 is regarded ‘good’ and above 0.9 it is regarded ‘high’ (Danner, 2015). For all factors but Contract Complexity, Cronbach’s Alpha was well above 0.7. How-ever, as already discussed, Contract Complexity is a formative measure that is based on com-pleteness of included items rather than their internal consistency. IOR Trust was virtually sig-nificant.

Also, Average Variance Extracted (AVE) and Composite Reliability (CR) were calcu-lated. All AVE scores were well above the suggested threshold, suggesting validity of the measurements (Poppo et al., 2008).

Each loading for the multi-item constructs of Contract Complexity, IOR Trust, Oppor-tunistic Behavior, Interorganizational Commitment and Partnership Performance was signifi-cantly related to its underlying factor, and all standardized item loadings were well above the cutoff of .50, supporting validity.

Overall, the measurement of constructs in the model can be regarded as valid and reliable.

Finally, the interrelations between latent variables were examined to test the estab-lished hypotheses. Each of them deals with the question of how an independent variable affects a dependent variable and if and how mediating processes are involved in which an independent variable affects a second (mediating) variable that, in turn, affects the dependent variable.

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Results

General

Table 1 presents the correlations between the identified factors and control variables. Since not all questions in the data pool were based on a 7-point Likert scale, the factors were standardized and therefore have a mean of 0 and standard deviation of 1. The highest correla-tion is between IOR trust and Opportunistic Behavior (=-.676, p<.005). This was expected since one of the characteristics of trust is the absence of opportunistic behavior. The second highest correlation shows between Opportunistic Behavior and Partnership Performance (=.508, p.005). It is interesting to find that Contract Complexity and Opportunistic Behavior share a positive relationship (=.347, p<.005) since contracts are often used to prevent such behavior.

The values on the diagonal main axis are the square roots of AVE (Average Variance Extracted) of the constructs (1 for control variables), while the other values in the table are correlations with the other constructs and the control variables. The Fornell-Larcker criterion requires that all AVE values be larger than any correlation value in the respective row or col-umn (Yaqub, 2013).

The table also shows that only two of the control variables share a significant correla-tion with any of the constructs in the model: Company Size is positively correlated with Con-tract Complexity (=.347, p<.001) and Previous Partnership History is positively correlated with Interorganizational Commitment (=.328, p<.001). These results do not surprise since one can easily imagine that larger firms put more effort into drafting longer and more complex contracts than smaller companies, and that companies with a longer history of mutual collab-oration continue their alliance with more commitment than companies that work together for the first time.

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Hypotheses

Hypothesis 1. Even though a U-shaped relationship between Contract Complexity and

IOR Trust was assumed in Hypothesis 1a, the data showed no evidence of such a relationship. The Pearson correlation coefficient was calculated and yielded a non-significant value of .113 which can be either due to a non-linear relationship or no relationship at all. This relationship was further evaluated by examining the scatter plot of the variables. This showed no sign of a turning point in the data, rather a random distribution of values. Finally, linearity was tested by applying the linearity test implemented in the SPSS procedure MEANS. The test showed a significance value of p = .618 which indicates that there is no linear relationship between the variables. The final test of deviation from linearity showed a value of p = .338, meaning there is also no non-linear relationship.

These test results led to Hypothesis 1a being rejected as there was no sign of a U-shape relation between Contract Complexity and IOR Trust. It is surprising that the data does not show much of a relationship at all. This could, however, be a result of the limited data pool that does not cover the whole spectrum of interfirm relationships. The extent of the complexity of a contract in interorganizational relationships is predominantly determined by the negotia-tion partners who may agree that there needs to be a contract for safeguard and coordinanegotia-tion but who stop short of going beyond the “safety threshold” (Cuganesan, 2007, p.109) where formal control and trust become substitutes.

Since it seems that there is no empirical reason to believe that any form of relationship in the data set is more likely than any other, it can be assumed that all alternatives are equally probable. Therefore, a linear relationship between the two constructs was assumed to allow for testing of the subsequent hypotheses.

Next, regression analysis was conducted to test Hypothesis 1. Therefore, the relation-ships between the different factors were tested in sequence to gain insights on the overall me-diating relationship.

For Hypothesis 1, the simple regression between Contract Complexity and IOR Trust shows a regression weight of a1 = -0.113 which is not significant (p = 0.374). The variance explained is estimated by R2_{to be a very modest 1.3%; F is not significant. Already this result} shows that there is likely no mediation of IOR Trust on the relation between Contract Com-plexity and Partnership Performance. Mediation only makes sense if Contract ComCom-plexity af-fects IOR Trust.

Step 2 of the mediation analysis showed in a multiple regression that the mediator IOR Trust was significant (b1 = 0.552, p = 0.000), and that Contract Complexity was also a signif-icant predictor of Partnership Performance (c’1 = -0.194, p = 0.022).

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The mediated, ‘indirect effect’ is given by a1*b1 = 0.113 * 0.522 = 0.062 or by c1 – c’1 = -0.256 - (-0.194) = 0.062). Given the complexity of the calculation and the stringent normality assumption, confidence intervals for the indirect effect were determined using the bootstrap method which showed that the indirect effect is barely significant.

Table 3 and Figure 6 summarize the findings, trust on partnership performance being the only significant relation.

Table 2: Regression Results H1

Paths Effects No control Controlled Δ Effect Δ R²

CC->IORT a1 -.113 -.192 -0,079 R² .013 .054 .041 F .799 1.212 IORT->PP b1 .552 ** .577 ** 0,025 CC->PP c'1 Direct -.194 * -.182 * 0,012 R² .367 .413 .046 F 9.756 ** 4.840 ** CC->IORT->PP c1=a1*b1 Indirect -.062 * -.111 -0,049 1 CC->PP c'i+ci Total -.256 * -.293 ** -0,037 R² .066 .098 .032 F 6.722 * 1.759

* Significance level of 0.05 (2-tailed); ** Significance level of 0.01 (2-tailed)

1_{no R}2_{, F and level of significance can be calculated for the indirect effect;}

significance was determined by bootstrapping

Including the control variables into the model showed two notable changes. First, the total effect of Contract Complexity on Partnership Performance increased by almost 15% and significance also increased. This is mainly due to the positive effect of Previous Partnership History. Second, the indirect effect increased but was no longer significant. However, this effect was barely significant before. This is because of the increase of the effect of Contract Complexity on IOR Trust which remained insignificant.

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Figure 6: Summary H1

Hypothesis 2. The test results for Hypothesis 2 mostly support the assumptions made

as all effects except the direct one of Contract Complexity on performance are significant (see Table 4 and Figure 7). Interestingly, Contract Complexity shows a significant positive rela-tionship with opportunistic behavior even though contracts are usually meant to curb Oppor-tunistic Behavior, indicating that there may be a non-linear relationship. However, as already discussed, this was not supported. The results strongly suggest that companies who employ long, elaborate and complex contracts should seriously consider simplifying them.

The direct effect of opportunistic behavior on partnership performance is negative as expected. The indirect effect and the total effect are also negative and significant, leaving sup-port for the hypothesis that Contract Complexity has a negative effect on partnership perfor-mance, mediated by opportunistic behavior. The simple regression of Contract Complexity on Partnership Performance, ignoring the mediator, representing the ‘total effect’, showed the same results as in Hypothesis 1.

85.9% of the total effect is explained by the indirect effect alone meaning that Oppor-tunistic Behavior almost completely mediates the total effect of Contract Complexity on Part-nership Performance (sometimes called full mediation, however, it is almost exclusively exe-cuted via the mediator.

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21 Table 3: Regression Results H2

CC->OB a2 .350 ** .414 ** 0,064 R² .122 .150 .028 F 10.296 ** 4.439 ** OB->PP b2 -.628 ** -.650 ** -0,022 CC->PP c'2 Direct -.037 -.023 0,014 R² .412 .458 .046 F 10.761 ** 4.776 ** CC->OB->PP c2=a2*b2 Indirect -.220 * -.269 * -0,049 1 CC->PP c2+c2 Total -.256 * -.293 ** -0,037 R² .066 .098 .032 F 6.722 * 1.759

With the control variables included, all effects were stronger but the direct ef-fect of Contract Complexity on Partnership Performance remained insignificant. The control variables improved model specification by raising R2 as well as the indirect effect, which is close to ideal total mediation with 91.8%.

Since the data showed that Opportunistic Behavior mediates the relationship between Contract Complexity and Partnership Performance, Hypothesis 2 is accepted.

The effects are summarized in Figure 7.

Hypothesis 3. For Hypothesis 3, all relationships turned out to be significant. The

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share positive relationships and that Interorganizational Commitment mediates the relation-ship between the other two variables. However, just 22.5% of the total effect is explained by the indirect effect, meaning that Interorganizational Commitment only partially mediates the total effect of IOR Trust on Partnership Performance.

Table 4: Regression Results H3

IORT->C a3 .331 * .392 ** 0,061 R² .110 .267 .157 F 5.393 * 4.657 ** C->PP b3 .390 ** .359 ** -0,031 IORT->PP c'3 Direct .445 ** .466 ** 0,021 R² .465 .481 .016 F 14.123 ** 7.239 ** IORT->C->PP c3=a3*b3 Indirect .129 * .141 * 0,012 1 IORT->PP c'3+c3 Total .574 ** .606 ** 0,032 R² .329 .386 .057 F 14.721 ** 5.015 **

The inclusion of the control variables led to more accurate results. Especially the effect of IOR Trust on Commitment increased both in strength and significance. Commitment is also better explained and the effect of IOR Trust on Partnership Performance increased. R2_-values also increased and the indirect effect represents a bigger part of the total effect. The explana-tion from the indirect effect marginally rose to 23.3%.

Hypothesis 3 is therefore accepted. The results are summarized in Figure 8.

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To summarize the interim results, the analysis showed that

• there is a small but significant negative relationship between Contract Complexity and Partnership Performance, which however is not exerted directly but almost fully through the mediator Opportunistic Behavior, and

• IOR Trust does not serve as a mediator between Contract Complexity and Partnership Performance, and that

• there is a strong significant relationship between IOR Trust and Partnership Perfor-mance, mediated by Interorganizational Commitment.

Hypothesis 4. Because of the results of the first hypotheses, the overall model was

modified to test a serial mediation of opportunistic behavior and commitment in the relation-ship between Contract Complexity and Partnerrelation-ship Performance.

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24 Table 5: Regression Results H4

CC->OB a2; a4.1 .350 ** .414 ** 0,064 R² .122 .150 .028 F 10.296 ** 4.439 ** OB->C d4.1 -.409 ** -.471 ** -0,062 CC>C a4.2 -.072 .041 0,113 R² .193 .325 .132 F 4.932 ** 4.147 ** OB>PP b4.1 -.498 ** -.513 ** -0,015 C->PP b4.2 .318 ** .293 ** -0,025 CC->PP c'4 Direct -.014 -.036 -0,022 R² .494 .516 .022 F 12.243 ** 9.261 **

CC>OB>C>PP c4 Total indir. -.238 * -.257 * -0,019

1

CC->PP c'i+ci Total -.256 * -.293 ** -0,037

R² .066 .098 .032

F 6.722 * 1.759

* Significance level of 0.05 (2-tailed); ** Significance level of 0.01 (2-tailed) 1 no R2_{, F and level of significance can be calculated for the indirect effect;}

With the control variables in hypothesis 4, the effect of Opportunistic Behavior on Interorganizational Commitment increased considerably as well as the related R2_{-value. The} effect of Interorganizational Commitment on Partnership performance decreased. It makes sense that Previous Partnership History directly increases commitment to proven partnerships and indirectly causes that problematic partnerships are not renewed.

87.7% of the total effect is now explained by the total indirect effect (compared to 91.8% in Hypothesis 2) meaning that Opportunistic Behavior together with Interorganiza-tional Commitment almost exclusively mediate the total effect of Contract Complexity on Partnership Performance.

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25 The results are summarized below:

Because the focus of the analysis was on the effects of the different constructs in the mediation analysis, the results for the control variables have not been reported in the preceding tables. Summarizing the results, it showed that for the sub-models covering hypothesis 1 and 2 the set of control variables did not have significant relationships with any of the dependent variables in the model (PP, IOR Trust, Commitment, and PP). For hypotheses 3 and 4, how-ever, the control variables had a significant positive impact on Interorganizational Commit-ment and Partnership Performance.

In the regression between IOR Trust and Partnership Performance, the explained vari-ance R2 for the control variables accounted for only 7% of the total explained varivari-ance when IOR Trust was also included in the model. For the other two regressions, this proportion was at 43.8% (IORT → C) and 36% (OB, CC → C) respectively. The latter results stand for the strong impact of Previous Partnership History on Commitment since the significance of the control variables was almost exclusively exerted by the prior cooperation experience.

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Discussion

Interpretation

The research question that this study aimed to answer was how the contents and com-plexity of a contract in interfirm relationships affect trust and opportunistic behavior between the partners and how this ultimately influences the performance achieved in the partnership. This was achieved since the implications of the research outcomes can be interpreted to bring new insights into the debate about the relationships between control, trust, opportunistic be-havior, and performance.

The first finding of this study is the relationship between a contract and the trust present in an interfirm partnership. The argument brought forward by Dekker (2004) that the relation-ship between formal control and trust may be U-shaped was not supported in the data. The absence of this relationship may be because short and simple contracts do not entail low trust and that both partners are careful to avoid overcomplicated contracts, leading to the fact that these extreme cases do not exist in practice. This is in line with Dekker’s observation that “partners will not unnecessarily use expensive, formal control mechanisms and in addition risk damaging the quality of their relationship” (2004, p.34).

Secondly, the test of a direct relationship between Contract Complexity and Perfor-mance showed that Contract Complexity has a small but significant effect. This does not match with contract theory arguments (Chen, 2000; Klein Woolthuis et al., 2002) and specifically with de Jong and Klein Woolthuis (2004) who could not find empirical evidence of a relation-ship, but rather no relationship.

As a third finding, there was no relationship between trust and control through a con-tract as instead, the test of Hypothesis 1 showed that trust itself has a highly significant effect on performance, rather than in combination with a contract. This supports the view that trust and control are two conceptually different and empirically separate constructs with no direct interaction. They both affect performance in partnerships but do this in their own ways, sug-gesting that control and trust seem to follow this pattern.

Following this, the fourth finding of the study is that IOR Trust showed a highly sig-nificant effect on Partnership Performance which is in line with empirical results from Zaheer et al. (1998). However, there was no indirect effect from Contract Complexity with IOR Trust as a mediator. This also supports the idea of control and trust being two separate constructs.

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nificant. Interestingly however, contract complexity seems to be connected to a higher expec-tation of opportunistic behavior which, in turn, decreases performance. This is surprising as a more complex and extensive contract is meant to do the exact opposite and lower the likeli-hood of opportunistic behavior (Cao & Lumineau, 2015). However, already Cao and Lu-mineau found no significant effect of contracts on opportunism (Cao & LuLu-mineau, 2015). The significant relationship revealed in this study could be explained in that a more complex con-tract could actually be more difficult to understand properly, leading to a higher risk of oppor-tunistic behavior. Including control variables in the model made this relationship even clearer.

Sixth, testing the third hypothesis showed that trust both directly and indirectly affects partnership performance through commitment. The highly significant results proved that trust increases the success in interfirm partnerships by increasing the commitment of both partners, implying that firms and managers are more willing to invest into business relationships in which they can trust their partners. However, it also shows that trust on its own raises perfor-mance. In fact, the indirect effect mediated by commitment accounts for only 23.3% of the total effect. This means that partnerships function better when there is a high level of trust in general. The results confirm empirical findings by (Vivek & Richey, 2013; Zaheer et al., 1998) and the correlation between the two constructs even fits with a value of .574 “within the range of .34 and .65 reported in prior studies” (Krishnan et al., 2006, p.900).

Lastly, testing of Hypothesis 4 showed that contract complexity increases opportunistic behavior which, in turn, decreased the commitment to the relationship, which again exerts its curbs the overall negative effect on performance. This result was in line with other empirical research (Wang & Yang, 2013) which showed that partners are more hesitant towards investing into a partnership if there is a risk of opportunistic behavior.

In short, the test results showed that contract complexity has a significant but small effect on the experienced performance in an interfirm partnership. On its own, it does not seem to play a major role in affecting partnership performance, but rather causes changes in ex-pected opportunistic behavior, as well as the level of commitment that in turn was proven to affect performance. Despite of the statistically verified relationship between a contract and partnership performance, the idea that softer factors of relational governance seem to play a more important role in managing interfirm relationships than formal controls is supported. The results also suggest that trust seems to play a somewhat separate role in the trust-control-per-formance universe. In summary, Hypotheses 2 and 4 offer two statistically almost equivalent approaches to explain these cross-linked relations and calls for further theoretical and empiri-cal work.

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commitment to make the alliance work given the trust among partners” (Kale et al., 2002, p.749).

In short, the results from testing the overall research model showed that contract com-plexity does not influence the experienced performance in an interfirm partnership directly. Contract complexity alone does not seem to play a major role in affecting partnership perfor-mance, but rather causes changes in expected opportunistic behavior, as well as the level of commitment that in turn was proved to affect performance.

Managerial and Theoretical Implications

One of the goals of this study was to identify factors to which managers should pay attention to improve interfirm relationships and partnership performance in which they are involved. The results of the analysis had interesting results regarding this goal.

The lack of an effect of contract complexity on the amount of trust, and an indirect effect on partnership performance by extension, indicates that a first glance may suggest that managers do not need to worry too much about the complexity of a contract jeopardizing trust in an interfirm relationship altogether. It instead implies that trust is a separate critical and possibly even more important factor in the trust-control-performance universe that is built by other means which could possibly include different parts of relational signaling. Since the study also confirmed that trust facilitates commitment to the relationship, leading to better performance, it seems that managers should focus on this aspect that builds trust on the side of their partners.

On the other hand, the analysis showed that a complex contract does not fulfill its intended role of mitigating opportunistic behavior perfectly, but may rather increase it, leading to a negative effect on performance. Actors in interfirm relationships should therefore limit the complexity of contracts to curb opportunistic behavior of their partners. According to this study, this also enables higher levels of commitment and overall better performance.

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Contract complexity at high levels may cause opportunistic behavior to occur more often. This is a previously undiscovered relation and gives opportunity to research more ex-tensively.

Limitations and Further Research

For all the findings this study provided, there are also several limitations. One of these is the relatively small data pool with only 74 usable data entries. A larger sample would im-prove the precision of estimates, the significance of test results, and could reinforce the new-found insights and lead to more generally transferable results. This concern of generalizability carries over in the fact that the study is primarily focused on European firms. Data collection should therefore be extended to a more international sample.

Another limitation of the study is that, while some assumptions and relationships be-tween constructs could be rejected, there are other factors in interfirm partnerships that were not considered and could be included into models of future research. This applies to different types of trust and their effect in similar models as well as other contract characteristics.

Furthermore, the unexpected positive relationship between contract complexity and opportunistic behavior should be studied more deeply to give an explanation of why these constructs show this behavior.

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The Effect of Contracts and Trust on Partnership Performance