Collaboration, Innovation, and Contract Design

The rise of the network as a form of economic organization renders problematic our standard understanding of how capitalism is governed. As the governance of production shifts from vertical integration to horizontal contract, a puzzle arises: how do contracts, presumed to be susceptible to hold-up problems due to incompleteness, control production arrangements that by their nature invite opportunism? Relying on publicly-available contracts taken from a number of industries, I argue that firms govern their collaborations through a number of new contract mechanisms, the summation of which is a novel governance system. Because traditional theories of contractual control struggle to fully explain this new behavior, I re-conceptualize contracting as an effort, inter alia, to establish a pragmatic learning process between collaborators. Such a learning process must be formally instituted among parties because of the unique, endogenous, and pervasive uncertainty that characterizes bilateral experimentation. Thus, to standard accounts of incomplete contracting, this article provides an alternative (but complementary) explanation of how contract governs inter-firm networks, not by downplaying the importance of hold-ups or by inflating the role of relational norms but by explicating a new positive theory of contract design