Contracts as Organization : Designing Flexible Formalization

The design of a proper formalization of economic relationships, through contractual and non-contractual documents, and its interaction with informal governance, is a re-emerging issue in organization theory. In fact it is of considerable importance in an era of increasing uncertainty and risk, where protection from hazards and coordination power on one side, but also flexibility on the other, are needed. A common way of framing and solving the problem has been to consider those needs as contrasting requirements affecting the effective degree of formalization. Integrating organization theory with contract theory this study shows that a better solution exists. Uncertainty changes the nature rather than the degree of effective formalization: ‘constitutional’ agreements (including decision, exit and property rights) can and should be more specified, rather than less, as uncertainty and conflict potential grow; while the detail of ‘operational’ agreements is the kind of formalization that is at odd with uncertainty. Survey-data analyses of the formal documents regulating 440 inter-organizational projects in different countries and sectors are presented, corroborating the main hypothesis and suggesting interesting refinements also on the other commonly used predictors of formalization (size/complexity of activities, partner irreplaceability and the longevity of relationships)