Contractual Governance, Business Groups and Transition

We suggest a unified framework to explain the following stylized pattern in the development of contractual governance and industrial organization. Contractual governance in many emerging economies is characterized by relational contracting. Coincident with relational contracts are large, diversified organizations - often referred to as business groups. As institutions and market intermediaries develop, a process of transition from relational contracting to arms-length explicit contracting takes place. During this phase relational and explicit contracts complement each other. Business groups initially expand in size, scope and increase the strength of ties. As development proceeds, a threshold is crossed after which business groups begin to unravel. This process of transition in contractual governance is often accompanied by a period of rapid growth, which eventually comes to a stop