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Exchange hazards, relational reliability, and contracts in China: The contingent role of legal enforceability

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Abstract

Building on institutional and transaction cost economics, this article proposes that legal enforceability increases the use of contract over relational reliability (e.g., beliefs that the other party acts in a non-opportunistic manner) to safeguard market exchanges characterized by non-trivial hazards. The results of 399 buyer–supplier exchanges in China show that: (1) when managers perceive that the legal system can protect their firm's interests, they tend to use explicit contracts rather than relational reliability to safeguard transactions involving risks (i.e., asset specificity, environmental uncertainty, and behavioral uncertainty); and (2) when managers do not perceive the legal system as credible, they are less likely to use contracts, and instead rely on relational reliability to safeguard transactions associated with specialized assets and environmental uncertainty, but not those involving behavioral uncertainty. We further find that legal enforceability does not moderate the effect of relational reliability on contracts, but does weaken the effect of contracts on relational reliability. These results endorse the importance of prior experience (e.g., relational reliability) in supporting the use of explicit contracts, and alternatively suggest that, under conditions of greater legal enforceability, the contract signals less regarding one's intention to be trustworthy but more about the efficacy of sanctions.

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Notes

  1. We acknowledge Professor Alain Verbeke for the specific term “relational reliability”, commonly referred to as “trust”. Some researchers posit that relational reliability is a more meaningful and useful concept than the term “trust” to characterize business relationships (Verbeke & Greidanus 2009; see also Williamson, 1996).

  2. This example is based on the information the authors obtained from field interviews with senior managers in China.

  3. There are a variety of informal governance mechanisms, such as reputation, bonds, network ties, and professional pressures (Verbeke, 2003). This study focuses on relational reliability, because it reflects the relational quality of informal mechanisms (Poppo et al., 2008; Uzzi, 1997), is linked to trust, a focal governance mechanism for research on interorganizational exchanges (Zaheer & Harris, 2005), and as such is theorized as an alternative to or substitute for formal governance mechanisms (e.g., contracts, vertical integration) (see Dyer & Singh, 1998; Peng, 2003; Poppo & Zenger, 2002).

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Acknowledgements

Kevin Zhou and Laura Poppo contributed equally to this paper. The authors thank Joe Mahoney, seminar participants at University of Kansas, University of Illinois, Monterrey Institute of Technology, the three anonymous reviewers, and Editors Professor Charles Galunic and Professor Alain Verbeke, for their insightful and constructive comments. This study was supported by a grant from the Research Grants Council, Hong Kong SAR Government.

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Authors and Affiliations

  1. School of Business, University of Hong Kong, Pokfulam, Hong Kong

    Kevin Zheng Zhou

  2. School of Business, University of Kansas, Lawrence, USA

    Laura Poppo

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  1. Kevin Zheng Zhou
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  2. Laura Poppo
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Correspondence to Laura Poppo.

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Accepted by Alain Verbeke, Area Editor, 22 December 2009. This paper has been with the authors for four revisions.

APPENDIX

APPENDIX

See Table A1.

Table a1 Measurement items and validity assessmenta
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Zhou, K., Poppo, L. Exchange hazards, relational reliability, and contracts in China: The contingent role of legal enforceability. J Int Bus Stud 41, 861–881 (2010). https://doi.org/10.1057/jibs.2010.7

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