Contractual Flexibility, Rent Seeking, and Renegotiation Design: An Empirical Analysis of Information Technology Outsourcing Contracts

Abstract

This paper examines renegotiation design in contracts for outsourced information technology (IT) services. Whereas prior literature in information systems has highlighted the likelihood of ex post rent seeking engendered by renegotiation, we build upon literature on incomplete contracts to posit that renegotiation can be Pareto improving by incorporating contingencies revealed ex post. Research on contract renegotiation has been hampered by two sets of challenges: the lack of appropriate data and empirical challenges in identification. We circumvent this problem both by appropriate data collection and by employing an identification strategy to address alternate causal explanations. We propose a measure, Pareto improving amendments, to assess renegotiation outcomes that enhance the value from outsourcing by hazard equilibration and by incorporating learning. Using a unique sample of 141 IT outsourcing contracts, we examine the role of decision rights delineated ex ante in enabling Pareto improving amendments and in resolving the trade-off between adaptation and rent seeking. We find that flexibility provisions, termination for convenience rights, and contractual rights whereby vendors are granted rights to reuse know-how are associated with Pareto improving amendments. The results are robust to potential endogeneity of contractual provisions when parties have feasible foresight and to the possibility of adverse selection in the sample. We also examine alternate explanations from the literature on contractual breach. Implications for practitioners and researchers are discussed. This paper was accepted by Sandra Slaughter, information systems.

Social Capital and Contract Duration in Buyer-Supplier Networks for Information Technology Outsourcing

“…Positional embeddedness also conveys centrality or prestige to nodes with which no direct ties exist due to the fact that the centrality of each node is not only a function of its connected ties but also of remote ties separated by a few other nodes. Mani et al 2010, Susarla 2012. Prior literature has demonstrated that reputation mechanisms are not very effective in the IT services sector (Banerjee and Duflo 2000).…”

“…When vendors anticipate bargaining over ex post surplus, they are reluctant to invest in noncontractible, client-specific investments (Klein et al 1978). With complexity and uncertainty in exchange conditions, vendor firms, who commit to exchange terms over a long horizon, are unlikely to adapt to disturbances, thereby, leading to maladaptation and dissipation of gains from outsourcing (Susarla 2012). The danger then is that the services delivered through the outsourcing initiative could be out of step with changing business objectives of the client organization (Susarla 2012).…”

“…With complexity and uncertainty in exchange conditions, vendor firms, who commit to exchange terms over a long horizon, are unlikely to adapt to disturbances, thereby, leading to maladaptation and dissipation of gains from outsourcing (Susarla 2012). The danger then is that the services delivered through the outsourcing initiative could be out of step with changing business objectives of the client organization (Susarla 2012). For instance, the client may be locked into high prices that do not reflect the lower prices of inputs such as hardware and data storage or may be locked into performance benchmarks that do not reflect the changing value of underlying technologies.…”

“…A long-term contract with a vendor minimizes the costs of transitioning and service disruption (Goo et al 2007). The difficulty with structuring long-term contracts for IT outsourcing, however, is the threat of vendor lock-in and inflexibility (e.g., Susarla 2012). Considering the salience of the phenomenon, there is comparatively limited guidance in the literature on how duration is awarded in contracts for IT outsourcing.…”

Contracting in Medical Equipment Maintenance Services: An Empirical Investigation

“…Particularly, papers on service contracts appear to focus more on projectbased services-e.g. IT software development (Banerjee and Duflo 2000, Gopal et al 2003, Kalnins and Mayer 2004, Susarla et al 2010, Susarla 2012, and offshore drilling (Corts and Singh 2004). The one-off relationship framed around a project that characterizes projectbased services differs significantly from the dynamics of repeated interactions found in the maintenance industry.…”