Week 7 – Susarla 2012 – Joe

Anjana Susarla, (2012) Contractual Flexibility, Rent Seeking, and Renegotiation Design: An Empirical Analysis of Information Technology Outsourcing Contracts. Management Science 58(7):1388-1407.

Although a substantial body of research recognizes that contracting for information technology (IT) services is inevitably incomplete. Since traditional complex IT outsourcing deals require long-term contracts, renegotiation design plays a more crucial role compared with that rent-seeking in other industries. However, two empirical challenges hampered the deeper exploration: the lack of appropriate data and the lack of rigorous identification strategy. The author addressed the gap by using a unique sample of 141 IT outsourcing contracts and by measuring the renegotiation decision results via Pareto improving amendments.

To get a deep insight into the renegotiation, the author examined the role of decision rights delineated ex-ante in enabling Pareto improving amendments and in resolving the trade-off between adaptation and rent seeking. To address the endogeneity of the relationship between ex-ante decision rights and Pareto improving amendments, she used a contract date prior to 2000 (coded as a binary variable) as an instrumental variable that affects the presence of flexibility provisions. The results show 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 the feasible foresight and to the possibility of adverse selection in the sample.

This work contributes to the literature by empirically showing the role of renegotiation design in fostering flexibility in IT outsourcing and by highlighting the nature of investments in the IT context and the implications for renegotiation design. A complementary approach is to examine the role of relational contracting that enables joint governance and resolution procedures.