Strategic Management Journal
Strat. Mgmt. J., 23: 707–725 (2002) Published online 1 May 2002 in Wiley InterScience (www.interscience.wiley.com). DOI: 10.1002/smj.249

DO FORMAL CONTRACTS AND RELATIONAL GOVERNANCE FUNCTION AS SUBSTITUTES OR COMPLEMENTS?
LAURA POPPO1 * and TODD ZENGER2
1 2

Pamplin College of Business, Virginia Tech, Blacksburg, Virginia, U.S.A. John M. Olin School of Business, Washington University, St Louis, Missouri, U.S.A.

Relational exchange arrangements supported by trust are commonly viewed as substitutes for complex contracts in interorganizational exchanges. Many argue that formal contracts actually undermine trust and thereby encourage the opportunistic behavior they are designed to discourage. In this paper, we develop and test an alternative perspective: that formal contracts and relational governance function as complements. Using data from a sample of information service exchanges, we find empirical support for this proposition of complementarity. Managers appear to couple their increasingly customized contracts with high levels of relational governance (and vice versa). Moreover, this interdependence underlies their ability to generate improvements in exchange performance. Our results concerning the determinants of these governance choices show their distinct origins, which further augments their complementarity in practice. Copyright  2002 John Wiley & Sons, Ltd.

Transaction cost economics (TCE) has emerged as a common framework for understanding how managers craft governance arrangements. The general proposition of this literature is that managers align the governance features of interorganizational relationships to match known exchange hazards, particularly those associated with specialized asset investments, difficult performance measurement, or uncertainty (Williamson, 1985, 1991). In response to exchange hazards, managers may