Paper presented at the EMNet 2011
December 1 to 3, 2011, Limassol, Cyprus
(http://emnet.univie.ac.at/)

EVOLVING FUNCTIONS OF INTERORGANIZATIONAL GOVERNANCE MECHANISMS

José M. Sánchez *
Universidad de Cádiz
Dpto. Organización de Empresas
Gta. Carlos Cano s/n
11002 Cádiz (Spain)
T. +34 956015455
F. +34 956015402
e-mail: / María L. Vélez
Universidad de Cádiz
Dpto. Economía financiera
Gta. Carlos Cano s/n
11002 Cádiz (Spain)
T. +34 956015435
e-mail: / Concha Álvarez-Dardet Universidad Pablo de Olavide Dpto. Dirección Empresas
Ctra. Utrera, km. 1
41013 Sevilla (Spain)
T. +34 954349357
e-mail:

* Corresponding author

This research was partly financed by the research project SEJ-5061 from Andalucia government.

ABSTRACT

Through a longitudinal case study, this article examines the evolution of the twofold function of formal governance mechanisms, for control and coordination, as an interorganizational relationship between supplier and distributors evolves. We ask whether all formal governance tools develop simultaneously, or whether each mechanism is designed and used for only one function; whether different mechanisms’ attributes foster one function rather than the other; and whether different mechanisms are developed over time in order to provoke both functions’ evolution. Finally, we explore whether the IOR evolution in part explains the evolution of the two functions, or vice versa. We find that in this case the various formal governance mechanisms were developed sequentially over time; that each of them could be used for both control and coordination, although from the supplier’s perspective certain tools had dominant functions; and that as a suite the mechanisms evolved over time from more a more coercive toward a more enabling character.

Key words: interorganizational governance, coordination, control

1. INTRODUCTION

There is a considerable body of research on the governance of interorganizational relationships (IORs) among nonintegrated firms (Hendrikse and Windsperger, 2009). Studies (e.g., Noordewier et al., 1990; Celly and Frazier, 1996; Vlaar et al., 2007; Mellewigt et al., 2007) argue that there are two main reasons why partners in IORs draw up interorganizational formal governance (IFG) mechanisms: control and coordination. Mellewigt and colleagues (2007) propose to analyze through a longitudinal study whether contracts serve more as safeguards in the initial stages and subsequently evolve toward a coordinating function as a relationship develops. But contracts are only a part of IFG mechanisms, and because in real life contracts are incomplete, they need to be complemented by other control systems (Gulati and Singh, 1998; Baiman and Rajan, 2002). Managers combine different mechanisms to govern IORs (Baiman and Rajan, 2002); thus, studying only a specific mechanism in isolation from other parts of the IFG system may show only partial results.

In this paper we study how the control and coordination functions of IFG mechanisms evolve, emphasizing the relationship between these two functions and IOR evolution. This project contributes to the related literature in several ways. First, we widen our study to include IFG mechanisms beyond the contract: a commission system, shared software, shared information, an evaluation system, and an operational manual. This allows us to analyze whether all IFG mechanisms develop both functions simultaneously, or whether each mechanism is designed and used for only one function. Second, we keep in mind that different mechanisms that make up the IFG system can have different attributes. Adler and Borys (1996) argued that there are two types of formalization—enabling vs. coercive—and analyzed their characteristics (internal transparency, global transparency, flexibility, and repair), the design process, and implementation differences. Applying this framework allows us to study whether mechanisms’ attributes foster one function rather than the other. Third, through a longitudinal case study, we analyze whether different mechanisms are developed over time to complete the contract. In fact, new IFG mechanisms can change the balance between the two key functions either by being used predominantly for one of them rather than the other, or by causing a decrease in the use of other mechanisms. Finally, following the proposal of Mellewigt, Madhok, and Weibel (2007), we explore whether the evolution of the IOR partly explains the evolution of both functions, or vice versa.

For the most part, research in this area has been conducted at the level of the dyad; we examine a larger group: a marketing channel. A marketing channel can be understood as a nonequity and open-ended IOR in which a set of smaller downstream distributors assumes part of the value chain functions from a bigger upstream manufacturer (Stern et al., 1996). Marketing channels are vertical and asymmetrical, with a dominant firm determining the terms of the nonownership contractual arrangement (Lassar and Kerr, 1996; Frazier, 1999).

IORs are developed and maintained over time, requiring the use of longitudinal research designs. We study a long period, from 1985 to the present, from both sides of the relationship. From the supplier side, the controlling firm unilaterally developed a set of IFG mechanisms in order to increase the likelihood of attaining its objectives. From the distributors’ side, controlled firms used IFG mechanisms to facilitate better-informed decision-making.

2. THE STRUCTURE AND NATURE OF INTERORGANIZATIONAL FORMAL GOVERNANCE FUNCTIONS

One important decision that executives make when forming an IOR is allocating duties, risks, procedures, and so on through contractual provisions, which determine exchanges in more precise terms (Ariño and Reuer, 2004; Mellewigt et al., 2007). These contractual terms try to help firms devise remedies for foreseeable contingencies or design processes for unforeseeable outcomes, protecting each firm against self-interested behaviors by the other party. Moreover, contracts clarify mutual expectations, enable goal congruence, and establish common ground. In order to manage their IORs, firms have a range of contractual options available (Lassar and Kerr, 1996).

However, even if the partners clearly understand their relationship’s objective and their mutual interests, it is not feasible to design a contract that anticipates all possible eventualities, no matter how complex the contract may be (Ariño and Reuer, 2004). In real settings, complex and complete contracts are impossible to define because of ex ante contingencies and ex post renegotiations (Gietzmann, 1996; Gulati and Singh, 1998). Furthermore, when a contract becomes excessively detailed, it will be inflexible (Poppo and Zenger, 2002). Thus, researchers often describe interfirm contracts as incomplete (Baiman and Rajan, 2002), pointing out that it may be impossible to envisage all future contingencies, or may be costly or impossible to account for them in the contract, so contracts never fully reflect working relationships (Gietzmann, 1996). Sometimes contracts are merely legal bases on which long-term relationships can be built.[1] Since self-interest makes partners likely to take advantage of any loopholes (Geyskens et al., 2006), there are authors who maintain that contracts should be complemented by other control mechanisms to mitigate the inefficiency of incomplete contracts (Baiman and Rajan, 2002; Langfield-Smith, 2008). Firms can choose a set of governance mechanisms shaping their IFG.

IFG mechanisms are generally understood as formal (written and standardized) procedures and statements used by managers to monitor and influence the behavior and activities in an IOR. IFG mechanisms include contracts, organizational structures, performance measures, administrative controls, and operational procedures, among others. They can play a vital role in creating a range of acceptable behaviors, performance expectations, and dispute resolution mechanisms, and also in facilitating knowledge transfer and structuring communication flows. To prevent IORs from failing, IFGs have to realize a twofold goal: control the risks of opportunistic behaviors, and coordinate activities and resources across firms (Mitchell et al., 2002; Gulati et al., 2005; Vlaar et al., 2007; Mellewigt et al., 2007). However, as Hendrikse and Windsperger (2009) note, the large majority of governance studies focus on mitigating the risks of opportunistic behavior.

The conventional view held by users of agency theory and transaction cost economics is that in an exchange relationship, agents tend to behave opportunistically, prompting the principal to adopt mechanisms for curbing such opportunism. Opportunistic behavior can arise from several sources, even in the absence of specific assets. A firm can misrepresent its capabilities or resources during the selection process, and/or during the relationship it can fail to contribute what it promised or can misapply the resources it gains from the relationship. IFG mechanisms can assert control, provide monitoring, and align incentives (Gulati and Singh, 1998), and thus mitigate agency problems. In this control function, IFG mechanisms try to motivate the partners to achieve desirable outcomes, inciting the agents to adopt the behavior required, and/or dissuading them from adopting others.

From the resource-based perspective, an IOR enables firms, in their quest for competitive advantage, to attain, through sharing and combining their resources, some beneficial outcome that they could not attain on their own (Mellewigt et al., 2006), even without the threat of partners’ opportunistic behavior. IORs entail mutual dependence, because tasks decomposed among partners need coordination and therefore communication and joint decision-making. As the tasks become more interdependent and more uncertain, this need increases (Gulati and Singh, 1998). Pooling resources, dividing labor across partners, and subsequently integrating the dispersed activities are critical to the generation of value in an IOR (Mitchell et al., 2002). Accomplishing this coordination requires developing complex linkages between different and interdependent task units (Mayer and Argyres, 2004). From the perspective of the resource-based view, as coordinating devices (Mellewigt et al., 2006), IFG offer the proper information flow between each partner firm, enabling goal congruence, and establishing common ground.

Some authors, like Dekker (2004), maintain that each mechanism is used simultaneously for both functions: “A contract is not only used to reduce a partner’s incentives to behave opportunistically, but in addition serves as a framework for coordination in which the cooperation proceeds. And a joint venture’s administrative hierarchy not only coordinates the joint venture’s day to day functioning and addresses problems as they arise; simultaneously it is used to detect opportunism when it occurs” (2004:31). However, other authors, like Hendrikse and Windsperger (2009), seem to indicate that each function will have specific mechanisms: “Situations with a joint interest problem require coordination by some mechanism, whereas situations with conflicting interests require alignment of incentives (by allocating ownership, control, and income rights) to a certain extent” (2009:3).

We must bear in mind that different tools that make up the IFG can have different attributes that may determine whether a given mechanism is used for both functions simultaneously, or whether different mechanisms suit each specific function. Adler and Borys (1996) argued that there are two types of formalization—enabling vs. coercive. Table 1 summarizes their framework. Any IFG mechanism can be categorized on the enabling vs. coercive continuum, because formalization is a continuous variable with a zone of indifference. Enabling tools provide detailed, objective, accurate information; build connections among people and business units, giving people a sense of the whole; and facilitate analysis and what-if thinking. Adler and Borys propose that enabling formalization provides needed guidance and clarifies responsibilities, helping individuals be and feel more effective. We may add that these characteristics favor coordination, and vice versa. Thus it is possible to determine which function each IFG mechanism serves by analyzing its characteristics as enabling or coercive.

RQ 1. Do mechanisms’ characteristics indicate their main function for control vs. coordination purposes?

-- Table 1 here --

Negotiating and forming an IOR initiates a dynamic relationship that must evolve if it is to be successful (Inkpen and Curral, 2004; Doz, 1996; Ariño and de la Torre, 1998; Ring and Van de Ven, 1994; Inkpen and Curral, 2004). Interorganizational governance is not static (Vlaar et al., 2007). During the relationship, managers wish to bring about changes in the coordination and control mechanisms that they adopt (Bijlsma-Frankema and Costa, 2005). Chenhall (2003) argued that control systems that are valid today might lose validity as they evolve through time, and recent research calls for further studies on IFG evolution.

As a logical extension of our first research question, we focus on the dynamics of the twofold IFG function, and its potential association with IOR evolution over time. The arguments above suggest that different mechanisms are developed over time, completing the contract, and that this development can change both functions and rebalance them. According to Baiman and Rajan (2002), IFGs may facilitate new interfirm arrangements. Thus it is arguable that the evolution of the IOR is rooted in the evolution of the two functions. In contrast, Mellewigt et al. (2007) propose that the twofold function may vary over the life cycle of an IOR, the primary driver being the level of trust. It could well be that IFGs serve more of a safeguarding function in the initial stages of a relationship and subsequently evolve toward a coordinating function. These contrasting arguments open our second research question, about what leads to what:

RQ 2. Could the evolution of IORs be explained by / explain the evolution of control and coordination functions?

3. CASE STUDY RESEARCH

In this paper we have adopted an exploratory longitudinal case study approach (Yin, 1984) to grasp the dynamics and complexities of IORs. We examined the distribution channel of a supplier that has externalized its distribution functions, offering partners a consignment contract, a geographical area, and a client portfolio. As a part of a bigger research project, our nonrandom choice of this IOR was influenced by several factors (Eisenhardt, 1989). First, the IOR is consolidated, longstanding, and stable. In 2010, over 95 percent of the distributors had been part of the relationship for over two decades. Second, this IOR is high performing: in 2010, the supplier’s return on investment ratio from its IOR was 3.8 times higher than from direct sales. Third, this IOR is long term and open ended. During the period of study (1985-present), the supplier progressively introduced several IFG mechanisms to manage the relationship, making observable the differences between IFG functions.

3.1. Research design and data sources

For proper triangulation (Eisenhardt, 1989) we obtained information from published sources, internal documents, direct observations, and interviews. Archival data dating back to 1985 included governance and financial documents; partners’ contracts; journals, norms, and procedures; materials and slides used in meetings; and computer reports. These data allowed us to identify the progression, objectives, and content of IFG mechanisms, and to confirm what we learned from interviews.