Governing Public Service Procurement Contracts: An Empirical Test of Transaction Cost Economics and Institutional Theory

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1 Governing Public Service Procurement Contracts: An Empirical Test of Transaction Cost Economics and Institutional Theory Roar Jakobsen, PhD student Norwegian School of Economics and Business Administration Department of Strategy and Management Phone: Abstract The purpose of this study is to test transaction cost economics against institutional theory. Therefore, this study used transaction cost economics and institutional theory as two different lenses to understand factors affecting relationship governance and relationship outcomes. A conceptual model of relationship governance was outlined and tested empirically on a large sample of public service procurement contracts in Norway, Sweden and Denmark. From the perspective of transaction cost economics, the results showed that asset specificity have positive effects on formal contracts and relational contracts. Furthermore, from the perspective of institutional theory, the results showed that bureaucratic pressure also have positive effect on formal contracts and relational contracts. These findings indicate that actors in such buyer-seller relationships both rely on efficiency concerns and legitimacy concerns. Transaction cost economics explain how contracts are used to safeguard transaction specific investments in order to obtain efficiency in such relationships. Institutional theory explains how contracts are used to obtain legitimacy when bureaucratic pressure is presence. Relationship outcomes were also explicitly investigated in this study. The results show that formal contracts have no direct effect on relationship outcomes, but that relational norms have strong positive effect on cost reduction outcomes and service enhancement outcomes. 1. Introduction A common framework for analyzing governance structures in interorganizational relationships is transaction cost economics (Williamson, 1979; 1985). According to transaction cost economics, the principal governance problem is to implement a governance structure that provides sufficient safeguarding to secure the return of investments in asset specificity (Buvik and Haugland, 2005, p. 42). Formal contracting is therefore viewed as the primary mechanism to safeguard these investments. Another framework for analyzing governance structures is relational exchange theory Macneil, 1978; 1980). Relational exchange theory identify the shortcomings of legal contracts for governing modern exchange, and explain why relations between firms tend to be more informal than would be expected by classical contract theory. Relational exchange theory predicts that the establishment of relational norms will function as a supportive safeguarding mechanism that harmonizes conflicts and solves

2 strategic dependence. A large body of empirical studies within this contractual perspective has verified that relation specific investments are an important antecedent to relationship governance. The first purpose of this paper is to investigate how asset specificity influences relationship governance in public service procurement contracts. Do these hypotheses outlined in transaction cost economics explain relationship governance as expected in such buyer-supplier relationships? A large body of empirical research has verified these hypotheses in business-to-business relations and distribution channels within private sector. But few tests have been done within the setting of service industry and the setting of public procurement. There is a call for papers testing transaction cost economics within these settings. The second purpose of this study is to investigate how institutional pressure influence relationship governance and relationship outcomes in public service procurement contracts. Do institutional pressures matter in such buyer-supplier relationships? Institutional theory highlights the importance of the wider social and cultural environment as the ground in which organizations are rooted (Scott, 1995). The key idea behind institutionalization is that much organizational action reflects a pattern of doing things that evolves over time and becomes legitimated within an organization and an environment (Pfeffer, 1982). Institutional theory is focusing on the external pressures from stakeholders in the social and economic environment and their influence on organizational behavior. Scott (1995) has outlined a framework to understand which different institutional forces may affect an organization. In this paper we focus on bureaucratic pressure. This kind of isomorphic pressure is related to the expectation that public administrations shall adopt bureaucratic forms with higher levels of impersonalism. Within public institutional theory, there exist several contributions that have explanations for why public managers are often drawn to bureaucratic forms and processes (see for example Pressman and Wildawsky, 1973). Wilson (1989) proposes for example that formalization can be simple response to uncertainty and external pressure, and the need to symbolize control, oversight and accountability. Despite extensive research and important progress within institutional theory, researchers have not paid much attention to the influences of institutional pressure on relationship governance (Grewal and Dharwadkar 2002). There is a call for papers addressing this question in the literature. This paper is outlined as follows. First, I will present the theoretical perspectives used in this study, primarily drawn on transaction cost economics and institutional theory. I will argue that asset specificity, formal contracts and relational norms are important construct related to efficiency concerns in buyer-supplier relationships. Furthermore, I will argue that bureaucratic pressures are an important determinant related to legitimacy concerns in such relationships. I will develop a conceptual model based on these constructs and outline and formulate a number of hypotheses. Next, I will describe the chosen research methodology and give a short presentation of empirical setting and

3 measures. Then I will present the empirical results. Finally, I will discus some of the findings and implications. 2. Theory and hypotheses 2.1 Transaction cost theory 2.2 Institutional theory 2.3 Hypotheses H 1: Asset specificity will have a positive effect on formal contracts. H 2: Asset specificity will have a positive effect on relational contracts. H 3: Bureaucratic pressure will have a positive effect on formal contracts. H 4: Bureaucratic pressure will have a positive effect on relational contracts. H 5: Formal contracts will have a positive effect on relationship outcomes. H 6: Relational contracts will have a positive effect on relationship outcomes. 3. Research method 3.1 Context, sampling and data collection The hypotheses were tested in the empirical context of public service procurement contracts in Norwegian, Swedish and Danish municipals. The units of analysis were buyer-supplier relationships, and data was collected from the buyer s side of the relationships. No complete lists of public procurement contracts exist. Therefore, official lists were used to track representative municipals and to recruit key informants who were involved in purchasing activities related to (1) road maintenance services, (2) recycling and waste collection services, (3) elderly care and health services, (4) cleaning services, or (5) information technology services. These services were selected partly because they represent the most common services contracted in Nordic municipals and partly because they are assumed to give variance on the antecedent variables in the study. The final questionnaire was mailed as electronic survey to 975 key informants. Total 310 completed answers were returned. In Appendix 1 this number is braked down for each country and each type of service. The total response rate is 32%, which is satisfactory compared to other large scale electronic surveys. The key informants were asked to choose the third most important purchasing relationship for the municipal within the selected service. The purpose of this was to secure that the key informants not were selecting only the most successful buyer-supplier relationships. 3.2 Measures Most of the scales in this study were based on previously empirical studies within business-tobusiness marketing and interorganizational research. The constructs of bureaucratic pressure was

4 developed as new scales based on in depth interviews with procurement managers in government organizations. The questionnaire was translated to Norwegian, Swedish and Danish languages. Formal contracts. Formal contracts were measured as the buyer s perceived degree to which the relationship was regulated by detailed obligations, responsibilities and procedures. The construct is reflected by two dimensions; (i) specification of roles and responsibilities and (ii) specification of adaptations to change. Relational contracts. Relational contracts were measured as the buyer s perceived degree to which the actors share expectations about behavior to make changes in the relationship as new contingencies occur. The construct is reflected by three dimensions; (i) norms of solidarity, (ii) norms of flexibility and (iii) norms of information exchange. Asset specificity. Supplier asset specificity was measured as the buyer s perceived degree to which the private service supplier had made specific investments dedicated to the relationship with the municipal organization as buyer. Cost reduction outcomes. Cost reduction outcomes were measured as the buyer s perceived degree to which the municipal organization have gained cost reduction benefits in the services delivered from the supplier. Service enhancement outcomes. Service enhancement outcomes were measured as the buyer s perceived degree to which the municipal organization have gained service enhancement benefits in the services delivered from the supplier. Bureaucratic pressure. Bureaucratic pressure was measured as the buyer s perceived degree to which the municipal as a buyer organization perceive pressure in the environment to behave in a saklig, klare regler, full konroll, skriftlig dokumentasjon, ikke påvirket av personlige relasjoner in relation to their purchasing activities. Following variables were included as control variables in this study; buyer asset specificity, environmental uncertainty, technological uncertainty, performance ambiguity, centralization, longevity of the relationship, size, value, contracting experience, and prize pressure. 4. Analysis This chapter contains the analysis conducted in the study. In section 4.1, the descriptive statistics for the variables are evaluated. Then, in section 4.2, the measurement model is established and evaluated. Finally, section 4.3 the structural relationship between the constructs are examined. The hypotheses were tested by structural equation modeling analysis (LISREL 8.71).

5 Asset specificity 0.26*** Formal contracts 0.08 / *** 0.35*** Relationship outcomes cost reduction / service enhancement Bureaucratic pressure 0.21** Relational norms 0.65*** / 0.56*** Significance levels: t>1.96: p<0.05*; t>2.58: p<0.01**; t>3.29: p<0.001*** Goodness-of-fit indices: X 2 =2230 (df=1530); RMSEA=0.038; CFI=0.96; SRMR=0.054; CN=211; PNFI= Discussion and implications REFERANSER APPENDIX Appendix 3: Measures of constructs Cost reduction outcomes Four-item, seven point scale, anchored by very poor description and very good description. Samarbeidet med denne leverandøren har gjort det mulig for oss å være fleksible og raskt kunne omstille oss til endringer i tjenestebehov. Samarbeidet med denne leverandøren har gjort det mulig for oss å etablere mer effektive rutiner og prosedyrer for utførelsen av de aktuelle tjenestene. Samarbeidet med denne leverandøren har gjort det mulig for oss å komme nærmere beste praksis innen tjenesteområdet. Samarbeidet med denne leverandøren har gjort det mulig for oss å redusere omfanget av ulønnsomme aktiviteter i tjenesteområdet. Service enhancement outcomes Four-item, seven point scale, anchored by very poor description and very good description. Samarbeidet med denne leverandøren har gjort det mulig for oss å heve kvalitetsnivået på de aktuelle tjenestene. Samarbeidet med denne leverandøren har gjort det mulig for oss å tilpasse de aktuelle tjenestene bedre til brukernes behov. Samarbeidet med denne leverandøren har gjort det mulig for oss å forbedre brukernes helhetlige inntrykk av disse tjenestene. Samarbeidet med denne leverandøren har gjort det mulig for oss å utvikle et tjenestenivå som overgår brukernes forventninger. Formal contracts Six-item (two-dimensional second order construct) seven point scale, anchored by very poor description and very good description. Formal Role Vi har en detaljert kontraktsmessig avtale med denne leverandøren.

6 Vår kontrakt eller avtale sier klart hva hver av partene skal bidra med. Det er utviklet regler og retningslinjer for de fleste aktiviteter i dette leverandørforholdet. Det er uttrykt i en skriftlig avtale hvordan den daglige styringen skal foregå. Formal Adaptation Vår kontrakt eller avtale sier klart hva de juridiske konsekvensene er av å ikke holde seg til avtalen. Vår kontrakt eller avtale sier klart hva som vil skje dersom noe uforutsett skjer. Vår kontrakt eller avtale sier klart hvordan uenighet mellom partene skal håndteres. Relational norms Ten-item (three-dimensional second order construct) seven point scale, anchored by very poor description and very good description. Solidarity Begge parter ser det som viktig at det gjøres forbedringer som gagner forholdet som helhet. Partene betrakter løsning av problemer som oppstår partene imellom som felles ansvar. Forholdet mellom partene kan bedre beskrives som et samarbeidspreget forhold enn en avstandspreget forhandling. Begge parter tar ansvar for at dette forholdet fungerer for begge to. Flexibility Dette forholdet er preget av fleksibilitet når den andre parten ønsker endringer i noe. Når noe uforutsett skjer, vil partene heller justere avtalen enn å tvinge hverandre til å overholde betingelsene i den gamle avtalen. For å være i stand til å håndtere skiftende omstendigheter, forventer begge parter at det kan gjøres tilpasninger i forholdet etter hvert. Information exchange I dette forholdet er det forventet at informasjon som kan gagne den andre parten vil bli formidlet til dem. I dette skjer utveksling av informasjon ofte og uformelt, og ikke bare i henhold til avtaler inngått på forhånd. Det forventes at vi holder hverandre informert om hendelser eller endringer som kan ha konsekvenser for den andre parten. Asset specificity Five-item, seven point scale, anchored by very poor description and very good description. Denne leverandøren har gjort betydelige interne tilpasninger i sin organisasjon for å arbeide effektivt med vår organisasjon. Denne leverandøren har gitt spesiell opplæring til ansatte som arbeider med vår organisasjon. Denne leverandøren har brukt mye tid på å sette seg inn i ulike sider ved vår organisasjons virksomhet. Denne leverandøren har gjennomført betydelige investeringer i i utstyr og/eller anlegg for å tilpasse seg innkjøpsbehovene i vår organisasjon. Denne leverandøren har i stor grad tilpasset sine oppfølgings- og rapporteringssystemer til vår organisasjon. Bureaucratic pressure Five-item, seven point scale, anchored by very poor description and very good description. Vi opplever sterke forventninger til oss om å sikre at alle våre beslutninger knyttet til innkjøp og leverandøroppfølging utelukkende er basert på saklighet og likebehandling Vi opplever sterke forventninger til oss om å styre våre forhold til eksterne tjenesteleverandører ved hjelp av så klare regler som mulig. Vi opplever sterke forventninger til oss om å ha full kontroll og oversikt over våre tjenesteinnkjøp. Vi opplever sterke forventninger til oss om å sikre at alle forhold knyttet til våre innkjøpsavtaler er skriftlig dokumentert. Vi opplever sterke forventninger til oss om å sikre at beslutninger knyttet til våre anskaffelser ikke blir påvirket av personlige relasjoner mellom partene.