Selecting the type of contract is an important aspect of governing interfirm transactions. The purpose of this article is to examine the use of fixed-fee and time-and-materials (T&M, or cost-plus) contracts and a hybrid contract that consists of a T&M contract with a cap. In addition to uncertainty and measurement factors, we also address a relatively unexplored aspect of contracting - how the prior relationship between the firms influences the type of contract the firms select. Using data on 394 contracts from the information technology (IT) services industry, we show that T&M contracts are preferred when the cost of measuring quality ex post is high and when it is difficult to estimate costs ex ante. We also find site-specific measures of relationship lead to a preference for tow-powered T&M contracts.
Kalnins, A., & Mayer, K. J. (2004). Relationships and hybrid contracts: An analysis of contract choice in information technology [Electronic version]. Retrieved [insert date], from Cornell University, School of Hotel Administration site: http://scholarship.sha.cornell.edu/articles/658/