Ex ante governance decisions in inter-organizational relationships: A case study in the airline industry

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Abstract

This paper discusses the theory behind ex ante governance decisions in inter-organizational relationships and uses an explanatory case study involving an inter-firm relationship between two European airlines to empirically assess the theoretical propositions. The case study complements existing literature by providing a comprehensive explanation of opportunism-based ex ante governance decisions. It deconstructs opportunism, links such behavior to unique governance responses and discusses the ex post effects of ex ante governance decisions in light of the necessary development of trust and relational governance mechanisms. In this context, it also takes account of differences in bargaining power between the two partners and examines the “control strategy” employed by the dominant partner. The paper offers further insights into the influence of bargaining power on governance decisions by illustrating how cooperating partners can address ex ante power differences. An interesting finding from this case study is the fact that the more powerful of the two partners deliberately relinquished the advantages associated with its ex ante privileged position. It accepted a governance structure that virtually equalized positions to motivate its weaker partner to participate and stimulate the development of trust.

Introduction

Previous research discusses opportunism as a serious management problem with practical implications for inter-organizational relationships (IORs, e.g. Brown et al., 2000, Oxley, 1997, Stump and Heide, 1996, Wathne and Heide, 2000). If there is a (potential) risk of opportunism in an IOR, significant resources must be invested in the ex ante governance design, because opportunistic behavior is “individually rational yet produces a collectively suboptimal outcome” (Parkhe, 1993, p. 794). Consequently, ex ante governance decisions are of considerable importance in successful IOR management (e.g. Dekker, 2004, Ittner et al., 1999, Kumar and Seth, 1998, Van der Meer-Kooistra and Vosselman, 2000). When considering such decisions in IORs, two main ex ante approaches can be identified: (1) selecting the “right” partner (particularly with regard to trust) and (2) safeguarding the relationship through a sound formal governance structure (e.g. Celly and Frazier, 1996, Das and Teng, 1998, Dekker, 2004, Emsley and Kidon, 2007, Ireland et al., 2002, Van der Meer-Kooistra and Vosselman, 2000). Such structures define contractual responsibilities and formal organizational mechanisms frequently divided into behavior and outcome control mechanisms, whereby the behavior or outcome is pre-specified and monitored ex post (Ouchi, 1979). Yet, when considering potential opportunism in IORs as a governance issue, recent literature has focused primarily on the hold-up problem encountered in transaction cost economics (TCE, e.g. Dekker, 2004, Langfield-Smith and Smith, 2003, Oxley, 1997). In doing so, it analyzes how appropriation concerns regarding specific investments can serve to explain ex ante governance decisions.

This article's contribution to existing research is twofold: it offers a comprehensive explanation of the complex phenomenon of opportunism in ex ante governance decisions and, at the same time, it takes asymmetric bargaining power into account in such decisions.

When defining opportunism, Williamson (1985, p. 47) states: “By opportunism I mean self-interest seeking with guile. This includes but is scarcely limited to more blatant forms, such as lying, stealing and cheating. Opportunism more often involves subtle forms of deceit. […]. More generally, opportunism refers to the incomplete or distorted disclosure of information, especially to calculated efforts to mislead, distort, obfuscate, or otherwise confuse.” By this definition, opportunistic behavior includes various kinds of ex ante deliberate misrepresentation at the initiation stage and various forms of (active or passive) ex post violation of formal contracts and/or exploitation of vulnerabilities when the IOR is in place (Wathne and Heide, 2000, p. 39). Appropriating the quasi rents from specific investments described in the hold-up problem is one example of opportunism. Another is the deliberate misrepresentation of a firm's true attributes prior to the signing of a contract, i.e. pre contract hidden information (Arrow, 1985). A further example is the ex post shirking on quality/effort or information known as hidden action and ex post hidden information (Holmström, 1982). These kinds of behavior often come together. However, shirking on action and/or information can also be a rational strategy without either partner making substantial specific investments (Barney and Hesterly, 1996). Thus, although these kinds of opportunism might not always be interpreted as distinct manifestations of opportunistic behavior, this can vary and different governance mechanisms are needed to safeguard the IOR. Consequently, this article examines opportunistic behavior with relation to hold-up, hidden action and hidden information situations in IORs (see e.g. Bai et al., 2004, Barney and Hesterly, 1996) and provides examples of the unique ex ante governance modes required to safeguard such relationships. It also distinguishes between ex ante governance decisions and their anticipated ex post effects (Puranam and Vanneste, 2009, Williamson, 1985, Williamson, 1991a), in particular the development of ex post trust and relational governance mechanisms.

This article also contributes to research by taking asymmetric bargaining power into account in ex ante governance decisions. This is particularly important given the central role accorded to opportunism in power theories (Barney and Hesterly, 1996). Although literature considers bargaining power to be a control issue in IORs, few studies actually analyze it in an IOR governance context (see recently e.g. Donanda and Nogatchewsky, 2006). The literature does, however, indicate different factors that affect bargaining power, i.e. the level of dependency on the relationship or its outcome, the availability of alternatives, and the possession or control of critical resources (Yan and Gray, 1994).

There are numerous, even conflicting, predictions regarding bargaining power and control. Approaches here include: a focus on the dependency that results from asymmetric specific investments (Donanda and Nogatchewsky, 2006), a straightforward relationship between power and control (Yan and Gray, 1994) or the use of bargaining power itself as a governance device alongside trust and formal safeguards (Alvarez et al., 2003). One question appears to have not yet been addressed in any depth in the available literature, namely how a dominant partner applies its bargaining power in ex ante governance decisions when trust is a key issue.

In short, this paper seeks firstly to explain how ex ante governance decisions in IORs can be reasoned by deconstructing opportunism and considering their ex post impact on the development of trust and relational mechanisms. It then describes how asymmetric bargaining power can influence these decisions paying particular attention to how the dominant partner applies its bargaining power to create and promote a relationship of trust. For this purpose, the paper develops a framework for ex ante governance decisions in IORs which deconstructs opportunism, incorporates the distinct formal governance mechanisms and partner selection, examines the ex post effects of such decisions on trust and relational governance mechanisms and discusses the impact of asymmetric bargaining power.

The explanatory power of this framework is then empirically assessed using an IOR between two European airlines. Numerous authors emphasize that opportunism is a crucial problem, particularly when competitors enter into an IOR (e.g. Bucklin and Sengupta, 1993, Park and Russo, 1996). These particular airlines are competitors and are also very different in terms of size and market power, thus raising the risk of opportunism and creating asymmetric bargaining power. Consequently, this case study offers a suitable empirical base for assessing the theoretical insights (Siggelkow, 2007) and permits an in-depth analysis of the data (the main advantage of case-based research; see Eisenhardt and Graebner, 2007).

The following section elaborates the theoretical framework, Section 3 presents the case study, while Section 4 provides conclusions and implications for further research.

Section snippets

Deconstructing opportunism in IORs

Transaction cost economics provides the basis for research into opportunism and governance decisions in IORs. In TCE terminology, transaction-specific investments in a world of incomplete contracts generate the safeguarding problem known as the hold-up problem (Williamson, 1985). Specific investments have less value outside a specific transaction than they do have in it. This difference is referred to as quasi rent. In an IOR context, examples of such investments might be the development of

Research design and methodology

This case study illustrates a bilateral IOR between two European airlines. The empirical data for the case study was gathered primarily through oral interviews and from written documents. There was also a considerable amount of less formal communication (e-mail, telephone and meetings) with some representatives of the firms. All data was collected between May 2005 and May 2006. The research began with preliminary meetings at company A, which provided background information on the companies, the

Conclusion and implications

By taking an explanatory approach to the ex ante governance decisions in an IOR between two airlines, this article contributes to the debate on IOR governance design. The results indicate that important insights into governance decisions and, thus, into the relationship between formal safeguarding mechanisms and trust, are gained by taking different kinds of opportunistic behavior, asymmetric bargaining power and the ex post effects of ex ante governance decisions simultaneously into account,

Acknowledgements

I gratefully appreciate the efforts of the Editor in Chief, Robert W. Scapens, and two anonymous reviewers in helping me develop this work and for their guidance and encouragement throughout the review process. I also thank the participants at the two case companies for their generous provision of time and data, particularly my main contact at company A, who actively and continuously supported this research from start to finish.

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