The Development of Asymmetric Contracting Capabilities : Exploring the Effect on Contract Design

I augment transaction cost economics and the learning to contract perspective by outlining the effect of asymmetric contracting capabilities on contract design and governance structure. According to the learning to contract literature, parties in contractual relationships adopt a governance structure that economizes on transaction costs, and then over time learn to govern relationships in a more efficient manner, thereby further reducing transaction costs. I argue that this perspective on contracting and governance should be supplemented with the notion that firms in contractual relationships are likely to develop asymmetrical contracting capabilities because of differential initial endowments and learning speed. As a result, the contract regulating the relationship is designed in a way that is expected to benefit the party with stronger contracting capability by allowing it to include contractual terms that externalize costs and internalize revenues. This shift in the expected distribution of payoffs between the contracting parties shapes the parties’ preferences over different contractual forms in ways presently not addressed in transaction cost economics and the learning to contract literature. A potentially counterintuitive implication is that repeated interaction and strong learning dynamics may lead to reduced incentive alignment and trust between the contracting parties