| Abstract: | Selecting the type of contract is an important aspect of governinginterfirm transactions. The purpose of this article is to examinethe use of fixed-fee and time-and-materials (T&M, or cost-plus)contracts and a hybrid contract that consists of a T&M contractwith a cap. In addition to uncertainty and measurement factors,we also address a relatively unexplored aspect of contracting—howthe prior relationship between the firms influences the typeof contract the firms select. Using data on 394 contracts fromthe information technology (IT) services industry, we show thatT&M contracts are preferred when the cost of measuring qualityex post is high and when it is difficult to estimate costs exante. We also find site-specific measures of relationship leadto a preference for low-powered T&M contracts. |
