Do Formal Contracts and Relational Governance Function As Substitutes or Complements?

While transaction cost economists have generally argued that hazardous exchange conditions warrant complex contracts or vertical integration, other scholars have argued that trust or relational forms of governance effectively support exchange. These scholars view relational governance as a substitute for complex, explicit contracts. Indeed, some have suggested that contracts directly undermine the evolution of trust in exchanges. We advance and empirically test the alternative argument that formal contracts and relational governance are complements. Rather than hindering or replacing relational governance, contracts may promote the formation of long-term, trusting exchange relations. Using data from a sample of exchanges in information services, we find empirical support for the proposed complementary relationship.