Relational Contracts, Competition and Innovation: Theory and Evidence from German Car Manufacturers

Using unique data from buyer-supplier relationships in the German automotive industry, we unveil a puzzle by which more trust in a relationship is associated with higher idiosyncratic investment, but also more competition. We develop a theoretical model of repeated procurement with non-contractible, buyer-specifi c investments rationalizing both observations. Against the idea that competition erodes rents needed to build trust and sustain relationships, we infer that trust and competition tend to go hand in hand. In our setting trust and rents from reduced supplier competition behave like substitutes, rather than complements as typically understood.