Select Page

Post a cohesive response based on scenario provided. To prepare for discussion read Learning Resource and your professional experience. Be sure to discuss the following: “See attachment for detailed instructions  

No plagiarism 
APA citing
Discussion: The Importance of Trust in Alliance Building
The importance of trust in all aspects of life is hard to overstate. Imagine a personal relationship in which trust is not present. In personal relationships, trust is usually gained over time, and becomes an unspoken, but essential, constant in successful relationships. This is also true of business relationships, and it is advisable for potential alliance partners to actively employ measures to build and strengthen trust. Negotiating written agreements that clarify the foundations of the relationships is paramount. As an HR professional, it is essential that you understand and practice the concepts underpinning the building of trust in business relationships.

In “How to Build a Framework for Strategic Alliances,” (Santora, 2009), in your Required Resources, the author focuses on the importance of trust in building alliances. On the other hand, in “Why Too Much Trust is Death to Innovation,” Bidault & Castello (2010), question whether there is actually such a thing as excessive trust in some alliances.

To prepare for this Discussion
,
Review this week’s Learning Resources, especially:
·
9 Challenges to Strategic Partnerships [INFOGRAPHIC] (powerlinx.com)

· Why Too Much Trust Is Death to Innovation – See pdf
· Human Resources – See pdf
· Understanding the Benefits – See pdf
· Maximizing Human Capital – See pdf
· TRUST AND COLLABORATION – See pdf

Assignment:

Post a cohesive and scholarly
response based on your readings and research this week that addresses the following:
Conduct additional research to evaluate the HR executive’s role in ensuring alliances built on trust and respond to the following questions, referring to your research and the Required Resources:
· What specific actions can an HR executive take to build trust with prospective alliance partners?
· Describe how HR executives can employ negotiation and conflict resolution skills to address areas of mistrust and increase trust in situations where there is a great strategic fit but high levels of mistrust.
· What would be your role as an HR executive in advising a CEO who seems determined to partner with a company you consider untrustworthy?
· No Plagiarism
· APA citing

CORPORATE GOVERNANCE

Human Resources and
Recruiting Management
By William Laurent

A
sk any employer, and he or she most likely
agrees with the ancient axiom “Good people are
difficult to find.” More than ever, global en-
terprises face an unprecedented degree of
competition in recruiting and hiring the best
candidates and talent at all levels of seniority.

Ironically, while the hiring and retention of quality person-
nel is critical to the growth and survival of 2 1 ” century
companies, the business processes and IT systems that sup-
port procurement and development of employees are often
ill conceived, poorly managed and devoid of value.

All too often, corporate HR offices lose control of the hir-
ing process without being aware of it. Despite the establishment
of an entrenched vendor list, senior and junior managers
from all business segments will have their own preferred ven-
dors, creating unlimited potential for conflicts of interest
and complicating the candidate search, recruitment and inter-
view processes for the organization. In large labor markets such
as London, New York, Hong Kong and Tokyo – where thou-
sands of recruitment and executive search agencies exist –
the problem can be compounded exponentially. And while many
large organizations have robust customer relationship man-
agement implementations that address and streamhne various
vendor management processes, there is inevitably a lack of ac-
tionable data captured and maintained by these systems that
will help recruitment firms and retained search firms add
maximum value to the hiring process lifecycle and become bet-
ter business partners.

In order to effectively manage vendors and have them be-
come true partners in the business, they must be held
accountable. This can only be accomplished by using per-
formance metrics that help both parties actively track and
comrhunicate issues in a timely manner. Without vendor key
performance indicators (KPIs), there can be no measurement
and thus no improvement. Businesses need to remember that
vendor lists are dynamic and subject to change. Data should
be accessible and help managers understand what vendors have
filled which requisitions, what the vendor’s commission fee was
and more. The value of having this sort of actionable knowl-
edge is rousing; in fact, the ROI on this data can be immediately
realized by using it to great advantage in the vendor-fee ne-
gotiating process. Just as sales and marketing departments are
always held accountable for their achievement via standard
qualitative and quantitative KPIs, so should an organization’s
vendors. According to Jason de Luca, senior managing partner
of Smart Partners, a Tokyo-based boutique consultancy, “Or-
ganizations are realizing that initial enterprise resource planning
projects have fallen short in terms of what is offered in the HR
space. Some of the more common performance metrics that
have been used internally need to be extended to vendors if they

are to add requisite value to the business.” Many recruiters
talk about how they add value, but few companies know if they
really are adding value because they don’t know how to
measure value externally; in fact, they are probably having quite
a few problems measuring it internally.

In addition to performance metrics for better vendor
accountability, another common problem is the monumen-
tal proliferation of candidates’ personal information, usually
in the form of resumes. Resumes contain a virtual treasure trove
of confidential information – a combination of personal and
professional facts that expose both the potential employee and
the corporation to unlimited risks. Far too often, a central-
ized repository or application to securely store and manage
this sort of information does not exist. Resumes freely get sent
in email attachments all around the organization and be-
tween the organization and its recruiting firms. Such practices
could spell disaster for all parties, and regulatory mandates
that aim to protect their citizens’ personal information are start-
ing to get tougher. Institutions across the world must now
balance the wealth of opportunities afforded to them by
their data assets with the risk that these data assets may be
compromised by numerous threats both internally and exter-
nally. Loosely structured data that resides on candidate
resumes is no exception.

Getting a handle on how the hiring function of the or-
ganization is running will always be a critical component of
fully understanding how the business is running as a whole.
However, employee hiring processes don’t usually get the
same amount of attention that is given to more strategic
customer-facing tasks or operational and sales processes.
Vendor management issues are commonly not transparent and
thus do not surface as obvious candidates for business process
reengineering, governance, best practices or system enhance-
ment. However, modern times necessitate that HR offices adopt
and foster a more proactive agenda in order to leapfrog
competitors in retaining and hiring staff. Likewise, executive
search firms, headhunters and recruiters of all stripes will find
themselves having to add measurable value to the recruiting
functions of their clients. Enterprises must do a better job work-
ing with their vendors to iteratively re-engineer recruiting
processes while mutually managing any associated risks.

A company’s most valuable assets are its people. For-
tune 500 companies allocate more than one-third of their
operating revenue – in remuneration, health care,
retirement/pension funds, training and additional programs
– on human capital. Prudent corporations don’t neglect to
extend governance and technology best practices to the
procurement of human capital. ®

William Laurent is a renoumed independent consultant in data, governance and
IT strategy. Please contact him at [email protected]

www.dmreview.com DM Review I June 2008 15

Maximizing Human Capital: Demonstrating HR
Value With Key Performance Indicators
Lockwood, Nancy R . HRMagazine ; Alexandria  Vol. 51, Iss. 9,  (Sep 2006): S1-S11.

ProQuest document link

ABSTRACT
To drive value and optimize company performance, human capital-the collective knowledge, skills and abilities of

people that contribute to organizational success-is an asset to be leveraged. Based on corporate culture,

organizational values and strategic business goals and objectives, human capital measures indicate the health of

the organization. The effective use of key performance indicators (KPIs) that measure human capital outcomes,

such as talent management, employee engagement and high performance, illustrates the firm’s business, financial

and strategic goals, promotes partnership with senior management for organizational success and demonstrates

HR value to the C-suite. [PUBLICATION ABSTRACT]

FULL TEXT
 

Headnote

Abstract

To drive value and optimize company performance, human capital-the collective knowledge, skills and abilities of

people that contribute to organizational success-is an asset to be leveraged. Based on corporate culture,

organizational values and strategic business goals and objectives, human capital measures indicate the health of

the organization. The effective use of key performance indicators (KPIs) that measure human capital outcomes,

such as talent management, employee engagement and high performance, illustrates the firm’s business, financial

and strategic goals, promotes partnership with senior management for organizational success and demonstrates

HR value to the C-suite.

Introduction

“In order to fully value human capital, we must go beyond the view of human effort as purely individual. We,

humans, affect each other profoundly, and it is the way we affect each other that determines our value to our

organizations. And, it is the way that strategic human resource professionals bring this understanding to the fore

of their organizations that determines HR’s value at the senior management table.”1

In 1995, the seminal study by management guru Mark Huselid linked high-performance work practices with

company performance and revealed that workforce practices had an economic effect on employee outcomes such

as turnover and productivity, as well as on short- and long-term measures of corporate financial performance.2

This study marked a new era of measuring the influence of HR to promote effective organizational performance,

sustainability and financial success.

As HR positions itself as a strategic business partner, one of the most effective ways to do so is to support the

strategic business goals through key performance indicators. Key performance indicators (also known as KPIs)

are defined as quantifiable, specific measures of an organization’s performance in certain areas of its business.

https://www.proquest.com/trade-journals/maximizing-human-capital-demonstrating-hr-value/docview/205269574/se-2?accountid=14872

https://www.proquest.com/trade-journals/maximizing-human-capital-demonstrating-hr-value/docview/205269574/se-2?accountid=14872

The purpose of KPIs is to provide the company with quantifiable measurements of what is determined to be

important to the organization’s critical success factors and long-term business goals. Once uncovered and

properly analyzed, KPIs can be used to understand and improve organizational performance and overall success.3

Why Measure Human Capital?

The primary motivation to measure human capital is to improve the bottom line. To design better KPIs, it is

essential for HR to understand what is important to the business and what key business measures exist. In

addition, the drive to measure human capital reflects the change of role of human resources from administrative to

that of a strategic business partner. In general, human capital measurement is a measure of effective human

resource management.

Broadly stated, HR metrics measure efficiency (time and cost) and the effectiveness of certain activities. Yet

mastering human capital measures can be a very complex undertaking. Today, HR professionals are expanding the

“traditional” metrics, such as head count, time-to-fill and turnover, to KPIs that align with corporate objectives and

create greater stakeholder value. However, KPIs often demand large amounts of data and technological support. In

addition, the trial-and-error required to set appropriate and meaningful measures comes into play, as well as

patience and education of those involved. Yet despite these challenges, 84% of companies expect to increase the

application of human capital measures in the next few years.4

With a clear line of sight on workforce and organizational performance, effective use of KPIs also illustrates HR’s

in-depth understanding of the links to business success. KPIs help build the credibility of the HR department,

demonstrate HR value and foster respect and partnership with senior management and the C-suite. For example,

when an HR professional not only shows that a new recruiting program resulted in a lower time to fill positions in

the organization, but can also demonstrate that the program yielded an additional amount of revenue because

billable staff were able to start at client sites more quickly, he or she builds HR credibility. Credibility is increased

because HR is able to link HR activities to firm performance and communicate it in financial/business terms.

Additional critical reasons to measure human capital include steering human capital resource allocation, winning

business cases for human capital investment, tracking human capital activities to develop human capital

predictions, linking variable compensation to human capital best practices, delivering human capital information

required by law and providing investors with information on human capital performance. Some firms even use

KPIs to enhance their company image as a progressive employer of choice.5

Further, with many HR functions increasingly being outsourced, credibility is earned through activities and

outcomes that result in “deliverables” that promote and lead to organizational success.6 Consequently, it is

important to select KPIs that are most meaningful to the organization. For example, logical KPIs to select are

those that reflect drivers for human capital measurement, such as financial outcome measures (e.g., revenue

growth and cost reduction) and performance drivers (e.g., customer satisfaction, process technology innovation,

product technology innovation, globalization). Within that framework, the most common categories of people

measures include turnover, productivity (revenue, profit per employee), employee satisfaction/employee

engagement, recruitment, diversity, remuneration, competencies/training, leadership, and health and safety. Most

frequently measured are turnover, voluntary resignation, average compensation, average workforce age, diversity

and compensation/ total cost. Such KPIs will help HR professionals predict what they need to know to act in a

timely and effective manner and identify ideas and areas where HR can develop new initiatives, or revisit others, to

obtain stronger results.7 Clearly, KPIs are the wave of the future for HR.

Culture, Stakeholders and KPIs

As the saying goes, “what gets measured gets managed.” The company culture and corresponding values define

what is measured. Therefore, when HR considers important KPIs, the first place to look is at corporate culture and

what is most valued within that culture. In addition, stakeholders (both internal and external) go hand-in-hand with

company culture. A stakeholder is an individual or entity with a stake in how the organization performs and/or

conducts itself. Internal stakeholders are employees, line managers, senior management, C-suite and the board of

directors. External stakeholders include shareholders, customers, vendors, the community and the government.

Working closely with internal stakeholders is beneficial for HR to 1) prioritize capabilities and create action plans

to deliver them; 2) focus on deliverables rather than doables; 3) build relationships of trust; and 4) help resolve

misconceptions of HR.8 Different stakeholders have different criteria. The key priority is to give business partners

the information they need to manage the company. For example, senior management values performance

measures that predict and lead to future organizational financial success and sustainability. On the other hand,

while one employee considers the availability of upward career mobility very important, another employee stays for

health care benefits. As a result, training to promote opportunities to move up in the organization and

informational sessions about employee benefits packages may be important. Overall, most important are KPIs that

track key business indicators of human capital issues. HR must focus on KPIs that best illustrate stakeholder

values that will lead to organizational success.

KPIs-A Strategic Management Tool

To think strategically about measurement and how best to use KPIs as a strategic management tool, it is essential

to understand the meaning of the measurements and their purpose. This approach will not only be beneficial to

help better manage the HR function, but also will naturally lead to aligning HR’s goals and objectives with those of

the organization.9

According to a recent national longitudinal study on the assessment of human resource organizations, strategy is

the top high-value add for HR. However, in only 60% of companies did the HR executive see HR as a “full partner.”

In addition, 24% of executives outside of human resources viewed their HR counterparts as working at lower levels

of strategic involvement, compared with 40% of HR executives. The study suggests that activities related to

strategy provide the most highend impact for HR to demonstrate its value (see Figure 1). In addition, the

relationship between business strategy activities and HR’s strategic role points to areas where HR can contribute:

growth, the core business, quality and speed, informationbased strategies, knowledge-based strategies, and

organizational performance. The study data also reveal key strategic HR activities that link business emphases

with the organization’s strategic focus: 1) having a data-based talent strategy; 2) partnering with line managers to

develop business strategy; 3) providing analytic support for business decision-making; 4) providing HR data to

support change management; 5) driving change management; and 6) making rigorous data-based decisions about

human capital management.10 From these HR strategy activities, key performance indicators can be developed.

At the same time, when determining strategic KPIs, it is essential to consider who designs human capital

measures and how they are created. Research by The Conference Board reveals key contributors to these metrics.

Overall, HR designs 94% of human capital measures, often basing them on measures in the company scorecard.

To create human capital measures, 77% of HR professionals meet with company business managers. For example,

finance, strategic planning, outside consulting experts, business managers and IT contribute to HR measurement

design. However, if HR lacks expertise with metrics, it is helpful to partner with groups such as marketing that have

considerable expertise in measure design and analysis.11

Alignment of people metrics with organizational strategy is still at an early stage in many firms. To move human

capital investments forward, several key points will assist HR to better strategically align with organizational goals

and garner support for human capital programs: 1) involve HR in the development of overall business strategy; 2)

enlist leaders outside of HR to help develop and back KPIs; 3) collaborate with business managers to ensure KPIs

link to business unit strategic goals; 4) focus more attention on links between people measures and intermediate

performance drivers (e.g., customer satisfaction, innovation, engagement); 5) increase manager acceptance

through training programs and concrete action plans; and 6) work with HR to simplify metric and automate data

collection.12

In addition, benchmarking can make human capital metrics more valuable. When used wisely, benchmarking data

can protect programs that are performing well, create support for organizational change and help executives in HR

and other disciplines make strategic decisions that affect their organizations.13 By focusing on internal

benchmarks, customized measures may help improve the alignment of activities to HR strategy. However, caution

should be used with external benchmarks due to mixing “apples and oranges”-that is, different industry sectors

and underlying issues in benchmarking measures. Also, external benchmarks tend to emphasize results rather

than processes. Because an external benchmark does not explain what part of the process can lead to better

results, the use of external measures may not always be appropriate for internal use. In the rapid expansion of

highly advanced e-learning programs, for example, different programs may deliver the same content at the same

low cost, but the quality of the programs is not revealed in the benchmark itself.14

Overall, the top KPIs for human capital and HR effectiveness can be used by all companies, regardless of size or

industry. For example, the Hay Group found that the most admired companies had effective business practices in

the following areas: organizational culture, strategy implementation, attraction and retention of talent, leadership

development, fostering innovation, and performance management. Successful companies assess performance by

balancing profit measures with measures of shareholder value, customer satisfaction and employee

satisfaction.15 Keeping this research in the forefront will help HR develop effective and strategic KPIs for their

organizations.

The Importance of Lagging and Leading Indicators

The purpose of measuring KPIs and determining what leads and what lags is to help the business make

predictions. To demonstrate HR value with KPIs, it is imperative that HR has a working knowledge of lagging and

leading indicators. These terms describe data regarding outcomes and/or events that affect organizational

performance. Lagging and leading indicators offer a way to understand and/or predict various aspects of firm

performance. However, to identify and quantify these relationships, it is essential to know more than HR is a

leading variable and customer satisfaction is a lagging variable.16 To accurately gauge the relationship between

lagging and leading indicators, a sense of the magnitude of the time lag between changes in the leading indicator

and subsequent changes in the lagging indicator is required. (see Figure 2 for an example of lagging and leading

indicators, with turnover as the lagging indicator in response to selection and supervisory training, the leading

indicators.)

To be more specific, a lagging indicator represents information that is the result of change or an event. Lagging

indicators, for example, are measures of profits, sales and service levels. They reveal various aspects regarding the

success or failure of a firm. Lagging indicators are particularly useful for shareholders, creditors and government

agencies. Lagging indicators do not, however, help a company react quickly, show what specifically went wrong or

right, or indicate exactly what needs to be done to improve. In general, lagging indicators are not useful in

managing on a day-to-day basis.17

In contrast, a leading indicator precedes, anticipates, predicts or affects the future. For example, higher employee

turnover can precede outcomes such as lower customer service scores. Of the two indicators, the leading indicator

is more useful for investments or predictions. The state of the major stock markets, for example, is a leading

economic indicator for the global economy. Figuring out how to measure events, practices, initiatives or outcomes

helps to determine the most valuable leading indicators-that is, those indicators that may lead to clear

outcomes.18 However, part of the difficulty is clearly proving what indicators lead and with what degree of

influence. For example, while the availability of talent is generally thought of as a leading indicator-as one can

measure the quality of hire from it (the larger the talent pool, the more likely you are to hire more qualified people)-

it is also a lagging indicator in comparison to certain political decisions. For example, consider how changes in a

local taxation rate, perception of crime and ratings of school quality affect people’s desire to move to a city and

become part of the talent pool. Here, political decisions lead and talent availability lags. In general, the most useful

measures are leading indicators, as they may predict future firm performance.

Scorecards and Dashboards

In recent years, HR scorecards and dashboards have gained popularity as a management tool. Documenting and

tracking defined metrics validates human capital investments. For example, firms are increasingly tracking

employee movement as a metric. Cisco Systems, Inc., the Californiabased communications giant, views building

talent as a priority and has added to its dashboard of people measures a metric to track how many people move

and the reason why, including revenue per employee. This KPI allows Cisco executives to quickly identify divisions

that are creating new talent. Another firm, Valero Energy Corp. in San Antonio, developed a recruitment model

using human capital metrics based on applying the supply-chain business process to labor. Scorecards help the

company track the labor sources that provide the most productive employees. Using a detailed analysis of these

metrics, the company can accurately forecast the demand for talent by division and title three years in advance.19

The HR scorecard, based on the format of the balanced scorecard, is a key management tool to strengthen HP’s

strategic influence in the organization. The scorecard has four perspectives-strategic, operational, financial and

customer-that help organize and track areas where HR adds value: 1) the strategic perspective focuses on

measurements of effectiveness of major strategylinked people goals; 2) the operational perspective reflects the

effectiveness of HR processes; 3) the financial perspective relates to financial measures of HR value to the

organization; and 4) the customer perspective focuses on the effectiveness of HR from the internal customer

viewpoint. Depending on the organization’s business goals, these perspectives also help determine KPIs that best

demonstrate HR value (see Figure 3).20 Additional key benefits of the HR scorecard are 1) reinforcement of the

distinction between HR “doables” and HR “deliverables” (i.e., a policy implementation is a doable and becomes a

deliverable when it creates employee behaviors that drive strategy); 2) HR’s ability to control cost and create value;

3) measurement of leading indicators; 4) assessment of HR’s contribution to strategy implementation and to the

bottom line; 5) support of HR to manage its strategic responsibility; and 6) encouragement of flexibility and

change.21

KPIs and Employee Engagement

Employee engagement is quickly becoming a critical success factor for competitive advantage. Using KPIs, HR

can demonstrate organizational success as well as gain support for initiatives related to employee engagement.

Research studies offer evidence that employee engagement is key to organizational success. In the SHRM 2006

Job Satisfaction Survey Report, employees identified four key aspects of job satisfaction directly linked to

employee engagement: meaningfulness of job, contribution of employee’s work to the firm’s business goals, the

work itself and variety of work.22 Watson Wyatt’s research, The Human Capital ROI Study, reinforces the link

between employee engagement, reward systems and retaining valuable human capital.23 A Carlson/Gallup study

on employee engagement and business success shows that employees who are extremely satisfied at work are

four times more likely than dissatisfied employees to have a formal measurement process in place as well as

receive regular recognition. Further, 82% said recognition motivated them to improve job performance.24 Thus, as

these studies highlight, employee engagement-whether through job satisfaction indicators, reward systems,

effective communication programs or succession planning initiatives-has the power not only to clearly

demonstrate HR value, but more importantly, to propel human capital investment to the forefront of the C-suite

agenda.

KPIs for Organizations With Small HR Departments-Mini Case Study No. 1

Not all organizations have the luxury of a dedicated HR staff to develop, track and analyze HR metrics. When an

HR staff of a small organization has limited time to track all possible HR KPIs, careful choices must be made about

which KPIs best serve HR’s needs. This mini case study illustrates the types of KPIs selected and tracked by a

small HR staff supporting a workforce of 400 employees of a firm that sells and leases health care equipment to

hospitals. With only an HR director and HR assistant, this tiny HR department tracks human capital measures that

reflect the state of the organization, selecting KPIs based on metrics that best reflect the company’s culture and

strategic goals. In this company, certain KPIs are tracked throughout the year, while others (e.g., absenteeism) are

reviewed on a quarterly basis. Overall, the HR department benchmarks progress against prior years, with the gcal

that the employee cost tracks favorably against .revenue and profit. The primary metrics tracked are employee

cost over sales revenue, employee cost over net income before taxes, turnover of full-time and part-time staff,

absenteeism, time-to-fill for critical positions, and HR performance ratings. Of these metrics, four are lagging

indicators: employee cost over sales revenue, employee cost over net income before taxes, turnover and

performance ratings. The other two metrics-absenteeism and time-to-fill-are leading indicators. The turnover of

full-time staff, for example, was 11% in 2004 and 16% in 2005, the difference reflecting the recent retirement of

several long-time employees. As a result of analyzing the turnover increase, HR developed a knowledge

management transfer program for employees close to retirement. Finally, to anticipate the possible effect on the

next year’s budget, HR reviews any changes in benefits programs against the cost of benefits per employee.

The Value of Qualitative KPIs-Mini Case Study No. 2

KPIs-as a simple tabulation of numerical indicators-do not necessarily provide management with useful

information. Moving from “bean counting” to strategic HR, a more qualitative type of key performance indicator

becomes essential. As this mini case study illustrates, turnover rate, as a leading indicator, is an excellent

example. In a mid-size manufacturing company with 650 employees, HR, using a qualitative assessment process,

asked questions to explore the true reason behind the high turnover rate of 30%. First, what was the value of the

employees who left the organization? Since the turnover rate was high, for example, were the employees who left a

drag on performance? If yes, then the hiring process was the next step to examine. Second, was the high turnover

among valuable employees? If yes, then the next step was to examine the nature of the employee-organization

interaction.

To begin, HR went back to its performance assessment process and considered people who left in each of the four

categories: 4-exceeds expectations, 3-meets expectations, 2-needs improvement to meet expectations and 1-not

performing even to minimal expectations. They looked at high turnover among the 3s and 4s, which represented a

loss of high performers who, assuming the performance assessment was valid, were more valuable to the

organization. They also considered high turnover among the 1s and 2s, a possible indication that supervisors were

doing a good job of weeding out those who could not perform. Looking at turnover rates over time, HR found a

need for supervisor training as well as the need to improve pre-hiring screening and the overall selection process.

After tracking turnover for a year following the supervisor training initiative and improvements in the hiring

process, the end result was that the savings in reduced turnover far outweighed the cost of the pre-hire

assessment and supervisor training.

Role of Technology and KPIs

Today, the increasing demand for HR technology runs parallel with the growing use of workforce analytics and

KPIs. HR technology systems are fast proving to be a critical vehicle for HR to contribute value to their

organizations. While initially used primarily by large organizations, more small and mid-size companies now use

software products to both effectively measure human capital investment and track a wide range of HR metrics.

Further, there is growing evidence of cost savings in organizations that effectively use HR technology.

Consequently, HR in companies of all sizes will increasingly use technology to better showcase the effects of

human capital initiatives.25

Research by management gurus Boudreau, Lawler and Mohrman points to the critical role of technology and the

corresponding strong relationship between HR and IT. Two key findings reveal that, due to technology, completely

integrated HR IT systems lead to the highest level of HR effectiveness, and the effectiveness of the HR IT system

is strongly related to the overall effectiveness of the HR organization. Further, the SHRM 2005 HR Technology

Survey Report emphasizes the importance of return on investment (ROI) to build a business case to incorporate

HR technology systems in the firm. The top five successes of HR technology systems are: increased accuracy of

employee information; decreased cycle time for processing employee information transactions; less time spent by

HR staff on administrative work; greater access by managers to employee information; and the HR department’s

ability to manage the workforce with the same number of HR staff. Yet, few organizations document the

advantages of HR technology systems:26

* 65% of organizations are not measuring the ROI for HR technology systems.

* Of those that do measure the ROI, 68% measure it by determining cost savings and losses and 31% consider HR

headcount.

* 10% of HR professionals do not know how the ROI is measured.

Recent Studies: Human Capital Practices Drive Performance

Increasingly, research finds that best practices around human capital can help companies successfully compete

with their peer organizations. The following studies highlight the importance of human capital practices to drive

organizational performance. Correspondingly, KPIs that measure these practices both validate the value of HR and

advance the profession at all levels.

* Achieving Strategic Excellence: An Assessment of Human Resource Organizations27

This national study, the fourth in a series on the HR function in large corporations, focuses on measuring whether

the HR function is changing to become more effective and, more specifically, whether HR is changing to become

an effective strategic partner. The key findings show a “strong relationship between what is happening in the HR

function and a company’s strategic focuses.” The degree to which the firm has knowledge and performance

strategies is the degree to which HR is viewed as a strategic business partner. Overall, with the importance placed

on talent management, the emphasis on human capital, knowledge and competencies creates a favorable

environment for the HR function.

* SHRM 2006 Human Capital Benchmarking Study28

This executive summary provides HR professionals with key human capital measures from nearly 600

organizations on HR departments and their expenses, employment, health care, compensation, and organizational

revenue and size. The key findings reveal changes and trends in the workplace. For example, of the 57% of firms

that expected their HR department expenses to increase, 11% were in durable goods manufacturing. For all

industries, the median for HR expense per full-time employee was $1,072. And in 2005, organizations also

increased their hiring by more than 50% from the previous year. Telecommunications, services (profit) and

biotechnology industries had the top three highest medians for percentages of positions filled in 2005.

* 2006 FORTUNE Most Admired Companies: The Effectiveness of Managing Globally29

This study of 74 companies worldwide found that successful global organizations exploit unique knowledge and

capabilities. They then effectively diffuse and adopt them worldwide to their strategic objectives, contributing to

competitive differentiation. Successful global leaders, for example, take a hands-on approach to develop talent

management and provide ongoing coaching to their workforce. Most admired companies have a better

understanding of their talent, and consequently, positions can be filled more quickly based on required skills and

career objectives.

* Maximizing the Return on Your Human Capital Investment: The 2005 Watson Wyatt Human Capital Index

Report30

This study of 147 organizations representing all major North American industries illustrates that companies with

superior human capital practices can create more shareholder value that substantially surpasses companies with

average human capital practices. Excellent human capital practices-such as recruiting excellence, employee

development, total rewards, turnover management and communication-make a difference, no matter the state of

the economy. Key findings, for example, show that companies that filled vacancies faster reduced disruption and

lost productivity from turnover. Organizations that filled positions quickly (in about two weeks) outperformed

those that took longer (around seven weeks) by 48% (59% three-year total returns to shareholders versus 11%).

Using KPIs in the Global HR Function

The value of global HR is assessed by how well global HR strategy, policies and practices link with, support and

forward organizational strategy (see Figure 4). In addition, global HR is often assessed by its effectiveness to

deliver major organizational change. HR is often called upon, for example, to help in the design of high-level

projects for major global business initiatives (e.g., talent management for expansion into new regions, a global

communications program regarding new organizational values).

Yet measuring the contribution of HR on an international level becomes ever more complicated due to factors

such as complexities of scope, authority level, and political, cultural and legislative barriers that directly affect the

link between organizational performance and HR. Two approaches are recommended: identifying and proving the

link between organizational performance and people management, and using methods of evaluation of the global

HR function’s contribution. The measure of the global HR function also often rests on “perceptions of

effectiveness” from key stakeholders-that is, the company’s worldwide employees and managers. Therefore, the

ability to market HR globally as a source of competitive and strategic advantage is fundamental to measuring the

contribution of the corporate global HR function.31

Measuring the value of international assignments, for example, is a critical success factor for global HR.

Companies measure the ROI of international assignments through cost estimating, tracking and comparison. A

recent global relocation trends survey, for example, found that 70% of companies required a statement of

assignment objectives prior to funding assignments. In addition, to minimize expatriate turnover-a global HR KPI-

64% of companies found opportunities to use international experience, with 50% of firms offering a greater choice

of positions upon return and 43% offering repatriation career support.32 However, as highlighted in an SHRM case

study on repatriation, different assignments have different measures of success and, consequently, different

results. A common KPI is the retention rate of expatriates following repatriation for one and/or two years. Other

measures may also reflect “softer” results, such as managerial approach shifts or cultural changes. The concept

behind using a variety of measures is to create a “report card” that can provide a broad view of the assignment

overall.33

In Closing

Becoming more facile with metrics in general is a goal of many HR professionals. Further, as more HR

professionals become immersed in human capital measurement, they can more effectively use key performance

indicators to illustrate the value of human capital investments through successful organizational performance at

many levels. These important steps will increasingly demonstrate the high value-add required by the C-suite to be a

true strategic business partner.

Acknowledgments

The author extends appreciation and thanks to members of the SHRM Human Capital/HR Metrics Special

Expertise Panel (Ronald L. Adler, Grist Berry, SPHR, Bette J. Francis, SPHR, Virginia C. Hall, SPHR, Janice Presser,

Ph.D.) and to Strategic Research at SHRM (John Dooney, Noël Smith and Belin Tai).

Sidebar

Recommendations

Selecting practical KPIs requires thoughtful consideration of the message behind measures and their

corresponding effect on the organization. The real-life examples below-starting at the idea stage and ending at

results with meaningful measures-demonstrate HR value through KPIs.

1. Qualitative measurement is one path to assess qualitative characteristics of the workforce, such as

engagement.

Example: A public agency was experiencing high customer complaints and low staff morale. A combination of

open-ended survey and focus group outputs was analyzed, and leading indicators were identified. Training was

specifically designed to target the key areas, and as a result, customer complaints fell as morale improved.

2. Employee feedback provides useful perspectives on HR efficiency.

Example: Health care cost? were unusually high and customer service was very poor for the last fiscal year. Six

months after a new health care provider was chosen, costs were down by 20%. The organization’s HR manager

developed a survey for employees to provide feedback about the new program relative to the previous one and

learned that employee perception of the new program was extremely favorable.

3. Whenever possible, the impact of recruiting is best described in terms of financial gains.

Example: An organization wanted to know the effect of its new recruiting program. The program was able to

reduce time-to-fill by an average of seven days, which meant new employees could start billing sooner to client

sites. Since the average daily bill rate per person was $900, the recruiting program was able to increase the firm’s

revenue by $6,300 per new billable employee hired.

4. Retaining older workers for future leadership roles depends on what they most value.

Example: A survey by a multinational corporation of its older worker population in North America and Europe

revealed the following top three key values: 1) support from managers; 2) ability to make one’s own job-related

decisions; and 3) opportunities for advancement. Leadership development programs were created to retain key

talent from this group. Over a two-year period, tracking of performance, mentoring and promotions of older workers

in the leadership development program found that turnover rates for older workers decreased by 28%.

Sidebar

Online Resources

2005 Watson Wyatt Human Capital Index* Report

www.watsonwyatt.com

Balanced Scorecard Institute

www.balancedscorecard.org

HR Technology Competencies: New Roles for HR Professionals

www.shrm.org/research/quarterly

Human Capital: The Elusive Asset

www.shrm.org/research/quarterly

Human Capital Institute

www.humancapitalinstitute.org

HR Metrics Toolkit

www.shrm.org/metrics/library

SHRM 2005 HR Technology Survey Report

www.shrm.org/surveys

SHRM Human Capital Customized Benchmarking Service

www.shrm.org/research/benchmarks

The Conference Board

www.conference-board.org

Understanding Expatriate ROI: Improving the Bottom Line

www.shrm.org/global

Footnote

Endnotes

1 Presser, J. (2006, February). Approaching a metric of human capital synergy [SHRM White Paper]. Retrieved June

10, 2006, from www.shrm.org

2 Huselid, M. (1995, June). The impact of human resource management practices on turnover, productivity and

corporate financial performance. Academy of Management Journal, 38, 3, 635+.

3 Glossary of Human Resources Terms, www.shrm.org/hrresources /hrglossary_published

4 Schneider, C. (2006, February 15). The new human-capital metrics. CFO Magazine, 1+.

5 Gates, S. (2002). Value at work: The risks and opportunities of human capital measurement and reporting. New

York: The Conference Board.

6 Ulrich, D., &Brockbank, W. (2005). The HR value proposition. Boston: Harvard Business School Press.

7 Gates, S. (2003). Linking people to strategy: From top management support to line management buy-in. New

York: The Conference Board.

8 Ulrich, D., &Brockbank, W. (2005). The HR value proposition. Boston: Harvard Business School Press.

9 Becker, B. E., Huselid, M. A., &Ulrich, D. (2001). The HR scorecard: Linking people, strategy and performance.

Boston: Harvard Business School Press.

10 Lawler III, E. E., Boudreau, J. W., &Mohrman, S. A. (2006). Achieving strategic excellence: An assessment of

human resource organizations. Palo Alto, CA: Stanford University Press.

11 Gates, S. (2002). Value at work: The risks and opportunities of human capital measurement and reporting. New

York: The Conference Board.

12 Ibid.

13 Dooney, J., &Smith, N. (2005). SHRM human capital benchmarking study: 2005 executive summary. Alexandria,

VA: Society for Human Resource Management.

14 Gates, S. (2002). Value at work: The risks and opportunities of human capital measurement and reporting. New

York: The Conference Board.

15 HayGroup. (2005, February). What makes the most admired companies great? Retrieved May 4, 2006, from

www.haygroup.com

16 Becker, B. E., Huselid, M. A., &Ulrich, D. (2001). The HR scorecard: Linking people, strategy and performance.

Boston: Harvard Business School Press.

17 Denton, D. K. (2006, March). Measuring relevant things. Performance Improvement, 45, 3, 33-38.

18 Ibid.

19 Schneider, C. (2006, February 15). The new human-capital metrics. CFO Magazine, 1+.

20 Becker, B. E., Huselid, M. A., &Ulrich, D. (2001). The HR scorecard: Linking people, strategy and performance.

Boston: Harvard Business School Press.

21 Ibid.

22 Esen, E. (2006, June). 2006 job satisfaction survey report Alexandria, VA: Society for Human Resource

Management.

23 Watson Wyatt and Human Resource Planning Society. (2006, April). The human capital ROI study. Retrieved

May 4, 2006, from www.watsonwyatt.com

24 The Gallup Organization. (1998). Employee engagement = Business success. Retrieved March 7, 2006, from

www.bcpublicservica.ca

25 Schramm, J. (2006, April). HR technology competencies: New roles for HR professionals. SHRM Research

Quarterly, 1.

26 Collison, J. (2005, March). 2005 HR technology survey report Alexandria, VA: Society for Human Resource

Management.

27 Lawler III, E. E., Boudreau, J. W., &Mohrman, S. A. (2006). Achieving strategic excellence: An assessment of

human resource organizations. Palo Alto, CA: Stanford University Press.

28 Dooney, J., &Smith, N. (2006). SHRM human capital benchmarking study: 2006 executive summary. Retrieved

June 29, 2006, from www.shrm.org

29 HayGroup. (2006, April). Leading the global organization: Structure, process, and people as the keys to success.

Hay Group Insight Selections, 11, 1-4.

30 Watson Wyatt Worldwide. (2005). Maximizing the return on your human capital investment The 2005 Watson

Wyatt human capital index report. Washington, D.C.: Author.

31 Sparrow, R, Brewster, C., &Harris, H. (2004). Globalizing human resource management. London: Routledge.

32 GMAC Relocation Services. (2006). Global relocation trends 2005 survey report. Woodridge, IL: Author.

33 Society for Human Resource Management. (2005, November). Measuring the success of a repatriation program

[SHRM case Study]. Retrieved May 9, 2006, from www.shrm.org/hrresources/casestudies_published

/GlobalHR.asp

AuthorAffiliation

Nancy R. Lockwood, SPHR, GPHR, M.A.

Manager, HR Content Program

AuthorAffiliation

ABOUT THE AUTHOR

Nancy R. Lockwood, SPHR, GPHR, MA, is manager, HR Content Program, for the Society for-Human Resource

Management. Her responsibilities include identifying topics and focus areas in need of additional human resource

management research and creating HR products of strategic and practical value for target audiences. She is

certified as a Senior Professional in Human Resource Management and a Global Professional in Human Resources

by the Human Resource Certification Institute. Ms. Lockwood can be reached by e-mail at [email protected]

ABOUT SHRM RESEARCH

SHRM Research, as part of the Knowledge Development Division supporting SHRM, produces high-quality, leading-

edge research and provides expertise on human resource and business issues. It acts as an advisor to SHRM for

the purpose of advancing the HR profession and generates and publishes cutting-edge research used by human

resource professionals to develop their knowledge and to provide strategic direction to their organizations. As

leading experts in the field of HR, SHRM Research works closely with leading academics, policy makers and

business leaders.

ABOUT SHRM

The Society for Human Resource Management (SHRM) is the world’s largest association devoted to human

resource management. Representing more than 210,000 individual members, the Society’s mission is to serve the

needs of HR professionals by providing the most essential and comprehensive resources available. As an

influential voice, the Society’s mission is also to advance the human resource profession to ensure that HR is

recognized as an essential partner in developing and executing organizational strategy. Founded in 1948, SHRM

currently has more than 550 affiliated chapters within the United States and members in more than 100 countries.

Visit SHRM Online at www.shrm.org.

© 2006 Society for Human Resource Management. All rights reserved.

This publication may not be reproduced, stored in a retrieval system or transmitted in whole or in part, in any form

or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior written

permission of the Society for Human Resource Management, 1800 Duke Street, Alexandria, VA 22314, USA.

For more information, please contact:

SHRM Research Department

1800 Duke Street, Alexandria, VA 22314, USA

Phone: (703) 548-3440 Fax: (703) 535-6473

www.shrm.org/research

Disclaimer

This report is published by the Society for Human Resource Management. All content is for informational purposes

only and is not to be construed as a guaranteed outcome. The Society for Human Resource Management cannot

accept responsibility for any errors or omissions or any liability resulting from the use or misuse of any such

information. The Society for Human Resource Management does not endorse or imply endorsement of these

materials. Reference to any specific commercial product, process or service by trade name, trademark, service

mark, manufacturer or otherwise does not constitute or imply endorsement, recommendation or favoring by

SHRM.

ISBN #: 1-932132-41-4

06-0445

DETAILS

Subject: Talent management; Compensation; Strategic management; Corporate culture;

Performance appraisal; Human resources; Business indicators; Line managers;

Employee involvement; Executives; Workforce; Human capital; Employment

practices; Professionals; Stakeholders; Strategic planning; Economic indicators;

Business metrics; Corporate objectives; Success; Credibility

Business indexing term: Subject: Talent management Compensation Strategic management Corporate

culture Performance appraisal Human resources Business indicators Line managers

Employee involvement Executives Workforce Human capital Employment practices

Professionals Stakeholders Strategic planning Economic indicators Business

metrics Corporate objectives

Location: United States–US

Classification: 9190: United States; 6200: Training &development; 2310: Planning

Publication title: HRMagazine; Alexandria

Volume: 51

Issue: 9

Pages: S1-S11

Number of pages: 11

Publication year: 2006

Publication date: Sep 2006

Publisher: Society for Human Resource Management

Place of publication: Alexandria

Country of publication: United States, Alexandria

Publication subject: Business And Economics–Management

ISSN: 10473149

Source type: Trade Journal

Language of publication: English

Document type: Feature

Document feature: Graphs

ProQuest document ID: 205269574

LINKS
Linking Service

Database copyright  2022 ProQuest LLC. All rights reserved.
Terms and Conditions Contact ProQuest

Document URL: https://www.proquest.com/trade-journals/maximizing-human-capital-

demonstrating-hr-value/docview/205269574/se-2?accountid=14872

Copyright: Copyright Society for Human Resource Management Sep 2006

Last updated: 2021-09-09

Database: ProQuest One Academic

https://www.proquest.com/trade-journals/maximizing-human-capital-demonstrating-hr-value/docview/205269574/se-2?accountid=14872

https://www.proquest.com/trade-journals/maximizing-human-capital-demonstrating-hr-value/docview/205269574/se-2?accountid=14872

https://resolver.ebscohost.com/openurl?ctx_ver=Z39.88-2004&ctx_enc=info:ofi/enc:UTF-8&rfr_id=info:sid/ProQ:abiglobal&rft_val_fmt=info:ofi/fmt:kev:mtx:journal&rft.genre=article&rft.jtitle=HRMagazine&rft.atitle=Maximizing%20Human%20Capital:%20Demonstrating%20HR%20Value%20With%20Key%20Performance%20Indicators&rft.au=Lockwood,%20Nancy%20R&rft.aulast=Lockwood&rft.aufirst=Nancy&rft.date=2006-09-01&rft.volume=51&rft.issue=9&rft.spage=S1&rft.isbn=&rft.btitle=&rft.title=HRMagazine&rft.issn=10473149&rft_id=info:doi/

https://www.proquest.com/info/termsAndConditions

http://about.proquest.com/go/pqissupportcontact

Maximizing Human Capital: Demonstrating HR Value With Key Performance Indicators

TRUST AND COLLABORATION IN THE AFTERMATH OF
CONFLICT: THE EFFECTS OF CONTRACT STRUCTURE

DEEPAK MALHOTRA
Harvard University

FABRICE LUMINEAU
University of Technology Sydney

Leveraging a longitudinal data set concerning 102 interfirm disputes, we evaluate the
effects of contract structure on trust and on the likelihood of continued collaboration.
We theoretically refine and empirically extend prior research by (1) distinguishing
between the control and coordination functions of contracts, (2) separating goodwill-
based and competence-based trust, and (3) evaluating the effects of contract structure
on relational outcomes in the context of disputes. We find that control provisions
increase competence-based trust but reduce goodwill-based trust, resulting in a net
decrease in the likelihood of continued collaboration. Coordination provisions in-
crease competence-based trust, leading to an increased likelihood of continued
collaboration.

Interfirm relationships allow firms to create
value and build competitive advantage (Agarwal,
Croson, & Mahoney, 2010), but cooperation in such
relationships is neither automatic nor easily fos-
tered. Two key impediments to cooperation are the
threat of exploitation by an opportunistic exchange
partner (Williamson, 1985) and the possibility of
coordination failures that can derail the efforts of
even well-intentioned parties (Gulati, Lawrence, &
Puranam, 2005; Knez & Camerer, 2000). Recogniz-
ing that mixed motives underlie most exchange
relationships (e.g., Kogut, 1988) and that coordinat-
ing partners’ expectations and actions is inherently
difficult (Camerer, 2003), firms rely on contracts to
mitigate risks, facilitate coordination, and promote
cooperation (Ring & Van de Ven, 1992).

Despite the use of contracts to facilitate coordi-
nation and control, however, interfirm disputes can
emerge. This raises questions regarding the kind of
relationship that will emerge and the viability of
continued collaboration after parties have been un-
successful in preventing conflict. In this study, we

examine these dynamics by evaluating how con-
tract structure affects trust, and subsequently, con-
tracting parties’ intent to continue collaboration, in
the context of interfirm disputes. We extend prior
research on the effects of contracts on trust by (1)
distinguishing between the control and coordina-
tion functions of contracts, (2) distinguishing be-
tween the goodwill and competence dimensions of
trust judgments, and (3) evaluating these relation-
ships in the context of interfirm conflict.

We argue that a more nuanced approach that
encompasses the different functions of contracts
(coordination versus control) and the different di-
mensions of trust judgments (goodwill versus com-
petence) may provide a more complete assessment
of the effects of contracts on trust and collabora-
tion. Prior research has often focused narrowly on a
subset of these distinctions and in some cases over-
looked these distinctions altogether (Puranam &
Vanneste, 2009). Furthermore, our analysis of
firms’ willingness to continue relationships after
suffering costly disputes allows us to evaluate the
mechanisms underlying an important but rarely
studied aspect of interfirm exchange: relationship
repair (Zaheer, Lofstrom, & George, 2002).

To test our hypotheses, we use a rich data set
comprising more than 150,000 pages of details re-
garding 102 business disputes arising in vertical
exchange relationships in the years 1991–2005.
The data include a wide range of contractual and
exchange characteristics for each relationship,
along with thousands of pages of communication
between the disputants. The contracts enabled us
to codify the degree to which control and coordi-

We thank our associate editor, Wenpin Tsai, and three
anonymous reviewers for their constructive feedback
throughout the review process. We also thank Jean
Beuve, Marc Fréchet, Michael Jensen, and Kathleen
McGinn for their comments on earlier versions of the
paper. We are grateful to the law firm that gave us access
to data and to the lawyers and law professors for sharing
their time and expertise with us.

Editor’s note: The manuscript for this article was ac-
cepted for publication during the term of AMJ’s previous
editor, Duane Ireland.

� Academy of Management Journal
2011, Vol. 54, No. 5, 981–998.
http://dx.doi.org/10.5465/amj.2009.0683

981

Copyright of the Academy of Management, all rights reserved. Contents may not be copied, emailed, posted to a listserv, or otherwise transmitted without the copyright holder’s express
written permission. Users may print, download, or email articles for individual use only.

nation provisions were incorporated into agree-
ments, and the communications allowed us to code
for statements that reveal goodwill-based and com-
petence-based trust in the relationships. This is
notable because, to our knowledge, the current data
set is the first to provide this level of detail on
interfirm conflict, and the first to allow such a
fine-grained analysis of trust in interorganizational
relationships.

THEORETICAL BACKGROUND
AND HYPOTHESES

Contracts as Instruments of Control
and Coordination

Seminal works in organization studies (Barnard,
1938; Burns & Stalker, 1961), as well as work by
legal scholars (e.g., Baird, Gertner, & Picker, 1994;
McAdams, 2009), decision theorists (e.g., Luce &
Raiffa, 1957; Schelling, 1963), and economists (e.g.,
Camerer, 2003; Knez & Camerer, 2000), have previ-
ously addressed the distinction between control
problems (those stemming from misaligned incen-
tives) and coordination problems (those stemming
from misaligned expectations and behavior) in ex-
change relationships (Gulati et al., 2005). Although
control and coordination have often been tackled
separately in the literature (Kretschmer & Puranam,
2008), some recent studies have suggested that or-
ganizational structures—and, in particular, inter-
firm contracts—serve both functions (e.g., Argyres,
Bercovitz, & Mayer, 2007; Mellewigt, Madhok, &
Weibel, 2007; Reuer & Ariño, 2007; Salbu, 1997).

Organizational scholars have long considered
contracts as instruments of control (Macneil, 1978;
Williamson, 1985, 1991). Interfirm collaborations
have the potential to create value, but parties to
such relationships must contend with the risk of
exploitation by their partners (Walker & Weber,
1984; Williamson, 1985). The legal underpinnings
of contracts give firms the option of sanctioning an
exchange partner who is unable or unwilling to
abide by agreed-upon terms (Joskow, 1987). The
coordination function of contracts has received less
attention (Argyres et al., 2007; Mayer & Argyres,
2004). A contract—and the contracting process—
help parties make explicit their assumptions and
expectations regarding their transaction and each
side’s role (Beatty & Samuelson, 2001; Smitka,
1994). Coordination-oriented provisions in a con-
tract are aimed at mitigating the risk that misunder-
standings will disrupt collaboration among (presum-
ably) well-intentioned parties (Macaulay, 1963).

In this article, we build on the work of those who
have called for a broader perspective on contractual

complexity and a more nuanced approach to study-
ing the effects of contracts on relational attitudes
and exchange outcomes (Puranam & Vanneste,
2009). We evaluate contracts at the level of individ-
ual provisions, distinguishing between provisions
aimed primarily at exerting control and those
aimed primarily at facilitating coordination.

Two Dimensions of Trust Judgments: Goodwill
and Competence

Following Rousseau, Sitkin, Burt, and Camerer
(1998), and in keeping with other influential con-
ceptualizations of trust (Lewicki, McAllister, &
Bies, 1998; Mayer, Davis, & Schoorman, 1995), we
define trust as the willingness of a party to be
vulnerable to the actions of another party based on
positive expectations regarding the other party’s
motivation and/or behavior. Trust, so defined, can
be distinguished from the underlying dimensions
of trust judgments, which entail attributions of an-
other party’s trustworthiness along relevant charac-
teristics (e.g., integrity). Following prior work on
the attributional basis of trust (Ferrin & Dirks, 2003;
Mayer et al., 1995; Weber, Malhotra, & Murnighan,
2005), we posit that attributions along relevant di-
mensions are what create in a truster a willingness
to accept vulnerability.

We follow the lead of Nooteboom (1996) and Das
and Teng (2001), who focused on two dimensions
of trust judgments: goodwill and competence. Per-
ceptions of goodwill entail attributions regarding
the intention of another party to behave in a trust-
worthy manner; perceptions of competence entail
attributions regarding the other party’s ability to
behave or perform as expected (Nooteboom, 1996).1

The Effect of Contracts on Trust

Contracts and trust represent alternative means
by which parties can manage risk in exchange re-
lationships, but in interfirm relationships, firms
typically use contracts while simultaneously at-
tempting to build trust (Poppo & Zenger, 2002;
Wicks, Berman, & Jones, 1999). The seemingly
modal preference regarding interfirm gover-

1 This distinction captures all three dimensions in
Mayer and colleagues’ (1995) trust framework: ability,
benevolence, and integrity. Competence captures attribu-
tions of ability; goodwill captures benevolence and in-
tegrity. Combining benevolence and integrity as “good-
will” is useful because many of the statements in our data
are hard to categorize as either benevolence or integrity
attributions; many are ambiguous or suggestive of a dual
attribution.

982 OctoberAcademy of Management Journal

nance—to use contracts and build trust— has
sparked a debate regarding the viability of this
strategy. Some have argued that contracts and trust
are often incompatible (Malhotra & Murnighan,
2002; Molm, Takahashi, & Peterson, 2000; Sitkin &
Roth, 1993). Others have suggested that contracts
and trust are not only compatible, but mutually
reinforcing (Gulati & Nickerson, 2008; Poppo &
Zenger, 2002). This divergence makes it difficult to
predict whether an emphasis on contracts in a re-
lationship between firms will enhance or inhibit
the prospects for the firms’ continued collaboration
after a dispute. Our goal is not to reconcile the vast
amount of prior research on this topic, nor do we
align ourselves completely with either side. Rather,
we borrow from the literatures forwarding each of
these viewpoints on the (in)compatibility of con-
tracts and trust to expound a more comprehensive
(and nuanced) perspective on the effect of contracts
on trust and collaboration in the aftermath of con-
flict. Our review of prior research suggests that both
positive and negative effects of contracts could be
better understood when we separately consider the
effects of control versus coordination provisions on
goodwill-versus competence-based trust.

The effect of control provisions on trust. Those
who have posited a negative relationship between
contracts and trust have largely focused on the
control function of contracts and on the goodwill
dimension of trust (Malhotra & Murnighan, 2002;
Sitkin & Roth, 1993; Tenbrunsel & Messick, 1999).
Macaulay (1963) and Ghoshal and Moran (1996)
suggested that the mere suggestion or introduction
of contracts may signal distrust of another party’s
intentions, thereby disrupting the process of trust
development (Pillutla, Malhotra, & Murnighan,
2003). Tenbrunsel and Messick (1999) argued that
an overreliance on control mechanisms changes the
“decision frames” of exchange partners; including
too many control provisions may, ironically, pro-
mote opportunistic behavior by inducing a “busi-
ness” rather than “ethical” framing of the interac-
tion. Finally, Malhotra and Murnighan (2002)
argued that overly controlling contracts, which
leave little room for discretion, crowd out trust
development because they lead to situational rather
than personal attributions for the cooperativeness
of partners. This crowding out may be especially
likely during conflict, because parties are less
likely to make generous attributions of each other’s
behavior when their relationship has turned antag-
onistic (Ross & Stillinger, 1991). These mechanisms
suggest:

Hypothesis 1. The higher the number of control
provisions in an interfirm contract, the lower

the subsequent level of goodwill-based trust
between them.

Prior research has not directly examined the ef-
fect of control provisions on competence-based
trust. However, there are two reasons to expect that
control provisions will enhance perceptions of
competence in the context of disputes. First, by
eliminating incentives for cheating and reneging,
control provisions may force parties to focus more
time and effort on their roles and responsibilities.
This “substitution effect,” by limiting nefarious
conduct, may promote exactly the types of behavior
(e.g., attention to detail, timeliness, etc.) that en-
hance competence attributions. Another possibility
is that the time spent on drafting contractual lan-
guage, even for control provisions, leads to a clari-
fication of expectations and assumptions, which in
turn facilitates competence attributions (Argyres et
al., 2007; Mayer & Argyres, 2004). We therefore
hypothesize the following:

Hypothesis 2. The higher the number of control
provisions in an interfirm contract, the higher
the subsequent level of competence-based trust
between them.

The effect of coordination provisions on trust.
In addition to serving a control function, contracts
provide a means by which parties can coordinate
their expectations and efforts (Gulati et al., 2005;
Mayer & Argyres, 2004; Reuer & Ariño, 2007). As a
result, common knowledge structures such as
shared language and routinized interactions
emerge that make it easier for the parties to com-
municate their ability to meet each other’s needs
(Morgan & Hunt, 1994; Puranam, Singh, & Zollo,
2006). The process of coordination can thus facili-
tate competence-based trust development. In their
analysis of 11 contracts signed between two firms,
Mayer and Argyres provided a relevant example:
“HW Inc. had expressed frustration in the first two
projects over the length of time it took Softstar to
complete what HW, Inc. perceived to be minor
changes. . . . Softstar added a system architecture
section to the third [contract]. This section allowed
both firms to better understand how the entire
product fit together and the impact to Softstar if
HW, Inc. made a late hardware change” (2004: 400).
In this incident, the revised contract was aimed at
aligning expectations regarding the link between
change requests and delays, lest HW Inc. attribute
delays to Softstar’s incompetence. Coordination
structures may be especially important for compe-
tence perceptions after a conflict has arisen, be-
cause disputing parties are otherwise unlikely to
engage in the kinds of spontaneous communication

2011 983Malhotra and Lumineau

that mitigate conflict and promote positive attribu-
tions (Hinds & Mortensen, 2005). This suggests:

Hypothesis 3. The higher the number of coor-
dination provisions in an interfirm contract,
the higher the subsequent level of competence-
based trust between them.

Coordination provisions are also expected to in-
crease goodwill-based trust in the context of dis-
putes. By creating channels through which differ-
ences in perspective will be resolved, coordination
provisions help mitigate misunderstandings of the
kind that raise questions about the intent of another
party; this promotes— or at least minimizes damage
to—attributions of goodwill during a conflict
(Vlaar, Van den Bosch, & Volberda, 2007). More-
over, parties that establish norms and procedures
allowing them to coordinate on when and how to
expend effort in their relationship are less likely to
face situations in which one party feels overworked
or exploited, or is concerned that the other side
is not meeting its reciprocal obligations (Malhotra,
2004). Laboratory evidence has supported this
argument. Ahn, Ostrom, Schmidt, Shupp, and
Walker (2001) found that prior experience in a pure
coordination game (with no incentives for nonco-
operation) helps parties to move toward a mutually
cooperative outcome, even in subsequent interac-
tions that provide incentives for noncooperation.
This suggests:

Hypothesis 4. The higher the number of coor-
dination provisions in an interfirm contract,
the higher the subsequent level of goodwill-
based trust between them.

Trust and consequences. The considerable re-
search attention devoted to the effect of contracts
on trust reveals the extent to which trust is seen as
crucial for interfirm collaboration and value cre-
ation (Arrow, 1974; Uzzi, 1997) and as a source of
competitive advantage for organizations (Barney &
Hansen, 1994; Nahapiet & Ghoshal, 1998). Here, we
consider a consequence of trust that has received
little direct attention but that is critical to the value-
creating potential of interfirm relationships: firms’
willingness to continue such relationships after
disputes have arisen. We expect that contractual
provisions aimed at coordination and control will
influence competence- and goodwill-based trust,
which will in turn influence parties’ decisions ei-
ther to stay together or to end a relationship that
has experienced conflict. Thus, our data allow us to
begin the process of linking contract choices with
relational outcomes, with trust serving as a
mediator.

Zand (1972) suggested that goodwill-based trust
increases the likelihood of continued collaboration
because it leads parties to share accurate and timely
information and to be more willing to accept de-
pendence on each other even when formal control
mechanisms cannot be applied. Zand (1972) also
found that a high degree of goodwill-based trust
increases motivation to implement agreements and
makes parties less likely to switch partners. Re-
search on the role of “psychological contracts” has
also shown the positive effect of goodwill-based
trust on relationship continuance (Morrison & Rob-
inson, 1997; Robinson, 1996). Uzzi (1997) argued
that, in interfirm contexts, (goodwill-based) trust is
a crucial predictor of future exchange. This
suggests:

Hypothesis 5. The higher the level of goodwill-
based trust in an interfirm relationship, the
higher their willingness to continue the rela-
tionship after a dispute has arisen.

Competence-based trust should also increase the
likelihood of relationship continuance. It is per-
haps axiomatic that parties prefer to do business
with those they consider to be competent. In the
aftermath of conflict, the importance of compe-
tence-based trust should be even greater. Das and
Teng argued that “the lower the level of acceptable
performance risk level, the higher the needed com-
petence trust level” (2001: 266). Parties exiting a
dispute will be especially sensitive to the degree of
performance risk involved in continuing their rela-
tionship. This suggests:

Hypothesis 6. The higher the level of compe-
tence-based trust in an interfirm relationship,
the higher their willingness to continue the
relationship after a dispute has arisen.

Contracts and the Continuation of Relationships
after a Dispute

We expect that control provisions, by reducing
goodwill-based trust, should lessen the likelihood
that disputing parties will agree to continue work-
ing together. If a dispute arises despite reliance on
provisions designed to protect against opportun-
ism, the parties are likely to seriously question the
viability of future exchange. The prospects for con-
tinued collaboration are even dimmer if control
provisions do not simply substitute for goodwill-
based trust, but actually undermine it (Malhotra &
Murnighan, 2002). By contrast, control provisions
may increase the desire for continued exchange
because of an increase in competence-based trust. If
control provisions crowd out self-serving behavior

984 OctoberAcademy of Management Journal

in favor of task-oriented activity, competence per-
ceptions should increase and make future collabo-
ration more attractive.

The net effect of enhanced control on future col-
laboration depends on whether the effect of good-
will-based trust or competence-based trust domi-
nates. We expect that the negative effect will
dominate. Prior research has suggested that
strained relationships are more difficult to repair
when there has been a breach of goodwill-based
trust rather than of competence-based trust (Kim,
Dirks, Cooper, & Ferrin, 2006). Moreover, after a
dispute, goodwill-based trust is likely to be more
important than competence-based trust for resur-
recting the scarred relationship: even if concerns
remain about a partner’s ability to meet all of its
obligations, the scope of the relationship can be
redefined to focus on areas where competence
is not in question; in contrast, concerns about the
other’s goodwill are unlikely to be limited to a
single domain, making it difficult to rekindle the
relationship (Kim, Ferrin, Cooper, & Dirks, 2004).
We therefore suggest:

Hypothesis 7a. The higher the number of con-
trol provisions in an interfirm contract, the
lower the firms’ willingness to continue their
relationship after a dispute has arisen.

Hypothesis 7b. The effect of control provisions
on relationship continuance is mediated by the
level of goodwill-based trust.

Hypothesis 7c. The effect of control provisions
on relationship continuance is mediated by the
level of competence-based trust.

Meanwhile, coordination provisions, by increas-
ing goodwill-based trust, will facilitate continued
exchange. Recent case studies have pointed to a
mutually reinforcing relationship between coordi-
nation, goodwill-based trust, and relationship de-
velopment (Faems, Janssens, Madhok, & Van Looy,
2008; Mayer & Argyres, 2004; Ness, 2009): relation-
ship development facilitates more efficient con-
tracting aimed at better coordination; better coordi-
nation facilitates cooperation; and increased
cooperation facilitates goodwill-based trust and re-
lationship development. Coordination provisions
should be especially important in the context of
disputes: parties may question the usefulness of
coordination provisions that failed to prevent a dis-
pute, but if coordination provisions have facilitated
goodwill-based trust in the interim, a basis on
which to rebuild the relationship exists. Coordina-
tion provisions should also facilitate relationship
continuance via an increase in competence-based
trust. As the relationship continues, the parties

learn more about the types of contingencies that
can arise, which leads to the development of addi-
tional coordination provisions aimed at improving
the working arrangement (cf. Zaheer & Venkatra-
man, 1994). Thus, as time goes on, coordination
provisions not only allow parties to make fewer
mistakes and appear more competent (as in Hy-
pothesis 3), but also allow them to increase the
domain of tasks in which they can demonstrate
competency (Argyres et al., 2007). Both of these
effects should facilitate continued collaboration.
This suggests:

Hypothesis 8a. The higher the number of coor-
dination provisions in an interfirm contract,
the greater the firms’ willingness to continue
their relationship after a dispute has arisen.

Hypothesis 8b. The effect of coordination pro-
visions on relationship continuance is medi-
ated by the level of goodwill-based trust.

Hypothesis 8c. The effect of coordination pro-
visions on relationship continuance is medi-
ated by the level of competence-based trust.

RESEARCH METHODS

Data

We were granted access to all legal files concern-
ing contract disputes handled by one law firm in
Western Europe between 1991 and 2005. This mid-
sized law firm is a generalist in the field of corpo-
rate law; its clients include small, midsize, and
large firms from a variety of industries. We re-
stricted our sample to all two-party disputes in-
volving vertical relationships; these represented 80
percent of all two-party disputes the firm handled.
Our sample consisted of 102 cases (i.e., disputes),
99 of which involved only European firms; each of
the other 3 involved at least one non-European
firm. Because some companies were repeat clients
and involved in more than one dispute, the sample
contained 178 different firms.2 To check for selec-
tion bias, we examined differences between in-
cluded and excluded files (i.e., those involving
nonvertical relationships). We found no significant
differences on any observable dimension (contrac-
tual complexity, firm size, etc.).3

2 The results were unchanged when a “repeat client”
control variable was included in the analyses.

3 Because all of the studied relationships involved
legal disputes, we evaluated the representativeness of
our sample—at the contract level and relationship lev-
el—relative to the broader universe of interfirm relation-

2011 985Malhotra and Lumineau

Each legal file contained between 800 and 5,000
pages and included (1) the original contract, along
with any contract revisions that were made prior to
the dispute and (2) all documents exchanged dur-
ing the dispute resolution process. In addition, the
lawyers in each case obtained from the clients all
potentially relevant information related to the ini-
tial context of the relationship, the origins of the
conflict, and its progression over time. In total, over
150,000 pages of documents were collected and
analyzed for this study. Data collection took place
over four months. The law firm did not allow us to
contact the disputing firms directly.

The firms in our sample came from a variety of
industries: manufacturing (52%), services (32%),
retail (15%), and construction (2%). There were
four types of contracts: distribution (35.3%), pro-
duction supply (29.4%), information technology
(IT; 26.5%), and consulting and other services
(8.8%). Forty-six percent of the cases involved
cross-border relationships; 65.7 percent of the con-
tracts were time-bound in that they stipulated a
prespecified an end to the relationship; and
32.4 percent of the cases included exchange part-
ners that had interacted with each other previously.

Dependent Variable: Intent to Continue

We analyzed the intent of parties to continue a
relationship after a dispute had been resolved. For
multiple reasons, this performance variable is es-
pecially relevant when one is considering the ef-
fects of contract structure on trust in the context of
conflict. First, strategic alliance scholars have tra-
ditionally sought to investigate factors that contrib-
ute to alliance survival (Dhanaraj & Beamish, 2004;
Park & Russo, 1996) and stability (Blodgett, 1992;
Inkpen & Beamish, 1997). Second, an analysis of
the parties’ intent to continue collaborating after a
dispute has arisen responds to the call by trust
researchers to examine when and how damaged
relationships can be repaired (Bottom, Gibson,
Daniels, & Murnighan, 2002; Dirks, Lewicki, & Za-
heer, 2009). Finally, this measure provides a more

direct measure of the consequences of trust than
would be provided by some (eventual) financial
measure of performance.

We examined the messages that were exchanged
between the parties to each dispute, as well as the
terms of the settlement/judgment recorded in the
legal files, to look for indications of a willingness to
continue with the relationship. Such intent was
sometimes manifested in a direct communication
between the firms (e.g., “I hope we have clarified
and overcome this “misunderstanding” and we can
now continue our fruitful collaboration on a sound
basis”). In other cases, it was made evident through
the crafting of a new agreement by the parties. For
example, in one case, the following clause was
added to the contract: “Addendum to Clause 14:
The Parties thereby agree that [Firm A] and [Firm
B] shall now each conduct by the end of each
month review of the progress made […] The Agree-
ment is thereby extended for a 2 (two)-year period.”
We coded as “no intent to continue” those cases in
which either or both parties explicitly stated no
willingness to continue the relationship (e.g., “You
should perfectly understand that we have put an
end to our collaboration”) and those cases in which
no indication of an intent to continue the relation-
ship was present. Intent to continue the relation-
ship was indicated in 29 cases out of 102.

Independent Variables
Control versus coordination provisions. Our

codification of contract provisions as control-ver-
sus coordination– oriented was based on existing
research (e.g., Parkhe, 1993; Reuer & Ariño, 2007)
and supplemented with extensive interviews with
legal experts specializing in contract law. We con-
ducted 17 interviews with three practicing lawyers
and seven professors in contract law. Interviews
lasted between 1.5 and 3 hours. The experts exam-
ined both the codification scheme we had prepared
drawing on the literature and a sample of contracts
from our data set. The experts then offered an eval-
uation of the coding scheme and proposed some
changes, which we implemented. Here, more pre-
cisely, is the method we followed in coding our
contract provisions:

Step 1: Codification based on prior research.
We relied upon a set of indicators developed by
Parkhe (1993: 829) that are designed to evaluate
various provisions in formal contracts. Parkhe
identified the following eight key provisions that
might be included in a contract: (1) the exchange of
periodic written reports of all relevant transactions,
(2) prompt written notice of any departures from
the agreement, (3) the right to examine and audit all

ships. On Parkhe’s (1993: 829) unweighted index of con-
tractual complexity, which tabulates the presence of up
to eight key contractual clause categories, our sample’s
score (4.36) was situated comfortably between the score
(3.69) for Reuer and Ariño’s (2002) sample and that (5.05)
for Reuer, Ariño, and Mellewigt’s (2006) sample. At the
relationship level, the percentage of prior ties among
firms in our sample (32.4%) was within the range ob-
served in prior research: 12 percent in Gulati (1995b);
20 percent in Reuer and Ariño (2002); and 53 percent in
Hagedoorn and Hesen (2009).

986 OctoberAcademy of Management Journal

relevant records through a firm of CPAs, (4) desig-
nation of certain information as proprietary and
subject to confidentiality provisions of the contract,
(5) nonuse of proprietary information even after
termination of agreement, (6) termination of agree-
ment clauses, (7) arbitration clauses, and (8) law-
suit provisions. Reuer and Ariño (2007) factor-
analyzed the inclusion of Parkhe’s eight provisions
in an analysis of 88 strategic alliances and found
that the first three provisions of Parkhe’s eight-item
index related primarily to coordination, whereas
the remaining five related primarily to enforcement
(what we call control). They therefore defined co-
ordination provisions as the number of coordina-
tion-related clauses included in a contract (i.e.,
clauses 1, 2, and/or 3 from Parkhe [1993]), a mea-
sure yielding an integer variable ranging from 0 to
3; control provisions, defined as the number of
control-related clauses in a contract (i.e., clauses 4,
5, 6, 7, and/or 8 from Parkhe), yielded a score
ranging from 0 to 5.

The coding of our contracts for control versus
coordination provisions was done by (1) one of the
authors and (2) a faculty member with a degree in
law who was unaware of the hypotheses or the
purpose of the study. To further eliminate the pos-
sibility of bias, all coding of contracts was done
prior to any analysis of dispute-related data (e.g.,
trust messages, intent to continue, etc.). Pairwise
correlation among raters for the coding of control-
related provisions (r � .91; p � .001) and for coor-
dination-related provisions (r � .92; p � .001),
along with high Cronbach’s alpha coefficients (0.95
and 0.96, respectively), confirmed the reliability of
the coding. Any disagreements on coding were re-
solved by discussion.

Step 2: Revisions based on expert advice. To
evaluate and refine our coding scheme, we pre-
sented the scheme, as well as a sample of real
contracts, to a set of legal experts. These interviews
yielded two primary results. First, the legal experts
supported our general approach to codification,
stating that contract provisions could be meaning-
fully distinguished as being focused primarily on
control versus coordination. Second, the legal ex-
perts expressed concerns with two clause catego-
ries from Reuer and Ariño’s (2007) coding frame-
work. Specifically, the experts argued that clause
category 3 (regarding the right to examine and audit
all relevant records through a firm of CPAs) did not
clearly represent a coordination function. In addi-
tion, the legal experts suggested that clause cate-
gory 7 (regarding arbitration clauses) was ambigu-
ous because such provisions may not serve a clear
control function. On the basis of this advice, we
revised our categorization scheme so that our mea-

sure of coordination provisions would be based on
clauses 1 and 2 from Parkhe (1993) and our mea-
sure of control provisions would be based on
clauses 4, 5, 6, and 8 from Parkhe (1993).4, 5

Robustness checks. The results below are based
on the measures of coordination and control provi-
sions derived by the two-step process described
above. In addition, we conducted two robustness
checks of our results. In the first set of analyses, we
used the initial (step 1) Reuer and Ariño (2007)
coding framework for our measures of coordination
and control provisions. The findings based on this
eight-clause analysis strongly converge with the
results reported below (results available on re-
quest). In the second set of analyses, we added an
interpretive (coding) step to the step 1 categoriza-
tion, in which a rater evaluated each provision in
every contract of the data set for seeming ambiguity
of intent (Hagedoorn & Hesen, 2009). All clauses
that seemed ambiguous as to whether their func-
tion was coordination or control were then elimi-
nated. To test the reliability of this elimination
procedure, a second rater evaluated ten randomly
selected clauses for each of the eight types of pro-
visions; the level of agreement was 91.25 percent.
This process yielded more conservative measures
in which we deleted 5.96 percent of the coordina-
tion provisions and 12.42 percent of the control
provisions. The results based on these measures
were also consistent with our primary (reported)
analyses, with no differences in the tests of our
hypotheses. Together, these two robustness checks
provide confidence in our reported analyses.

Mediator Variables: Competence-Based Trust and
Goodwill-Based Trust

To assess the level of trust between the parties
during the conflict, we analyzed every communi-
cation (paper or electronic) exchanged between dis-
puting firms during the entire resolution process
for a focal dispute. The choice not to reply to a
communication by the other party was also coded
as a (“no reply”) message. In total, 2,293 messages
were studied (of which only 132 were coded as “no
reply”). A scheme for categorizing statements as
relating to competence- and/or goodwill-based
trust (or neither) was constructed to evaluate each
message (see below for more details). We allowed

4 A confirmatory factor analysis confirmed that the
revised scheme improves on Parkhe’s (1993) eight-clause
coding.

5 Following Lui and Ngo (2004) and Barthélemy and
Quélin (2006), we used unweighted composite indexes.

2011 987Malhotra and Lumineau

each message to be coded as signaling neither, one,
or both types of trust. After an evaluation of all
documents in a given dispute, the ratio of compe-
tence-based trust messages to total messages was
calculated, and it served as a measure of the degree
of competence-based trust. Likewise, the ratio of
goodwill-based trust messages to total messages
served as a measure of the degree of goodwill-based
trust. Thus, the score on each variable could vary
between 0 (i.e., a complete absence of this type of
trust) and 1 (i.e., all the messages exchanged be-
tween the partners conveyed this type of trust).

A team of two researchers coded the messages: a
coauthor of this paper and a colleague (with a law
degree) who was unaware of the hypotheses or the
topic of research. We followed the coding proce-
dure developed by Weber (1990: 21–24), which
includes the following steps: defining the message
as our unit of analysis; developing a list of relevant
preliminary response categories; applying the cod-
ing scheme to a subsample (four cases); assessing
and revising the coding rules as a result; and having
both raters independently read and code each mes-
sage in the data set.6 The percentage of agreement
between raters (97 percent for competence-based
trust and 95 percent for goodwill-based trust) and
the pairwise correlation between raters (r � .94,
p � .01 for competence-based trust, and r � .93,
p � .01 for goodwill-based trust) were high. Any
disagreements were resolved through discussion.
(See Appendix A for examples of statements that
were coded as competence-based trust and good-
will-based trust.)

Control Variables
Asymmetry of revenues. We controlled for

power asymmetry between the parties using firm
revenues as a proxy for firm strength. Asymmetry is
necessary to control because it may affect the like-
lihood that the parties include coordination and/or
control provision in the contract. Asymmetry was
measured as ln(ABS[revenue of firm A – revenue of
firm B]). Revenue was measured in thousands of
inflation-adjusted euros for the year when the con-
tract was signed. These data were obtained from the
Bureau van Dijk’s ORBIS database.

Type of dispute. We evaluated the nature of each
dispute as described by the disputants (Weaver &
Dickson, 1998) at the outset. Disputes could be
meaningfully distinguished as either disagree-
ments regarding the nature of the transaction in-

volved (30.4%) or as a perceived failure on the part
of one party to meet payment, delivery, or other
clear objectives (69.6%). Type of dispute took a
value of 1 in disputes regarding the nature of the
transaction and 0 otherwise.7

Type of settlement. We controlled for the type of
resolution that was eventually pursued—litigation
versus private settlement— because the anticipa-
tion of this eventuality may have influenced a par-
ty’s willingness to make statements that admit to
the other party’s trustworthiness (or lack thereof).
Type of settlement took a value of 0 if the dispute
was eventually settled through litigation and the
value of 1 if the dispute was eventually settled via
private negotiation.

Prior ties. To mitigate endogeneity concerns re-
garding the relationship between contract provi-
sions and trust, we controlled for preexisting trust.
Following Gulati (1995a), we used the existence of
prior ties between the parties to a dispute as a
proxy. We then improved on this measure by cod-
ing whether the parties viewed the previous trans-
actions (if any) positively or negatively. Following
prior research on satisfaction with trading partners
(Heide & John, 1992; Jap & Ganesan, 2000), we
coded files with messages that explicitly referenced
norms of flexibility, participation, and/or solidarity
as positive prior ties; files referencing inflexibility,
nonparticipation, and/or individualism in prior in-
teractions were coded as negative prior ties. Two
dummy variables were created: 16.67 percent of
relationships were coded as having positive prior
ties, and 12.74 percent had negative prior ties.
When there was no prior tie (67.65%), or if there
was no reference to positive or negative percep-
tions (2.94%), both variables took a value of 0.

Prior relationship length. We controlled for the
length of the prior relationship between the parties
to a dispute because a lengthy interaction history
may help parties build trust (Kramer, 1999). As
such, controlling for prior relationship length helps
to further mitigate endogeneity concerns. Also, or-
ganizations interacting repeatedly may learn from
prior experiences, allowing contracts to be speci-
fied in greater detail (Mayer & Argyres, 2004; Van-
neste & Puranam, 2010). We measured the amount

6 We based coding on the item selection and classifi-
cation process outlined by Jauch, Osborn, and Martin
(1980).

7 It is arguable that disagreements regarding the na-
ture of the transaction are coordination problems and
that failure to meet objectives is a control problem. We
pursued this intriguing possibility with supplemental
analyses to test whether (1) our control or coordination
independent variables predicted type of dispute and (2)
type of dispute interacted with either independent vari-
able to predict intent to continue. Neither test produced
significant results.

988 OctoberAcademy of Management Journal

of time for which the firms had transacted prior to
engaging in the transaction that led to the current
conflict (Argyres et al., 2007; Dekker, 2008) as
ln(number of days � 1). The mean prior relation-
ship length was 942 days for the 33 cases in which
firms had prior ties.

Revisions to the initial contract. In 10.8 percent
of cases, the contract in place at the outset of the
dispute was not identical to the original contract
that was signed by the parties. Amendments over
time may indicate recurrent conflict— or, to the
contrary, the ability of parties to cooperatively re-
engage to improve their relationship (Mayer &
Teece, 2008; Reuer & Ariño, 2002). Thus, we con-
trolled for whether a contract had been revised
previously, prior to the current conflict.8 (We
did not observe any revisions during a dispute
period.)

Asymmetry of alternatives. Even parties that
have low levels of trust may decide to continue
collaborating if they have few viable alternatives.
Given our dyad-level outcome variables, we con-
trolled for outside alternatives by evaluating the
degree of asymmetry between the parties’ alterna-
tives, as well as the sum of their alternatives. To
approximate each party’s number of alternatives to
dealing with the other, we content-analyzed the
communications to look for mentions of alternative
options and/or partners (e.g., “You know that if you
continue to deny the facts, we will turn to [firm X]
to supply this part”; “If we aren’t able to put this
relationship on the right track, we will produce the
[part] ourselves”). Because the texts did not allow
us to calculate the precise number of each party’s
alternatives, we estimated the strength of alterna-
tives in terms of the frequency with which a party
mentioned alternatives. Asymmetry of alternatives
was measured as ABS [(number of references to
alternatives by firm A) – (number of references to
alternatives by firm B)].

Sum of alternatives. We evaluated mutual de-
pendence by calculating the sum of each party’s
alternatives. A higher value indicated that the par-
ties had strong alternatives to dealing with each
other (i.e., a lower degree of mutual dependence).

Dropped variables. The following variables
were tested in a supplemental set of tests for our
hypotheses but dropped from the analyses reported
below because they did not have any significant

effects in any of the analyses: industry (e.g., man-
ufacturing), type of transaction (e.g., distribution
contract), international (i.e., whether the transac-
tion entailed a cross-border relationship), time
bound (i.e., a dichotomous variable capturing
whether an initial contract had a specified end
time), technical detail (i.e., the level of complexity
of a transaction), stakes (i.e., the amount of money
involved in the contract), and geographic distance
between contracting firms.

Analyses

Regression analyses were used to test the impact
of contractual provisions on the level of each type
of trust (Hypotheses 1– 4). As some companies in
our sample were repeat clients (i.e., were involved
in multiple disputes), correlated residuals across
observations were possible; we therefore report re-
sults with robust standard errors clustered on firms
(76 clusters). When intent to continue the relation-
ship, a binary variable, served as the dependent
measure (Hypotheses 5– 8), we used probit models.
As a robustness check, we also used logit models
for these analyses; results were identical. Hypoth-
eses 7b, 7c, 8b, and 8c predict mediated relation-
ships. To test for mediation, we followed the pro-
cedure outlined by Baron and Kenny (1986).
Mediation is supported if (1) the independent vari-
able (IV) significantly predicts the dependent vari-
able (DV), (2) the IV significantly predicts the me-
diator (MV), (3) the MV significantly predicts the
DV, and (4) when the IV and MV are simultane-
ously included in the analysis, the MV is a signif-
icant predictor, but the IV is less (or no longer)
significant.

It is worth noting that although regression anal-
ysis cannot evaluate temporal causality, our data
suggest that a temporal sequence is in play. The
data on contract provisions and transaction attri-
butes are based on information that predates the
onset of the disputes (T � 1). The data on goodwill-
and competence-based trust are based on messages
exchanged at a later time (T � 2), after the onset of
the conflict. Finally, the intent to continue the re-
lationship is manifested at the end of the dispute
resolution process (T � 3). In addition, we tried to
address this issue of alternative relationships by
including a host of control variables (described
above) that might influence initial contract struc-
ture, most notably the existence and influence of
preexisting trust (measured both by the length of
prior ties and with measures of the quality of prior
ties). Finally, as an additional robustness check, we
conducted a supplemental analysis aimed at miti-
gating, to the degree possible, concerns regarding

8 We conducted an additional analysis at the provi-
sion level and found that 96.1 percent of the control
provisions and 94.4 percent of the coordination provi-
sions were in the contracts from the beginning of the
transactions. Including controls for changes made at the
provision level did not change any of the results.

2011 989Malhotra and Lumineau

whether prior relationships (and prior trust, specif-
ically) influenced the types of contractual clauses.
In this analysis, we eliminated all 32.35 percent of
relationships that contained any prior ties. The re-
sults are consistent with those of our core analyses,
again suggesting that endogeneity is perhaps not
problematic for our results.

RESULTS

Interfirm relationships varied in the degree to
which their associated contracts included coordi-
nation versus control provisions. The mean num-
ber of coordination provisions was 0.99 (out of 2),
and the mean number of control provisions was
2.30 (out of 4). Table 1 provides summary statistics
and Pearson correlations for the variables in our
analysis. Because some variables were significantly
correlated, we checked for multicollinearity prob-
lems. The observed variance inflation factor (VIF)
ranged from 2.47 to 4.70, diminishing this concern
(Chatterjee & Price, 1991).

Table 2 displays the first set of results in which
goodwill-based trust and competence-based trust
are regressed on contractual provisions (control vs.
coordination). As Hypothesis 1 predicts (Table 2,
model 1d), when attributes of transaction, of dis-
pute, and of relationship are controlled for, the
higher the level of control provisions, the lower the
level of goodwill-based trust (� � �0.05, p � .001).
We also found (Table 2, model 2d) that control
provisions positively influence competence-based
trust (� � 0.06, p � .001), supporting Hypothesis 2.
As Hypothesis 3 predicts, increasing the coordina-
tion provisions of a contract results in an increase
in competence-based trust (� � 0.16, p � .001;
Table 2, model 2d). However, Hypothesis 4, which

predicts that an increase in coordination provisions
will result in an increase in goodwill-based trust,
was not supported (Table 2, model 1d).

Table 3 shows the results of binomial probit re-
gressions in which the dichotomous dependent
variable is intent to continue. A positive coefficient
indicates an increased likelihood of continuing a
relationship. In keeping with our predictions, we
found (Table 3, model 3d) that both goodwill-based
trust (� � 17.07, p � .001) and competence-based
trust (� � 9.45, p � .01) positively impact the intent
to continue, supporting Hypotheses 5 and 6, re-
spectively.

We also predicted that the greater the level of
control provisions in a contract, the less likely it
would be that the parties to the contract would
intend to continue the relationship (Hypothesis 7a)
and that both goodwill-based (Hypothesis 7b) and
competence-based (Hypothesis 7c) trust would me-
diate this relationship. Supporting Hypothesis 7a
(Table 3, model 4c), the higher the number of con-
trol provisions, the lower the likelihood of continu-
ing the relationship (� � �0.62, p � .01).

The mediation predictions of Hypotheses 7b and
7c required multiple tests (Baron & Kenny, 1986).
We have already shown that control provisions pre-
dict goodwill-based and competence-based trust.
We have also shown that goodwill-based trust and
competence-based trust are positively related to the
intent to continue. Finally, in keeping with Hy-
pothesis 7b, when we simultaneously included
control provisions (the independent variable) and
goodwill-based trust (the mediator variable) as pre-
dictors of intent to continue (Table 3, model 5a),
goodwill-based trust was still a significant predic-
tor (� � 12.93, p � .001), but number of control
provisions was no longer significant (� � �0.15,

TABLE 1
Descriptive Statistics and Correlations

Variables Mean Min. Max. s.d. 1 2 3 4 5 6 7 8 9 10 11 12 13

1. Intent to continue 0.28 0 1 0.45
2. Control provisions 2.30 0 4 0.90 �.13
3. Coordination provisions 0.99 0 2 0.89 .39* �.11
4. Goodwill-based trust 0.22 0 0.66 0.16 .78* �.16 .21*
5. Competence-based trust 0.26 0 0.8 0.22 .60* .24* .68* .47*
6. Asymmetry 7.66 5.17 10.28 0.96 .00 .04 �.02 .03 �.08
7. Type of conflict 0.32 0 1 0.47 .02 �.02 .14 .01 .16 .00
8. Settlement type 0.40 0 1 0.49 .45* .12 .09 .57* .36* .14 �.05
9. Negative prior ties 0.12 0 1 0.33 �.11 �.19 .07 �.12 �.20* .22* �.07 �.25*

10. Positive prior ties 0.16 0 1 0.37 .00 �.00 .00 .02 .03 .03 �.08 .16 �.17
11. Prior relationship length 1.80 0 8.63 2.94 �.08 �.14 .01 �.07 �.16 .15 �.13 �.07 .64* .59*
12. Revisions 0.22 0 4 0.72 .13 .32* .15 .13 .20 .12 �.09 .21* �.03 .11 .07
13. Asymmetry of alternatives 1.18 0 5 1.27 �.07 .10 �.10 �.06 .00 .09 �.08 �.13 .05 �.10 �.04 �.02
14. Sum of alternatives 1.51 0 8 1.65 .02 .09 �.04 �.05 .33 .03 �.00 �.14 .04 �.01 �.00 �.04 .82*

* p � .05

990 OctoberAcademy of Management Journal

n.s.), suggesting full mediation. To evaluate the
mediation effect, we conducted a Sobel test (Sobel,
1982), computing a Z-value to assess whether the
indirect effect of the independent variable on the
dependent variable through the mediator is signif-
icantly different from zero. The Sobel test con-
firmed the mediating effect of goodwill-based trust
between control provisions and the intent to con-
tinue (Z � �2.71, p � .01). In contrast, when we
simultaneously included control provisions (the
IV) and competence-based trust (as the MV) as pre-
dictors of intent to continue (Table 3, model 5b),
both variables— competence-based trust (� � 11.90,
p � .001) and control provisions (� � �2.11,
p � .001)—remained highly significant, suggesting
no support for the mediation predicted in Hypoth-
esis 7c. Thus, the (negative) effect of control provi-
sions on intent to continue a relationship is medi-
ated by goodwill-based (but not competence-
based) trust.

Hypothesis 8a predicts that coordination provi-
sions will positively influence intent to continue.
Hypotheses 8b and 8c predict that goodwill-based
trust (8b) and competence-based trust (8c) will me-
diate this effect. Supporting Hypothesis 8a, we
found (Table 3, model 4c) that the higher the level
of coordination provisions in the contract for a
relationship between firms, the higher the likeli-
hood of the firms’ continuing the relationship after

a dispute (� � 0.77, p � .01). Since we had already
established, in failing to support Hypothesis 4, that
coordination provisions do not affect goodwill-
based trust, we did not need to assess the role of
goodwill-based trust as a mediator; Hypothesis 8b
was not supported. The mediation prediction re-
garding competence-based trust (Hypothesis 8c),
however, was supported: we have already shown
that competence-based trust positively influences
intent to continue a relationship. When we simul-
taneously included coordination provisions and
competence-based trust as predictors of intent to
continue (Table 3, model 5b), competence-based
trust remained a significant predictor (� � 11.90,
p � .001), but coordination provisions did not
(� � �0.61, n.s.). This pattern of results suggests
full mediation, which a follow-up Sobel test con-
firmed (Z � 3.32, p � .001). Thus, the (positive)
effect of coordination provisions on the intent to
continue collaboration is mediated by competence-
based (but not goodwill-based) trust.

For completeness, as a final analysis (Table 3,
model 5c), we simultaneously included both inde-
pendent variables (coordination and control provi-
sions) and both mediators (competence- and good-
will-based trust) as predictors of intent to continue.
Both mediators remained marginally significant
predictors of intent to continue (� � 19.38, p � .01,
and � � 14.96, p � .01). Also consistently with

TABLE 2
Effects of Control vs. Coordination Provisions on Goodwill- and Competence-Based Trusta

Variables

Goodwill-Based Trust Competence-Based Trust

Model 1a Model 1b Model 1c Model 1d Model 2a Model 2b Model 2c Model 2d

Independent
Control provisions –.05*** (.01) –.05*** (.01) .03† (.02) .06*** (.01)
Coordination provisions .03† (.01) .02 (.01) .15*** (.01) .16*** (.01)

Control
Asymmetry �.00 (.01) �.00 (.01) �.00 (.01) �.00 (.01) �.03 (.02) -.03† (.02) �.02 (.01) �.02 (.01)
Type of conflict .01 (.02) .01 (.02) .00 (.02) .00 (.02) .08† (.04) .08† (.04) .03 (.03) .03 (.03)
Settlement type .20*** (.03) .20*** (.03) .20*** (.03) .20*** (.03) .16** (.04) .16** (.04) .13*** (.02) .12*** (.02)
Negative prior ties �.01 (.10) �.05 (.10) �.06 (.10) �.08 (.10) .22 (.28) .24 (.27) �.02 (.18) �.00 (.16)
Positive prior ties �.06 (.08) �.07 (.08) �.09 (.07) �.09 (.08) .18 (.23) .19 (.23) .03 (.15) .04 (.13)
Prior relationship length .00 (.01) .00 (.01) .01 (.01) .00 (.01) �.03 (.03) �.03 (.03) �.01 (.02) �.01 (.02)
Revisions .00 (.02) .02 (.01) �.00 (.01) .02 (.01) .05* (.02) .04† (.02) .02 (.01) �.00 (.01)
Asymmetry of alternatives �.00 (.01) �.00 (.01) �.00 (.01) �.00 (.01) �.02 (.02) �.02 (.02) �.01 (.01) �.01 (.01)
Sum of alternatives .00 (.01) .01 (.01) .00 (.01) .01 (.01) .03† (.01) .03† (.01) .03** (.01) .02* (.01)

Constant .19† (.11) .29* (.11) .15 (.11) .25* (.11) .42* (.17) .36† (.16) .18 (.12) .04 (.12)
R2 .34 .41 .36 .42 .27 .29 .64 .70

a n � 102. Standard errors are in parentheses; clustering (n � 76) is on firms.
† p � .10
* p � .05

** p � .01
*** p � .001

2011 991Malhotra and Lumineau

T
A

B
L

E
3

E
ff

ec
ts

o
f

C
o
n

tr
o
l

a
n

d
C

o
o
rd

in
a
ti

o
n

P
ro

v
is

io
n

s
o
n

th
e

In
te

n
t

to
C

o
n

ti
n

u
e

in
a

R
el

a
ti

o
n

sh
ip

a

V
a
ri

a
b
le

s
M

o
d

el
3
a

M
o
d

el
3
b

M
o
d

el
3
c

M
o
d

el
3
d

M
o
d

el
4
a

M
o
d

el
4
b

M
o

d
el

4
c

M
o

d
el

5
a

M
o

d
el

5
b

M
o

d
el

5
c

In
d

ep
en

d
en

t
C

o
n

tr
o
l

p
ro

v
is

io
n

s

0
.6

2
*

(0
.2

4
)


0
.6

2
*

*
(0

.2
2

)

0
.1

5
(0

.2
8

)

2
.1

1
*

*
*

(0
.5

1
)


1

.4
5


(0

.7
5

)
C

o
o
rd

in
at

io
n

p
ro

v
is

io
n

s
0
.7

8
*
*

(0
.2

3
)

0
.7

7
*

*
(0

.2
4

)
1

.1
3

*
(0

.4
5

)

0
.6

1
(0

.3
7

)
0

.4
6

(0
.6

0
)

G
o
o
d

w
il

l-
b
as

ed
tr

u
st

1
0
.5

9
*
*
*

(1
.4

7
)

1
7
.0

7
*
*
*

(4
.4

4
)

1
2

.9
3

*
*

*
(1

.9
0

)
1

9
.3

8
*

*
(6

.0
3

)
C

o
m

p
et

en
ce

-b
as

ed
tr

u
st

4
.6

4
*
*
*

(0
.8

9
)

9
.4

5
*
*

(2
.7

3
)

1
1

.9
0

*
*

*
(3

.0
1

)
1

4
.9

6
*

*
(5

.5
4

)

C
o
n

tr
o
l

A
sy

m
m

et
ry


0
.1

3
(0

.1
4
)


0
.1

1
(0

.2
4
)


0
.0

2
(0

.1
6
)


0
.0

0
(0

.2
5
)


0
.1

4
(0

.1
6
)


0
.0

9
(0

.1
4
)


0
.1

1
(0

.1
6

)

0
.1

1
(0

.2
0

)

0
.1

4
(0

.2
0

)

0
.0

2
(0

.2
3

)
T

y
p

e
o
f

co
n

fl
ic

t
0
.0

9
(0

.3
0
)


0
.0

8
(0

.4
3
)


0
.3

6
(0

.3
5
)


0
.8

4
(0

.5
1
)

0
.1

6
(0

.3
6
)


0
.1

2
(0

.3
3
)


0
.0

4
(0

.3
3

)

0
.2

3
(0

.4
5

)

0
.4

1
(0

.4
5

)

1
.2

7
(0

.9
4

)
S

et
tl

em
en

t
ty

p
e

1
.5

3
*
*
*

(0
.3

2
)

0
.3

0
(0

.5
3
)

1
.2

1
*
*

(0
.3

8
)


0
.2

2
(0

.7
3
)

1
.7

9
*
*
*

(0
.3

7
)

1
.6

8
*
*
*

(0
.4

4
)

1
.9

3
*

*
*

(0
.4

9
)

0
.2

1
(0

.6
8

)
2

.0
8

*
*

(0
.6

1
)

0
.3

4
(1

.1
6

)
N

eg
at

iv
e

p
ri

o
r

ti
es

0
.2

7
(1

.4
3
)

1
.0

2
(1

.4
9
)


0
.1

2
(1

.1
6
)

1
.0

7
(1

.5
4
)


0
.0

0
(1

.6
5
)


0
.6

7
(1

.2
8
)


0

.8
2

(1
.4

3
)

0
.1

0
(1

.4
8

)
1

.5
2

(1
.4

7
)

1
.7

4
(1

.7
3

)
P

o
si

ti
v
e

p
ri

o
r

ti
es


0
.3

1
(1

.1
5
)

0
.4

2
(1

.1
9
)


0
.9

2
(1

.0
1
)

0
.1

6
(1

.2
5
)


0
.4

5
(1

.3
5
)


1
.0

5
(1

.0
7
)


1

.1
2

(1
.2

0
)


0

.1
1

(1
.1

9
)


0

.6
0

(1
.0

6
)

0
.1

3
(1

.4
7

)
P

ri
o
r

re
la

ti
o
n

sh
ip

le
n

gt
h


0
.0

2
(0

.1
8
)


0
.1

2
(0

.2
0
)

0
.1

0
(0

.1
6
)

0
.0

1
(0

.2
2
)


0
.0

4
(0

.2
2
)

0
.0

9
(0

.1
7
)

0
.0

5
(0

.1
9

)

0
.0

5
(0

.2
0

)

0
.1

8
(0

.2
1

)

0
.1

5
(0

.2
5

)
R

ev
is

io
n

s
0
.1

1
(0

.1
9
)

0
.0

5
(0

.2
0
)


0
.1

6
(0

.1
8
)


1
.3

5
*

(0
.5

5
)

0
.4

4
(0

.2
2
)

0
.0

4
(0

.1
7
)

0
.3

1
(0

.2
0

)

0
.2

1
(0

.2
7

)
0

.6
7

*
(0

.2
6

)

1
.1

4

(0
.6

6
)

A
sy

m
m

et
ry

o
f

al
te

rn
at

iv
es


0
.3

9

(0
.2

2
)


0
.7

4
*
*

(0
.2

6
)


0
.3

6
(0

.2
6
)


0
.4

5
(0

.3
4
)


0
.3

5
(0

.2
2
)


0
.3

9
(0

.2
7
)


0

.3
2

(0
.2

7
)


0

.6
2


(0

.3
1

)

0
.1

9
(0

.3
1

)

0
.2

5
(0

.3
7

)
S

u
m

o
f

al
te

rn
at

iv
es

0
.3

4
*

(0
.1

6
)

0
.5

5
*
*

(0
.1

8
)

0
.2

4
(0

.2
1
)

0
.2

5
(0

.2
0
)

0
.3

7
*

(0
.1

5
)

0
.3

8

(0
.2

1
)

0
.3

9

(0
.2

0
)

0
.5

1

(0
.2

4
)

0
.1

1
(0

.2
4

)
0

.2
0

(0
.2

8
)

C
o
n

st
an

t

0
.4

0
(1

.1
4
)


2
.6

1
(1

.8
3
)


2
.1

8
(1

.4
7
)


6
.5

2
*
*

(2
.4

8
)

0
.7

7
(1

.3
9
)


1
.6

0
(1

.2
8
)


0
.2

2
(1

.5
1

)

3
.8

8
*

(1
.8

9
)

1
.3

3
(1

.8
1

)

6
.5

4
*

(2
.7

8
)

P
se

u
d

o
-R

2
.2

3
.6

5
.4

3
.7

6
.3

1
.3

6
.4

2
.7

5
.6

5
.8

3
W

al
d


2

2
6
.9

0
8
1
.7

3
4
3
.6

4
3
9
.8

2
3
3
.1

1
2
3
.6

0
3
1
.3

7
9

6
.7

3
2

8
.8

5
5

8
.7

3

a
n


1
0
2
.

S
ta

n
d

ar
d

er
ro

rs
ar

e
in

p
ar

en
th

es
es

;
cl

u
st

er
in

g
(n


7
6
)

is
o
n

fi
rm

s.

p

.1
0

*
p


.0

5
*
*

p

.0
1

*
*
*

p

.0
0
1

predictions, coordination provisions was no longer
significant (� � 0.46, n.s.). Meanwhile, control pro-
visions continued to have a marginally significant,
direct negative effect on intent to continue (� �
�1.45, p � .10), which suggests that control provi-
sions may negatively influence the intent to con-
tinue in ways that are not fully accounted for by the
effects of control provisions on trust.

DISCUSSION

We sought to extend theoretical and empirical
work by distinguishing between the control and
coordination functions of contracts, and between
goodwill-based and competence-based dimensions
of trust judgments. Prior research on the effects of
contracts on trust has focused primarily on the
control function of contracts and the goodwill di-
mension of trust judgments. Less attention has been
paid to the coordination function of contracts, and
the competence dimension of trust has been largely
ignored. We found, as have those who have argued
that contracts crowd out trust (e.g., Malhotra &
Murnighan, 2002), that the greater the number of
control-oriented provisions in a contract, the lower
the subsequent level of goodwill-based trust in the
associated relationship. In addition, in keeping
with those who have perceived a more complemen-
tary relationship between contracts and trust (e.g.,
Lazzarini, Miller, & Zenger, 2004; Poppo & Zenger,
2002), we found that increases in control provi-
sions as well as increases in coordination provi-
sions lead to higher levels of competence-based
trust. Thus, our more nuanced approach to analyz-
ing contracts and trust reveals that seemingly di-
vergent conclusions in prior research are not nec-
essarily incompatible.

The current investigation also addresses the scar-
city of research on the effects of contractual gover-
nance on performance and relational outcomes
(e.g., Argyres et al., 2007; Lumineau, Fréchet, &
Puthod, 2011). Our findings indicate that contract
design affects the degree of trust that exists after a
conflict has arisen, and, through this effect, the
likelihood of relationship continuance. In particu-
lar, control provisions have a negative effect on the
willingness to continue a damaged relationship,
and goodwill-based trust mediates this effect. Al-
though control provisions enhance perceptions of
competence and high levels of competence-based
trust increase the likelihood of continued collabo-
ration, competence-based trust does not act as a
mediator in the relationship between control pro-
visions and the intent to continue collaboration.
Whereas the argument that control mechanisms
can diminish goodwill-based trust has been made

in prior research (e.g., Malhotra & Murnighan,
2002), ours is the first study to document (1) the
effects of control mechanisms on the willingness to
continue a relationship and (2) the mediating role
of goodwill-based trust in this relationship. Fur-
thermore, although perceptions of competence
do not mediate the effects of control on collabora-
tion, ours is the first study to empirically document
a positive relationship between (control provisions
in) contracts and competence-based trust.

We also find that coordination provisions in-
crease the likelihood of continued collaboration
after a dispute and that perceptions of competence
mediate this effect. Although prior research has
predicted a relationship between coordination and
continued collaboration (Argyres et al., 2007;
Mayer & Argyres, 2004), ours is the first empirical
study to identify a mechanism— enhanced percep-
tions of competence— underlying this relationship.
Contrary to predictions, we did not find an effect of
coordination provisions on goodwill-based trust.

Theoretical Implications

The results yield a number of theoretical impli-
cations that build upon and clarify prior research.
Our study extends research based on transaction
cost economics (e.g., Barthélemy & Quélin, 2006;
Reuer & Ariño, 2002) by showing that firm deci-
sions regarding contractual governance structures
should embrace not only (1) transaction attributes
(as per the transaction costs approach [Sampson,
2004; Williamson, 1985]) and (2) existing levels of
trust (e.g., Gulati, 1995a), but also (3) the effect of
contract choices on subsequent trust and commit-
ment (cf. Puranam & Vanneste, 2009).

Another important implication of our results
concerns the simultaneity with which contracts
can produce positive and negative effects. Previ-
ously, Vlaar argued:

The relationship between contracting and interor-
ganizational performance is likely to follow a curve-
linear path, where too little contracting gives rise to
chaos and destructive or opportunistic behaviour
and where too much contracting causes rigidity and
curbs creativeness and entrepreneurial activities
(Foss, Foss, & Klein, 2007; Luo, 2002; Mintzberg,
1994; Sampson, 2004a). In this respect, Mintzberg
(1994: 386) notes that “formalization is a double-
edged sword, easily reaching the point where help
becomes hindrance.” (2008: 18)

Although this logic suggests that there may be an
optimal level of contracting, our results suggest
otherwise, at least as far as control provisions are
concerned. We find that an increase in control pro-

2011 993Malhotra and Lumineau

visions decreases goodwill-based trust and in-
creases competence-based trust, suggesting that an
optimal contract will not be found by discovering
the “point where help becomes hindrance,” but by
appreciating inherent trade-offs and evaluating the
priorities of current relationships. Future research
that studies whether it is possible to avoid such
trade-offs—for example, by mitigating the effects of
control on goodwill-based trust—would be of sig-
nificant value.

Finally, the current research suggests that future
work on the effects of contractual governance
should include outcome measures as well as medi-
ator variables. In our complete model, for example,
we find that our mediator, goodwill-based trust,
accounts for some, but not all, of the effects of
control provisions on the intent to continue collab-
oration, thus raising additional questions regarding
the mechanisms underlying these relationships.

Managerial Implications

The current investigation also has implications
for managers who are tasked with the responsibility
of mitigating relationship risks. By distinguishing
between control and coordination provisions
(rather than relying on standard measures of con-
tractual complexity, such as length or detail [Jos-
kow, 1987; Pirrong, 1993]), we are able to advocate
for an increase in coordination provisions as a
means of building competence-based trust in antic-
ipation of conflict. In keeping with this view, a
South Asian executive recently explained to one of
us that he refuses to do business with any U.S. firm
unless the firm contractually agrees to sending each
new project manager to his city and on a car ride
from the airport to his manufacturing facility; the
facility is 18 kilometers from the airport, but re-
quires three hours of travel. “Because if the manag-
ers have not done that, they do not understand how
things work here—and the next time something
goes wrong, they think it is because we are incom-
petent.”

Our results regarding control give us pause and
suggest that optimal decisions regarding contract
structure require an assessment of the key sources
of vulnerability in a relationship. If the relationship
is likely to evolve, and it is difficult to predict the
kinds of vulnerabilities that will emerge over
time—as is often the case when negotiating con-
tracts at the outset of a long-term joint venture, or
among partners in a start-up environment— good-
will-based trust is likely to be critical, and manag-
ers may choose to reduce the emphasis on control
and increase the emphasis on coordination. If
competence-based trust is critical, as it is in re-

lationships in which one or both of the parties are
providing technically or operationally complex
services, managers may increase reliance not
only on coordination provisions (an obvious ini-
tiative), but also on control provisions.

Managers might also take note that although 29
percent of the disputes in our sample—all of which
had escalated to the point that law firms were in-
volved—were resolved with the parties intending
to continue collaborating, contract structure influ-
enced whether the relationships could be revived.
They were more likely to survive when they con-
tained fewer control provisions and more coordi-
nation provisions. This finding suggests that if
parties anticipate future conflict (for example, in
cross-cultural relationships) they might choose
contracting structures that, even if they are subop-
timal in some ways (e.g., for minimizing risk via
control), are better able to encourage trust develop-
ment (through an increase in coordination provi-
sions). This suggestion highlights another insight
for managers to appreciate: the types of contracts
that are best at avoiding conflict may not be the
most helpful in situations in which conflict has not
been avoided.

Limitations and Directions for Future Research

A number of limitations of the current research
can be identified. First, we focus on only one type
of outcome variable: relationship continuance. Re-
search on other performance variables (e.g., profits)
and relational variables (e.g., partner satisfaction)
would be of clear benefit. Second, as with any such
analysis, it is impossible to fully ensure that the
results of our analyses precisely support the causal
relationships we have predicted. Our longitudinal
data, control variables, and numerous robustness
checks help mitigate these concerns, but future re-
search using experimental designs would nicely
complement the current investigation. Third, al-
though our empirical approach suggests a clear dis-
tinction between control and coordination provi-
sions, we acknowledge that some provisions may
simultaneously accomplish both objectives. To ad-
dress this concern, we (1) revised the coding
scheme that was derived from existing research
with the help of legal experts and (2) conducted
two separate robustness checks. Future research
could extend our approach by seeking other meth-
ods of evaluating the coordination versus control
functions of contracts.

In this study, we sought to conceptually refine
and empirically extend previous work on the effect
of contracts on trust and trust-related outcomes in
interorganizational relationships. The findings pro-

994 OctoberAcademy of Management Journal

vide a more nuanced understanding of these issues,
as well as unique and actionable theoretical and
managerial insights. We hope our investigation
aids future research that builds on the strengths of
our approach and overcomes the weaknesses
herein admitted.

REFERENCES

Agarwal, R., Croson, R., & Mahoney, J. T. 2010. The role
of incentives and communication in strategic alli-
ances: An experimental investigation. Strategic
Management Journal, 31: 413– 437.

Ahn, T. K., Ostrom, E., Schmidt, D., Shupp, R., & Walker,
J. 2001. Cooperation in PD games: Fear, greed, and
history of play. Public Choice, 106: 137–155.

Argyres, N. S., Bercovitz, J., & Mayer, K. J. 2007. Comple-
mentarity and evolution of contractual provisions:
An empirical study of IT service contracts. Organi-
zation Science, 18: 3–19.

Arrow, K. J. 1974. The limits of organization. New York:
Norton.

Baird, D., Gertner, R., & Picker, R. 1994. Game theory
and the law. Cambridge, MA: Harvard University
Press.

Barnard, C. 1938. The functions of the executive. Cam-
bridge, MA: Harvard University Press.

Barney, J. B., & Hansen, M. H. 1994. Trustworthiness as a
source of competitive advantage. Strategic Manage-
ment Journal, 15: 175–190.

Baron, R. M., & Kenny, D. A. 1986. The mediator-moder-
ator variables distinction in social psychological
research: Conceptual, strategic and statistical con-
siderations. Journal of Personality and Social Psy-
chology, 51: 1173–1182.

Barthélemy, J., & Quélin, B. V. 2006. Complexity of out-
sourcing contracts and ex post transaction costs: An
empirical investigation. Journal of Management
Studies, 43: 1775–1797.

Beatty, J., & Samuelson, S. 2001. Business law for a new
century. Cincinnati: West Legal Studies in Business.

Blodgett, L. L. 1992. Factors in instability of international
joint venture: An event history analysis. Strategic
Management Journal, 13: 475– 481.

Bottom, W. P., Gibson, K., Daniels, S. E., & Murnighan,
J. K. 2002. When talk is not cheap: Substantive pen-
ance and expressions of intent in rebuilding cooper-
ation. Organization Science, 13: 497–513.

Burns, T., & Stalker, G. M. 1961. The management of
innovation. London: Tavistock.

Camerer, C. F. 2003. Behavioral game theory: Experi-
ments in strategic interaction. Princeton, NJ: Prince-
ton University Press.

Chatterjee, S., & Price, B. 1991. Regression analysis by
example (2nd ed.). New York: Wiley.

Das, T. K., & Teng, B. S. 2001. Trust, control, and risk in
strategic alliances: An integrated framework. Orga-
nization Studies, 22: 251–283.

Davis, J. H., Schoorman, F. D., Mayer, R. C., & Tan, H. H.
2000. The trusted general manager and business unit
performance: Empirical evidence of a competitive
advantage. Strategic Management Journal, 21: 563–
576.

Dekker, H. C. 2008. Partner selection and governance
design. Accounting, Organizations and Society, 33:
915–941.

Dhanaraj, C., & Beamish, P. W. 2004. Effect of equity
ownership on the survival of international joint ven-
tures. Strategic Management Journal, 25: 295–305.

Dirks, K. T., Lewicki, R. J., & Zaheer, A. 2009. Repairing
relationships within and between organizations:
Building a conceptual foundation. Academy of
Management Review, 34: 401– 422.

Faems, D., Janssens, M., Madhok, A., & Van Looy, B.
2008. Towards an integrative perspective on alliance
governance: Connecting contract design, contract ap-
plication, and trust dynamics. Academy of Manage-
ment Journal, 51: 1053–1078.

Ferrin, D. L., & Dirks, K. T. 2003. The use of rewards to
increase and decrease trust: Mediating processes and
differential effects. Organization Science, 14: 18 –31.

Foss, K., Foss, N. J., & Klein, P. G. 2007. Peripheral
vision. Organization Studies, 28: 1893–1912.

Ghoshal, S., & Moran, P. 1996. Bad for practice: A critic
of the transaction cost theory. Academy of Manage-
ment Review, 21: 13– 47.

Gulati, R. 1995a. Does familiarity breed trust? The impli-
cations of repeated ties for contractual choice in
alliances. Academy of Management Journal, 38:
85–112.

Gulati, R. 1995b. Social structure and alliance formation
patterns: A longitudinal analysis. Administrative
Science Quarterly, 40: 619 – 652.

Gulati, R., Lawrence, P. R., & Puranam, P. 2005. Adapta-
tion in vertical relationships: beyond incentive con-
flict. Strategic Management Journal, 26: 415– 440.

Gulati, R., & Nickerson, J. 2008. Interorganizational trust,
governance choice, and exchange performance. Or-
ganization Science, 19: 688 –708.

Hagedoorn, J., & Hesen, G. 2009. Contractual complexity
and the cognitive load of R&D alliance contracts.
Journal of Empirical Legal Studies, 6: 867–903.

Heide, J. B., & John, G. 1992. Do norms matter in market-
ing relationships? Journal of Marketing, 56(2): 32–
44.

2011 995Malhotra and Lumineau

Hinds, P. J., & Mortensen, M. 2005. Understanding con-
flict in geographically distributed teams: The mod-
erating effects of shared identity, shared context, and
spontaneous communication. Organization Science,
16: 290 –307.

Inkpen, A. C., & Beamish, W. P. 1997. Knowledge, bar-
gaining power and the instability of international
joint venture. Academy of Management Review,
22: 177–202.

Jap, S. D., & Ganesan, S. 2000. Control mechanisms and
the relationship life cycle: Implication for safeguard-
ing specific investments and developing commit-
ment. Journal of Marketing Research, 37: 227–245.

Jauch, L. R., Osborn, R. N., & Martin, T. N. 1980. Struc-
tured content analysis of cases: A complimentary
method for organizational research. Academy of
Management Journal, 5: 517–526.

Joskow, P. L. 1987. Contract duration and relationship-
specific investments: Empirical evidence from coal
markets. American Economic Review, 77: 168 –185.

Kim, P. H., Dirks, K. T., Cooper, C. D., & Ferrin, D. L.
2006. When more blame is better than less: The
implications of internal vs. external attributions for
the repair of trust after a competence- vs. integrity-
based trust violation. Organizational Behavior and
Human Decision Processes, 99: 49 – 65.

Kim, P. H., Ferrin, D. L., Cooper, C. D., & Dirks, K. T.
2004. Removing the shadow of suspicion: The effects
of apology versus denial for repairing competence-
versus integrity-based trust violations. Journal of
Applied Psychology, 89: 104 –118.

Knez, M., & Camerer, C. F. 2000. Increasing cooperation
in prisoner’s dilemmas by establishing a precedent
of efficiency in coordination games. Organizational
Behavior and Human Decision Processes, 82: 194 –
216.

Kogut, B. 1988. Joint ventures: Theoretical and empirical
perspectives. Strategic Management Journal, 9:
319 –332.

Kramer, R. M. 1999. Trust and distrust in organizations:
Emerging perspectives, enduring questions. In J. T.
Spence (Ed.), Annual review of psychology, vol. 50:
569 –598. Palo Alto, CA: Annual Reviews.

Kretschmer, T., & Puranam, P. 2008. Integration through
incentives in differentiated organizations. Organi-
zation Science, 19: 860 – 875.

Lazzarini, S. G., Miller, G. J., & Zenger, T. R. 2004. Order
with some law: Complementarity versus substitution
of formal and informal arrangements. Journal of
Law, Economics and Organization, 20: 261–298.

Lewicki, R. J., McAllister, D. J., & Bies, R. J. 1998. Trust
and distrust: New relationships and realities. Acad-
emy of Management Review, 23: 438 – 458.

Luce, R. D., & Raiffa, H. 1957. Games and decisions. New
York: Wiley.

Lui, S. S., & Ngo, H. Y. 2004. The role of trust and
contractual safeguards on cooperation in non-equity
alliances. Journal of Management, 30: 471– 485.

Lumineau, F., Fréchet, M., & Puthod, D. 2011. An organ-
izational learning perspective on contract design.
Strategic Organization, 9: 8 –32.

Luo, Y. 2002. Contract, cooperation, and performance in
international joint ventures. Strategic Management
Journal, 23: 903–919.

Macaulay, S. 1963. Non-contractual relations in busi-
ness. American Sociological Review, 28: 55–70.

Macneil, I. 1978. Contracts: Adjustment of long-term eco-
nomic relations under classical, neoclassical, and
relational contract law. Northwestern University
Law Review, 72: 854 –902.

Malhotra, D. 2004. Trust and reciprocity decisions: The
differing perspectives of trusters and trusted parties.
Organizational Behavior and Human Decision
Processes, 94: 61–73.

Malhotra, D., & Murnighan, J. K. 2002. The effects of
contracts on interpersonal trust. Administrative Sci-
ence Quarterly, 47: 534 –559.

Mayer, K. J., & Argyres, N. S. 2004. Learning to contract:
Evidence from the personal computer industry. Or-
ganization Science, 15: 394 – 410.

Mayer, K. J., & Teece, D. J. 2008. Unpacking strategic
alliances: The structure and purpose of alliance ver-
sus supplier relationships. Journal of Economic Be-
havior and Organization, 66: 106 –127.

Mayer, R. C., & Davis, J. H. 1999. The effect of the per-
formance appraisal system on trust for management:
A field quasi-experiment. Journal of Applied Psy-
chology, 84: 123–136.

Mayer, R. C., Davis, J. H., & Schoorman, F. D. 1995. An
integrative model of organizational trust. Academy
of Management Review, 20: 709 –734.

McAdams, R. H. 2009. Beyond the prisoners’ dilemma:
Coordination, game theory, and the law. Southern
California Law Review, 82: 209 –258.

Mellewigt, T., Madhok, A., & Weibel, A. 2007. Trust and
formal contracts in interorganizational relationships:
Substitutes and complements. Managerial and De-
cision Economics, 28: 833– 847.

Mintzberg, H. 1994. The rise and fall of strategic plan-
ning. Hemel Hempstead, U.K.: Prentice Hall.

Molm, L. D., Takahashi, N., & Peterson, G. 2000. Risk and
trust in social exchange: An experimental test of a
classical proposition. American Journal of Sociol-
ogy, 105: 1396 –1427.

Morgan, R. M., & Hunt, S. D. 1994. The commitment-trust

996 OctoberAcademy of Management Journal

theory of relationship marketing. Journal of Market-
ing, 58: 20 –38.

Morrison, E. W., & Robinson, S. L. 1997. When employ-
ees feel betrayed: A model of how psychological
contract violation develops. Academy of Manage-
ment Review, 22: 226 –256.

Nahapiet, J., & Ghoshal, S. 1998. Social capital, intellec-
tual capital, and the organizational advantage. Acad-
emy of Management Review, 23: 242–266.

Ness, H. 2009. Governance, negotiations, and alliance
dynamics: Explaining the evolution of relational
practice. Journal of Management Studies, 46: 451–
480.

Nooteboom, B. 1996. Trust, opportunism and gover-
nance: A process and control model. Organization
Studies, 17: 985–1010.

Park, S. H., & Russo, M. 1996. When competition eclipses
cooperation: An event history analysis of alliance
failure. Management Science, 42: 875– 890.

Parkhe, A. 1993. Strategic alliance structuring: A game
theoretic and transaction cost examination of inter-
firm cooperation. Academy of Management Jour-
nal, 36: 794 – 829.

Pillutla, M. M., Malhotra, D., & Murnighan, J. K. 2003.
Attributions of trust and the calculus of reciprocity.
Journal of Experimental Social Psychology, 39:
448 – 455.

Pirrong, S. C. 1993. Contracting practices in bulk ship-
ping markets: A transactions cost explanation. Jour-
nal of Law and Economics, 36: 937–976.

Poppo, L., & Zenger, T. 2002. Do formal contracts and
relational governance function as substitutes or com-
plements? Strategic Management Journal, 23: 707–
726.

Puranam, P., Singh, H., & Zollo, M. 2006. Organizing for
innovation: Managing the coordination-autonomy
dilemma in technology acquisitions. Academy of
Management Journal, 49: 263–280.

Puranam, P., & Vanneste, B. S. 2009. Trust and gover-
nance: Untangling a tangled web. Academy of Man-
agement Review, 34: 11–31.

Reuer, J., & Ariño, A. 2002. Contractual renegotiations in
strategic alliances. Journal of Management, 28: 47–
68.

Reuer, J., & Ariño, A. 2007. Strategic alliance contracts:
Dimensions and determinants of contractual com-
plexity. Strategic Management Journal, 28: 313–
330.

Reuer, J., Ariño, A., & Mellewigt, T. 2006. Entrepreneur-
ial alliances as contractual forms. Journal of Busi-
ness Venturing, 21: 306 –325.

Ring, P. S., & Van de Ven, A. H. 1992. Structuring coop-

erative relationships between organizations. Strate-
gic Management Journal, 13: 483– 498.

Robinson, S. L. 1996. Trust and breach of the psycholog-
ical contract. Administrative Science Quarterly,
41: 574 –599.

Ross, L., & Stillinger, C. 1991. Barriers to conflict resolu-
tion. Negotiation Journal, 7: 389 – 404.

Rousseau, D. M., Sitkin, S. B., Burt, R. S., & Camerer, C.
1998. Not so different after all: A cross-discipline
view of trust. Academy of Management Review, 23:
393– 404.

Salbu, S. R. 1997. Evolving contract as a device for flex-
ible coordination and control. American Business
Law Journal, 34: 329 –384.

Sampson, R. C. 2004. The cost of misaligned governance
in R&D alliances. Journal of Law, Economics and
Organization, 20: 484 –526.

Schelling, T. 1963. The strategy of conflict. New York:
Oxford University Press.

Schoorman, F. D., Mayer, R. C., & Davis, J. H. 2007. An
integrative model of organizational trust: Past, pres-
ent, and future. Academy of Management Review,
32: 344 –354.

Sitkin, S. B., & Roth, N. L. 1993. Explaining the limited
effectiveness of legalistic “remedies” for trust/dis-
trust. Organization Science, 4: 367–392.

Smitka, M. J. 1994. Contracting without contracts: How
the Japanese manage organizational transactions. In
S. B. Sitkin, & R. J. Flies (Eds.), The legalistic organ-
ization: 91–109. Thousand Oaks, CA: Sage.

Sobel, M. E. 1982. Asymptotic confidence intervals for
indirect effects in structural models. In S. Leinhardt
(Ed.), Sociological methodology: 290 –312. San
Francisco: Jossey-Bass.

Tenbrunsel, A. E., & Messick, D. M. 1999. Sanctioning
systems, decision frames, and cooperation. Admin-
istrative Science Quarterly, 44: 684 –707.

Uzzi, B. 1997. Social structure and competition in inter-
firm networks: The paradox of embeddedness. Ad-
ministrative Science Quarterly, 42: 35– 67.

Vanneste, B. S., & Puranam, P. 2010. Repeated interac-
tions and contractual detail: Identifying the learning
effect. Organization Science, 21: 186 –201.

Vlaar, P. W. L. 2008. Contracts and trust in alliances.
Discovering, creating, and appropriating value.
Cheltenham: Edward Elgar.

Vlaar, P. W. L., Van den Bosch, F. A. J., & Volberda, H. W.
2007. On the evolution of trust, distrust, and formal
coordination and control in interorganizational rela-
tionships. Group and Organization Management,
32: 407– 429.

Walker, G., & Weber, D. 1984. A transaction cost ap-

2011 997Malhotra and Lumineau

proach to make-or-buy decisions. Administrative
Science Quarterly, 29: 373–391.

Weaver, K. M., & Dickson, P. H. 1998. Outcome quality of
small-to medium-sized enterprise-based alliances:
The role of perceived partner behaviors. Journal of
Business Venturing, 13: 505–522.

Weber, J. M., Malhotra, D., & Murnighan, J. K. 2005.
Normal acts of irrational trust: Motivated attribu-
tions and the trust development process. In R. M.
Kramer (Ed.), Research in organizational behavior,
vol. 27: 75–101. New York: Elsevier/JAI.

Weber, R. P. 1990. Basic content analysis. Thousand
Oaks: Sage.

Wicks, A. C., Berman, S. L., & Jones, T. M. 1999. The
structure of optimal trust: Moral and strategic impli-
cations. Academy of Management Review, 24: 99 –
116.

Williamson, O. E. 1985. The economic institutions of
capitalism. New York: Free Press.

Williamson, O. E. 1991. Comparative economic Organiza-
tion: The analysis of discrete structural alternatives.
Administrative Science Quarterly, 36: 269 –296.

Zaheer, A., Lofstrom, S., & George, V. 2002. Interpersonal
and organizational trust in alliances. In F. Contractor
& P. Lorange (Eds.), Cooperative strategies and al-
liances: What we know 15 years later: 347–377.
London: Elsevier Science.

Zaheer, A., & Venkatraman, N. 1994. Determinants of
electronic integration in the insurance industry: An
empirical test. Management Science, 40: 549 –566.

Zand, D. E. 1972. Trust and managerial problem solving.
Administrative Science Quarterly, 17: 229 –239.

APPENDIX A

Examples of Statements Coded as Competence-
or Goodwill-Based Trust

Response categories were derived from definitions of
trust dimensions in Davis, Schoorman, Mayer, and Tan
(2000), Mayer and Davis (1999), Mayer and colleagues
(1995), and Schoorman, Mayer, and Davis (2007).

Competence-Based Trust
Messages were coded for references to skills, com-

petencies, aptitude, training, and/or experience.
Examples:
“We know that you are able to do it properly.”
“Usually you deliver it on time.”
“My engineers told me that they are confident about

your experience in the […] field.”
“You manifested your high level of competence during

Phase 1 of the Project.”

Goodwill-Based Trust
Messages were coded for references to benevolence

and/or integrity.
Benevolence examples:
“We know you want the success of this Project.”
“We really appreciated your technicians’ efforts to re-

pair the damage during the night.”
“Your employees have been kind and friendly to help

[Firm A] to face this issue.”
Integrity examples:
“So far, you have been fair and honest.”
“[Firm B] is well known for respecting its employees.

It is what gives you a great reputation!”
“You have moral principles and I like that.”

Deepak Malhotra ([email protected]) is a professor at
Harvard Business School. He received his Ph.D. from the
Kellogg School of Management at Northwestern Univer-
sity. His research interests include issues related to trust
development, competitive escalation, negotiation, and
international and ethnic conflict.

Fabrice Lumineau ([email protected]) is an
assistant professor at the University of Technology, Syd-
ney. He received his Ph.D. in strategic management from
HEC Paris. His research interests include interorgani-
zational partnerships, governance design, contractual
structures, and dispute negotiation strategies.

998 OctoberAcademy of Management Journal

Copyright of Academy of Management Journal is the property of Academy of Management and its content may

not be copied or emailed to multiple sites or posted to a listserv without the copyright holder’s express written

permission. However, users may print, download, or email articles for individual use.

MANAGEMENT & OPERATIONS

Understanding the Benefits and
Challenges of Strategic Alliances
Franchisors should go into partnerships unselfishly and with clear expectations from both

sides-just as they would before signing on a franchisee.

BY JOHN F. BUCKLES

I o prosper and grow as
a franchise, more often
than not, there will be
a point when it will
be necessary to find
creative new ways to

expand and develop into new markets.
Strategic business alliance relation-
ships have grown increasingly popular
and serve as a means for both parties
to increase their brand awareness and
capital, without expending extra time

or experiencing significant financial impact.

Before pursuing a business partnership, franchisors should
identify businesses that offer different, yet complimentary
services from their own franchise system, but serve a similar
market.

In approaching a potential alliance partner, one of the
most important things to keep in mind is, “Ask not what your
strategic partner can do for you, but what you can do for the
partnership? ” After identifying a potential business that can
help your franchise tap into a new market, the organization
must clearly identify what it brings to the table. How will
the partner gain value from the alliance with your company?
The most important point to keep in mind about a strategic
alliance is that it will be mutually beneficial. If both parties
are not benefitting from the partnership, it will languish over
time, resulting in a damaged business relationship.

After the franchised company has identified a business
with whom it can build a mutually beneficial partnership, it
will be ready to establish a relationship with the representatives
and solidify a healthy alliance. Strategic business alliances can
be extremely beneficial to growing your franchise, offering
opportunities to increase exposure of your brand through the
partner’s channels, as well as the potential to offer supplemen-
tary services to existing ones. However, partnerships must be
approached with caution. It is human nature to be motivated
by self interest, and both parties must overcome this emotion
to establish a partnership that will be beneficial to both.

Benefits of Strategic Alliances

Access to Supplementary Services

One of the most attractive benefits of an alliance with
another business is the opporttmity to offer supplementary
services to clients that otherwise would not be available. It
is vital to a business’ success to focus on its core competen-
cies because when a business becomes a jack of all trades, it
becomes a master of none. An alliance allows a company to
offer its clients a whole new realm of services without losing
focus on its capabilities and its specialized services.

If both parties are not benefitting
from the partnership, it will
languish overtime, resulting in a
damaged business relationship.

Opportunity to Reach New Markets

Entering a strategic alliance will automatically increase
awareness of a brand among an entirely new market that the
franchise business has not had the resources to reach before-
hand. In most cases of franchising alliances, a partner will
be a business that offers a completely different set of services
to a market that is similar to its own, allowing the business
to increase its market size with little impact on the franchise
business.

For example, while 1-800-GOT-JUNK? offers an entirely
different service than Caring Transitions, their clients are
ideal for our service. In partnering together. Caring Transi-
tions is able to increase awareness of both the brands among
a larger target market without the risk of overshadowing each
other’s services.

Increased Brand Awareness

The opportunity to grow market size with a partnership
presents the additional opportunity to increase awareness of

4 8 FRAIMCHISIIMG W O R L D SEPTEMBER 2011

the brand. One of the key elements of
A business’ success is constant, growing
brand awareness. If your brand awareness
isn’t growing, your business isn’t growing.
Strategic alliances allow an organization to
reach a broader audience without putting
in extra time and capital.

Access to New Customer Base

A franchise business is constantly
searching for new, creative ways to increase
its clientele and reach new potential
customers, and forming a strategic alliance
provides an opportunity to do that. A
trusting, solid business partnership
will provide access to a completely new
customer base that the franchise would
not have had access to otherwise.

Potential Challenges

Choosing the Right Partner

The challenges to a strategic alliance
begin during the very first stage of choosing
a partner. Choosing the wrong partner can
be damaging if it is not able to contribute
to the growth of your business and offer a
degree of dedication, honesty and integrity
to the partnership. When researching
different businesses that your company
could potentially form an alliance with,
it is important to keep in mind that this
will often be an exclusive relationship,
meaning it may very well be the only
business your brand will be able to partner
with in the category. In partnerships, the
franchise company is going to want to
choose businesses with a positive reputa-
tion in its industry that uphold similar
policies and values as within its business
model. Once a relationship is formed with
a business in a specific industry, the odds
of forming more in that same industry are
very slim, so it is important to do it right
the first time.

Building a Mutually Beneficial Alliance

1-800-GOT-JUNK? believes that
one of the biggest challenges of entering
a strategic alliance is ensuring that the
partnership is going to benefit both busi-
nesses involved. With human nature
being motivated by self-interest, it is often
difficult to enter into a btisiness relation-
ship with the goal to benefit the other

party just as much as it will benefit your
brand. Once that emotion is overcome,
a new challenge arises to continue to
keep the relationship mutually beneficial
throughout its lifetime, which will require
dedication, trust and honesty.

Upholding Trust and Honesty

Without a certain degree of trust and
honesty, a partnership has no foundation
to build on. It is important for both parties
approaching an alliance to set their expec-
tations clearly and concisely before the
partnership is solidified.

It is a good idea to
reassess a business
alliance at regular
intervals.

According to 1-800-COT-JUNK?
Senior Strategic Account Manager Chris
Hilliard, before entering a partnership, it is
essential to discuss and address the “what-
if’s” of things that could potentially occur
down the road that may be damaging to
the relationship. For example, 1-800-
COT-JUNK may eventually find it
necessary to change its insurance coverage
for its truck teams which would defi-
nitely affect the job being done with the
partnering company. If this what-if isn’t
discussed in the beginning stages of solidi-
fying the partnership, it could potentially
affect the agreement and foundation built
with your partner.

Knowing When to Reassess the Alliance

Every business will experience constant
flux and change and initiatives that have
once been prosperous may not be right
two to three years down the road. To
ensure that a business alliance continues
to mutually benefit both parties, it is
important to know when to reassess the
alliance and change the foundation. Both
businesses must understatid that change
is inevitable and must be able to work
together to reach new agreements over
time. Sometimes the need to restructure
will be clear, while at other times it will
take the initiative of one or both sides of
the partnership to actively seek whether or

not the partnership is still working. It is a
good idea to reassess a business alliance at
regular intervals.

Strategic business alliances could be
the next step in the growth and marketing
initiatives for your franchise as they offer
a wealth of benefits including increased
brand awareness and the ability to reach
new markets and offer supplementary
services to your clients, but there is a
certain level of risk involved and partner-
ships should be approached carefully.

Business alliances should be
approached just as one would approach a
friendship. Both need constant nurturing
to grow and prosper. There must be consis-
tent and quality interaction as well as
thorough, clear communication to obtain
the best results. If a friendship or alliance
is not constantly being nurtured, “fall out”
might result.

In the end, strategic alliances offer
tremendous potential benefits to both
parties. But like any relationship, both
companies need to carefully assess each
other’s motivations and expectations before
making a commitment. It’s necessary for
both companies to bring equal value to the
partnership. Franchisors should go into
partnerships unselfishly and with clear
expectations from both sides-just as they
would before signing on a franchisee. •

John F. Buckles is co-founder and president,

as well as a memher of the Board of Directors

of Caring Transitions. He is a certified senior

advisor, a ceriified relocation <& transition specialist and a proven senior care franchising expert with more than 20 years of glohal and operational business experience. Buckles has experienced and managed the care and transitioning challenges of his parents for over 20 years, starting with his mother's stroke in 1983 during his senior year at college. He can be reached at JBuckles(a),caringtransitions.net. FRANCHISING WORLD SEPTEMBER 2011 4 9 Copyright of Franchising World is the property of International Franchise Association and its content may not be copied or emailed to multiple sites or posted to a listserv without the copyright holder's express written permission. However, users may print, download, or email articles for individual use. Why Too Much Trust Is Death to Innovation S U M M E R 2 0 1 0 V O L . 5 1 N O . 4 R E P R I N T N U M B E R 5 1 4 1 1 Francis Bidault and Alessio Castello SUMMER 2010 MIT SLOAN MANAGEMENT REVIEW 33 I N N O VA T I O N THE SMART MICROCAR, invented by the tumultuous partnership between Daimler-Benz AG & Co. and The Swatch Group Ltd., finally seems to be reaping the benefits of its provocative de- sign as more consumers order this compact automobile. By contrast, the minivan codeveloped by PSA Peugeot Citroën SA and Fiat SPA (initially sold as the Peugeot 806 and the Fiat Ulysse) was the result of a harmonious relationship but never garnered much attention. It was just another minivan. These outcomes contradict common sense as well as a large body of academic literature. The general assumption, after all, is that success grows out of good relationships — based on a com- mon vision, cultural proximity, a sense of fairness and equity and, eventually, mutual trust — while poor cooperation and lack of trust lead to disaster. Yet examples abound of high-trust partner- ships that fail to innovate and of turbulent ones that succeed. Admittedly, many factors influence the level of creativity and innovativeness of partnerships, and trust is only one of them. But it is deemed to be a central one.1 Is trust in fact overrated? Is it sometimes an actual hindrance to innovation? Can we think in terms of an optimal level of trust — not too little and not too much? When companies collaborate, low trust is detrimental to innovation. But so is very high trust. The optimal level, yielding maximum impact, lies in between. BY FRANCIS BIDAULT AND ALESSIO CASTELLO THE LEADING QUESTION Can very high trust between innovation project part- ners be too much of a good thing? FINDINGS ! Some kinds of conflict between collaborators can be good for innovation performance. ! While personality conflicts hinder innovation, conflict- ing opinions about tasks can spur new solutions. ! Trusting partners are more likely to commit the re- sources needed to implement jointly developed ideas. Why Too Much Trust Is Death to Innovation The tensions between the Smart car’s codevelopers led them to explore new concepts — and engineer a breakthrough solution. COURTESY OF SMART USA 34 MIT SLOAN MANAGEMENT REVIEW SUMMER 2010 SLOANREVIEW.MIT.EDU I N N O VA T I O N Trust as a Critical Ingredient One party trusts another not only when he perceives honesty and an absence of opportunism but also when expecting that the other’s attitudes and capabilities will turn out as promised.2 For example, we need to trust that the plumbers repairing our bathroom will not overcharge us and that they have the required com- petencies — knowledge, acumen, equipment and supplies — to get the job done well and on time. Trust is, above all, an interpersonal phenome- non. It occurs (or fails to occur) between individuals. Even in terms of trust between organizations, it is their key executives, more or less willing to rely on trust in their dealings with each other, who make or break the relationship. The higher the trust between the executives involved, the higher the “relational quality” between the organizations.3 Companies are increasingly joining forces to de- ve lop innovations, such as in supply chain partnerships or precompetitive alliances. This trend toward joint efforts, or “co-innovation” projects, derives from factors that have lately been affecting most industries — companies’ need to cope with rising R&D costs, decrease development times, in- crease R&D project flexibility, access new markets and boost revenues.4 Technology alliances have be- come particularly important, as evidenced by a recent survey in which over 94% of the technology executive respondents believed that alliances were becoming critical to their strategy.5 Nevertheless, it is not easy for organizations to create, and especially to maintain, such innovation- oriented partnerships. Not only must they find the right partner, negotiate and agree on common goals, but the organizations must thereafter cooperate on a daily basis — a process that faces many stumbling blocks.6 A partner may be unable to contribute as promised. The decision-making structure may lack sufficient communication. Or the mechanism for cooperation may be unable to adapt to unforeseen changes in the market or the technological environ- ment. It is therefore not surprising that 50% to 80% of such partnerships end in failure.7 Innovation is by its very nature a risky activity, and joint innovation projects can add further com- plications. For example, even when partners accept the consequences of their risk exposure, they may differ in their risk profiles. In such a situation, partners typically rely on a contract that specifies what is expected of whom under various contin- gencies. But although necessary, contracts tend to be insufficient for coping with all the difficulties that joint innovation can encounter. In contrast, trust “constitutes a critical ingredient by which partners can weather the conflicts that economic and competitive changes, as well as shifts in corpo- rate priorities, will throw their way.”8 Trust is beneficial to all types of partnerships that face risk and require constant flexibility. Joint innovation also requires something extra: the sharing of knowledge. Partners look to create innovation-oriented joint ventures largely because they need to combine their own knowledge with oth- ers’ in order to find solutions that will probably not ABOUT THE RESEARCH The pairs of partners were given an assignment to design and build a construction using 200 colored plastic bricks on the theme of a small-scale clothes stand. We in- formed the partners that the other players would evaluate the construction by voting on its originality and novelty, both in terms of functionality and aesthetics. In particular, we asked participants to assess all constructions (other than their own) by distributing 20 tokens in ballot boxes next to each construction. We then collected the scores and entered them into the data set, but we did not communicate the results to participants. At this stage, participants received virtual capital of 300 euros each and were in- vited to bet all or part of their money on the ranking of the partnerships’ next construction. Before betting, we informed all participants that at the end of the session one of them would be selected randomly to receive the value of their capital in actual euros. We introduced this reward to ensure more rational betting among participants. After betting, participants joined their partners, and the process started again. This time they designed and built a small-scale clothes stand using 400 bricks, then once more assessed and voted for the resulting structures made by others. Each run was limited to a maximum of 30 participants. We conducted 18 work- shops in total, involving 364 players. Participants were executive MBA students (with an average age of 28.2 years) with employment experience. In addition to the experiment itself, questionnaire data were also needed from each player. The first questionnaire, conducted before the experiment, assessed the amount of contact the two partners had experienced beforehand (work, study, lei- sure) and the level of trust within the pair. We also asked questions designed to assess each individual’s propensity to trust others in general. The second question- naire, conducted after the experiment, asked about the task itself and the role that each partner played. It also polled the participants’ general propensity to trust and their individual character and self-esteem traits. Finally, we collected demographic information in an attempt to link one’s propensity to trust, and the individual’s own trustworthiness, to personal characteristics. We must acknowledge that our methodology does not eliminate the risk of bias in participant behavior. With up to 30 participants, it is difficult to ensure that each voted in- dependently and objectively for the best design, regardless of outside factors such as friendship. To check for this possible bias, we ask a panel of outside observers to rank the different constructions in some of our test rounds. In any case, we believe that the methodology merits consideration from scholars interested in R&D management as well as from companies involved in the setup of joint development teams. www.sloanreview.mit.edu COURTESY OF MANITOWOC SUMMER 2010 MIT SLOAN MANAGEMENT REVIEW 35 materialize if they act alone. But such a relationship is unlikely to occur unless there is a sufficient level of trust to counter fears of abuses of confidential infor- mation and know-how. Contracts alone won’t help; in fact, they could inhibit innovation because they imply control of information flow and a range of legal dispositions that typically slow the project down. Consider the case of Poclain (formerly Europe’s hydraulic shovel leader) and Potain (the leading French tower crane maker), which decided in the 1960s to enter the mobile crane industry by using their complementary technologies. The idea was that Poclain’s mastery of hydraulic circuits would com- bine with Potain’s competence in crane design and development to create new and improved machines. But the joint venture, under the name PPM, lagged behind because of scant innovation. The two part- ners’ management teams developed a system of mutual control and double signatures, even on minor expenses, necessitated by unrelieved mutual suspi- cion. In this atmosphere, the joint engineering projects dragged along for years with little success, delivering nothing more than “me-too” products. Can Trust Become Detrimental? Given this ex- ample, along with many similar ones in the literature, it is tempting to suggest that higher levels of trust would have produced higher levels of innovation success. After all, trusting partners are more open, more supportive, less hostile, less competitive and therefore show more creativity — that is, generate more new ideas.9 Of course, creativity is not innova- tion, which is the implementation of new ideas. But one might expect that more creativity would lead to more innovation in a higher trust partnership, which would lead to greater partner commitment and con- sequently, better implementation. After close observation of numerous joint inno- vations, however, it is obvious that very high trust partnerships sometimes fail to be innovative. Fiat and Peugeot’s long and lucrative alliance in the commercial and passenger van markets serves as a useful example. In the late 1970s, the two companies launched Sevel, a partnership to design and manufacture a commercial van that would be marketed separately as the Fiat Ducato and Peugeot J5. It met with immediate success. Sevel was able to exceed all expectations, exhibiting a production capacity twice that of the original plan. As a result, Fiat and Peugeot announced in 1988 the Sevelnord project, which would try to build on Sevel’s achievements and aim to compete in the passenger minivan market as well. The partners adopted the same governance structure, the same general economic principles of cost and investment sharing and even the same key executives as in the previous successful venture. After all, why fix what isn’t broken? Both partners publicly hailed the excellent atmo- sphere of camaraderie they had established. “We find solutions together,” they reported. “Whether it is Fiat or Peugeot that has the idea — both groups come out ahead. There is an exchange of experience that is extremely rich.”10 Unfortunately, after Sevelnord introduced the resulting passenger minivan — Peugeot’s 806 and Fiat’s Ulysse — in 1994, the product did not attain even half of its predecessor’s success. It was simply not a very innovative minivan and thus failed to gain much of a share in a market already dominated by competitors. How could this happen, given the “extremely rich” possibilities? Although partners who trust each other may commit more of their resources to a joint venture, this does not ensure a high level of creativ- ity, which requires a certain level of tension that may not exist in a high-trust environment. On the con- trary, a high level of mutual trust between partners may result in soft, unchallenging and accommodat- ing teamwork behaviors — the opposite of what is needed to develop creative solutions. In fact, recent studies do not find a positive link between R&D teams’ mutual trust and resulting creativity.11 The Trust Experiments Case studies such as the above are not adequate for evaluating whether trust level is associated with higher or lower levels of in- novativeness, as it is impossible to disentangle this factor from the many other contributors. For this reason, we decided to set up a series of ex- periments. We enrolled groups with up to 30 players each, assigned them to as many as 15 pairs, and in- structed each pair to design and build an object in the most creative way possible. Because we needed to en- sure that the pairs represented a spectrum from very high to very low levels of trust, we chose individuals who already knew each other and who had sufficient The promise of Potain’s collaboration with Poclain was hampered by mutual suspicion and mistrust, and ultimately produced disappointing results. 36 MIT SLOAN MANAGEMENT REVIEW SUMMER 2010 SLOANREVIEW.MIT.EDU I N N O VA T I O N prior experience together to have formed distinct trust perceptions. To compose the pairs, we used an algorithm that we had developed to minimize the dif- ference of mutual trust between partners in a pair and maximize it among pairs. A betting mechanism was also included to gauge partner confidence in each pair’s prospects. (For more detail on the procedures employed, see “About the Research,” p. 34.) The results point to a major finding: As mutual trust increases, the partnership’s creativity goes up, reaches a maximum point and then starts to decline. (See “The Sweet Spot of Mutual Trust.”) To control for the inherent creativity of individual participants in the experiment, we considered not the individuals’ creativ- ity but the pairs’ creativity arising from the partnership. The difference between the two was termed “partner- ship effectiveness.” Partnership Effectiveness as a Function of Mutual Trust As the level of trust increases, effectiveness rises to a maximum level and thereafter decreases. As trust gets very high, effectiveness even goes negative. As expected, there was also a strong correlation between trust in the partner and the amount bet in the partnership, suggesting that trusting partners are more likely to commit the resources needed to implement jointly developed ideas. If innovation is the combination of creativity and commitment to bring new ideas to fruition, then innovativeness in a joint venture is the partnership payoff resulting from the combination of the partners’ commit- ment and their respective creativity gains. If we define innovativeness as the amount that an individual gains on his investment thanks to the creativity realized from cooperation with his part- ner, we can quantify its value as the product of an individual’s initial investment (amount bet) and creativity gained (percentage difference between an individual’s creativity and the pair’s creativity). So if those betting 300 euros exhibit high creativity (say, twice their own creativity), they will obtain 600 euros as a payoff. By contrast, if a player betting 120 euros experiences a creativity loss in the part- nership (say, 50% lower than his own), he will only get 60 euros back. When we plot the average payoff as a function of the pair’s mutual trust, we observe another bell-shaped curve. Innovativeness as a Function of Combined Mutual Trust Although innovativeness, like partnership effec- tiveness, also decreases after passing an optimal point, its values are higher than those realized at lower levels of trust. Our findings show, as one would expect, that low trust is not conducive to innovation. But coun- terintuitively, too much trust is bad for innovation too. As mutual trust goes up, innovativeness in- creases, but only to a certain point (9.5 on our trust scale). Afterward, innovativeness declines, even though it stays at higher levels because of greater commitment. Creativity gains, on the other hand, can become negative (creativity loss) for very high levels of mutual trust. There seems to be an optimal level of trust, above or below which innovativeness or creativity is impeded. Moderate Trust Could Be the Most Effective We can explain this seemingly strange pattern by observ- ing how conflicts affect team performance. According to some management thinkers, tension does not al- ways play a negative role in team dynamics.12 Indeed, while relational conflicts (which may arise, for exam- ple, from personal contempt for one or more team members) are extremely detrimental to team perfor- mance, task-oriented conflicts are beneficial because they foster critical thinking and in-depth analysis of the team’s goals and actions. From our findings, we could say that low levels of trust cause relational con- flicts, while high levels of trust may induce a reduction in task-oriented conflicts. According to this analysis, participants who do not trust each other experience relational conflict, which prevents them from working together effi- ciently. If, on the other hand, a team enjoys a high level of trust and mutual caring, individuals might become too accommodating, quickly accepting their partners’ ideas and thus reducing the amount of dynamic task-oriented conflict. The team would then have lower creative tension, consequently re- ducing the partnership’s effectiveness. Trust is a combination of integrity, reliability and mutual caring, and each component is likely to play a different role in creativity and innovative- ness. We can expect integrity and reliability to generally favor joint problem solving and innova- www.sloanreview.mit.edu SLOANREVIEW.MIT.EDU SUMMER 2010 MIT SLOAN MANAGEMENT REVIEW 37 tion. On the other hand, mutual caring, or the extent to which one partner empathizes with the other, may result in excessive accommodation. Under such circumstances, a team member would prefer to please his partner rather than to openly question the partner’s ideas, decisions and actions. Consider the example of the Renault Espace, which was the product of a hugely successful part- nership that lasted for nearly two decades. Undoubtedly one of most innovative car models in Europe in the 1990s, the Espace originated from a challenging partnership between Renault SA and Matra Automobile (now part of Lagardère SCA). While the companies’ CEOs were said to have a good relationship, Renault’s engineering and prod- uct management teams questioned Matra’s ability to develop a successful car, given its modest achieve- ments with previous models (such as the Bagheera, Murena and Rancho). While the Renault teams liked the freshness of Matra’s ideas, they were skep- tical about its design solutions.13 For example, when Renault’s advanced marketing group members found that customers increasingly valued modular interiors (in which the car owner could modify the seating arrangement) and deemed that Matra’s minivan idea made this feature possible, they insisted that the car incorporate it. At the same time, however, the group was unsure that Matra would be able to engineer the car on a high enough level to reach minimum quality standards. Renault’s marketing executives were so concerned that the Es- pace would not sell effectively as a passenger car that they demanded it be designed with a flat floor, to easily convert into a delivery van if need be. Matra en- gineers, who had designed racing cars, did not appreciate this compromise. Nevertheless, the Espace gradually became the leader in its category in Europe, causing the two partners to repeatedly adjust the production capac- ity upward, eventually reaching an impressive 600% of its initial level. Renault and Matra, despite a stormy relation- ship, were able to find an effective balance in their partnership and offer the market an innovative concept that competitors later adopted. The ten- sions and limited trust between the two teams resulted in a set of unconventional solutions, and a unique car design, that enjoyed long-term success. Managerial Implications Our findings clearly confirm that joint innovation projects benefit from a committed and trusting environment. But com- panies not only should avoid very low mutual trust among the individuals working on the project, they also should avoid situations in which it is very high. Trust matters not just at the sponsor or execu- tive level; it is also essential in the teams formed to be creative and produce innovations. Leaders en- tering a joint innovation partnership should therefore consider the following: ■ Do not expect much innovation from new part- ners (or new teams); it takes time for trust, and the consequent openness and cooperative behav- ior that generate benefits, to develop. ■ Help teams involved in a joint innovation project to build trust early. This implies that a minimum level of trust should be created through trust-building ac- tivities such as those of the FAcT-Mirror method.14 ■ Monitor the level of mutual trust during the proj- ect in order to avoid a rift and improve efficacy. Too often, managers pay no attention to trust; it is left to develop, or degrade, haphazardly. Proper moni- toring should include a clear warning system. ■ Ensure that there is an appropriate level of healthy criticism. If too much trust develops, it might be necessary to remind the team of its objectives and priorities. Here again, careful monitoring can alert management to an excessive buildup of groupthink. ■ The risk of excessive trust should not be overesti- mated, however. Barring extreme conditions, there THE SWEET SPOT OF MUTUAL TRUST The degree to which collaborators trust each other has a large effect on their ability to innovate. But more trust isn’t always better. Innovativeness increases with the degree of trust until a “sweet spot” is reached, after which it declines even as trust becomes greater. 0 08 00 -04 -06 -08 2 6 Effectiveness 4 06 04 02 16 Mutual Trust 8 10 12 14 -02 www.sloanreview.mit.edu 38 MIT SLOAN MANAGEMENT REVIEW SUMMER 2010 SLOANREVIEW.MIT.EDU I N N O VA T I O N is still a creativity gain. It is just lower than the peak that occurs in the medium-to-high-trust range. At this writing (late 2009), Daimler-Benz and Swatch’s codeveloped Smart car is reaping the ben- efits of its innovative design. As gas prices increase, global warming concerns grow and consumers flock to microcar dealerships, the Smart factory in Ham- bach, France, is running at full capacity. Despite initially disappointing sales and a fair amount of mockery among observers, the market seems ripe to adopt the microcar concept, and other automakers must now catch up if they hope to compete in this new product category. When innovation analysts study this chapter of the car industry’s history, surely they will debate who was the mastermind behind the microcar: Ni- colas Hayek, CEO of Swatch, or Helmut Werner, then head of Mercedes-Benz. But given our find- ings about the dynamics of innovation, it may be that neither gentleman was the true innovator. Rather, it was the tension between the two compa- nies (and their respective teams) that caused the partners to explore new concepts and designs that led to the Smart car breakthrough. When inventing together, trust is good; but avoiding too much trust is better. Francis Bidault is a professor of management at the European School of Management and Technology in Berlin, Germany. Alessio Castello is adjunct profes- sor of management at the Institut d’Administration des Entreprises, l’Université de Nice, in Nice, France. Comment on this article or contact the authors at [email protected] ACKNOWLEDGMENT The authors wish to express their gratitude to the Peter- Curtius Stiftung (Peter Curtius Foundation) for its generous support of the research project reported in this article. REFERENCES 1. J.H. Dyer and N.W. Hatch, “Using Supplier Networks to Learn Faster,” MIT Sloan Management Review 45, no. 3 (spring 2004): 57-63; R. Gulati, “Does Familiarity Breed Trust? The Implications of Repeated Ties for Contractual Choice in Alliance,” Academy of Management Journal 38, no. 1 (1995): 85-112; and J. Hagedoorn and G. Duysters, “External Sources of Innovative Capabilities: The Prefer- ence for Strategic Alliances or Mergers and Acquisitions,” Journal of Management Studies 39, no. 2 (2002): 167-188. 2. F.D. Schoorman, R.C. Mayer and J.H. Davis, “An Inte- grative Model of Organizational Trust: Past, Present and Future,” Academy of Management Review 32, no. 2 (2007): 344-354. 3. A. Ariño, J. de la Torre and P.S. Ring, “Relational Qual- ity: Managing Trust in Corporate Alliances,” California Management Review 44, no. 1 (2001): 109-131. 4. H.W. Chesbrough, “Open Innovation: The New Imper- ative for Creating and Profiting from Technology” (Boston: Harvard Business School Press, 2003). 5. M.J. Kelly, J.-L. Schaan and H. Joncas, “Managing Alli- ance Relationships: Key Challenges in the Early Stages of Collaboration,” R&D Management 32, no. 1 (2002): 11-22. 6. D. Littler, F. Leverick and D. Wilson, “Collaboration in New Technology-Based Product Markets,” International Journal of Technology Management 15, no. 1/2 (1998): 139-159. 7. K. Heimeriks, “Alliance Capability, Collaboration Quality and Alliance Performance: An Integrated Framework,” working paper 02.05, Eindhoven Centre for Innovation Studies, Eindhoven University of Technology, Nether- lands, 2002; and T.E. Stuart, “Interorganizational Alliances and the Performance of Firms: A Study of Growth and In- novation Rates in a High-Technology Industry,” Strategic Management Journal 21, no. 8 (August 2000): 791–811. 8. Ariño et al., “Relational Quality.” 9. A.G. Robinson and S. Stern, “Corporate Creativity: How Innovation and Improvement Actually Happen” (San Francisco: Berrett-Koehler, 1997). 10. F. Bidault and M. Schweinberg, “Fiat and Peugeot’s Sevelnord Venture (A),” IMD case no. 3-0644 (Lausanne, Switzerland: IMD, 1996). 11. M.-H. Chen, Y.-C. Chang and S.-C. Hung, “Social Capital and Creativity in R&D Project Teams,” R&D Management 38, no. 1 (2008): 21-34; and D. De Clercq, N. Thongpapanl and D. Dimov, “The Role of Conflict and Social Capital in Cross-Functional Collaboration” (paper presented at the Fourth Workshop on Trust Within and Between Organiza- tions, Amsterdam, Netherlands, October 2007). 12. A.C. Amason, “Distinguishing the Effects of Func- tional and Dysfunctional Conflict on Strategic Decision Making: Resolving a Paradox for Top Management Teams,” Academy of Management Journal 39, no. 1 (1996): 123-148; and K.A. Jehn and E.A. Mannix, “The Dynamic Nature of Conflict: A Longitudinal Study of Intra- group Conflict and Group Performance,” Academy of Management Journal 44, no. 2 (2001): 238-251. 13. P. Dussauge, B. Garrette and A. Dumont, “The Ma- tra-Renault Espace Alliance and the European Minivan Market,” HEC Paris case study no. 397-025-1 (Paris: HEC Paris, 1997). 14. G. Le Cardinal, J.-F. Guyonnet, B. Pouzoullic and J. Rigby, “Intervention Methodology for Complex Problems: The FAcT-Mirror Method,” European Journal of Opera- tional Research 132, no. 3 (2001): 694-702. Reprint 51411. Copyright © Massachusetts Institute of Technology, 2010. All rights reserved. www.sloanreview.mit.edu PDFs ■ Permission to Copy ■ Back Issues ■ Reprints Articles published in MIT Sloan Management Review are copyrighted by the Massachusetts Institute of Technology unless otherwise specified at the end of an article. MIT Sloan Management Review articles, permissions, and back issues can be purchased on our Web site: www.pubservice.com/msstore or you may order through our Business Service Center (9 a.m.-7 p.m. ET) at the phone numbers listed below. Paper reprints are available in quantities of 250 or more. To reproduce or transmit one or more MIT Sloan Management Review articles by electronic or mechanical means (including photocopying or archiving in any information storage or retrieval system) requires written permission. To request permission, use our Web site (www.pubservice.com/msstore), call or e-mail: Toll-free: 800-876-5764 (US and Canada) International: 818-487-2064 Fax: 818-487-4550 E-mail: [email protected] Posting of full-text SMR articles on publicly accessible Internet sites is prohibited. To obtain permission to post articles on secure and/or password-protected intranet sites, e-mail your request to [email protected] Customer Service MIT Sloan Management Review PO Box 15955 North Hollywood, CA 91615 http://www.pubservice.com/msstore http://www.pubservice.com/msstore mailto:[email protected] mailto:[email protected] Reproduced with permission of the copyright owner. Further reproduction prohibited without permission.