Incomplete contracts and behavioural aspects – a case study in the construction and IT industries

Abstract

Contracts capture an agreement between two parties to exchange a resource in the future (ex-ante), however the future is not certain. Only after the event has happened, might the two parties compare the resources they have received to what they expected (ex-post). Entering into a contract with unknowns gives rise to incomplete contracts theory, the focus of which includes the study of human behavior. Relational contracting is currently being studied as a method of reducing the transaction costs and incompleteness of contracts. Using case studies, this research aimed to reach a conclusion regarding why certain contractual projects run over budget. Overruns are often related to a variation agreement that is incomplete and open to interpretation. Understanding what the issues are and how to mitigate contractual risks was thus a key focus of this research. The research examined two industries - construction and IT. From the case studies, 16 interviews were conducted and 12 contracts reviewed. The least concern for all the parties was disputes, as the parties find solutions to address issues not considered when drafting contracts. Industry specific experience and knowledge is needed to mitigate some unknown contractual risks, however. Relational contracting was also very evident in resolving issues outside of a contract. Further studies into ancillary contracts will reveal more insight into behavioural and relational contracting.