The impediments to inter-firm contractual relations, the existing formal and informal ways of getting around them and the role of reputation and trust in mitigating conflict of interest between firms in the context of Indian IT industry is analyzed in this paper. Contract design is specified as a function of reputation (age, repeated contracts and quality certification), asset specificity, complexity and uncertainty. We test the likelihood of observing Time and Material contract, a better propertied contract in the face of uncertainty. Empirical evidence confirms the propositions posited. Reputed firms tend to get highly complicated and uncertain projects. Asset specific investments do not seem to have any implication on contract type and complexity. The results broadly hint that the firms reckon more on creating understanding through formal quality certifications to solve pre-contractual adverse selection problems and repeated contracting to solve the problems of behavioral uncertainties rather than relying on a court of law.

New institutional economics, particularly the tools of Transaction Cost Economics (TCE), help unravel the economic rationale behind inter-firm relations, among other organizational decisions. Inter-firm relations are determined by reconciling the relative cost of transacting within the firm, using the market and a hybrid mix of contractual relations. They adhere not only to technology but also to the available organizational modes resulting from the interaction of transactional characteristics and the external environment.

An attempt is made to understand the nature of inter-firm relations in the Information Technology (IT) sector in India. The IT sector was chosen for its uniqueness in terms of the kind of products it produces and services it renders. Large-scale vertical integration is uneconomical as the industry renders services that are non-core to the buyers. Moreover, the spot markets cannot coordinate these transactions, as the production requires asset specific investments and also uncertainty and complexity are pervasive. Thus, contracts perform a vital role in Business Process Outsourcing (BPO) and Information Technology Enabled Services (ITES) outsourcing. In this context, we test for the determinants of contract design.

The fountainhead of inefficiency in outsourcing relationships is the difficulty in providing incentives and identifying the capabilities of the agents. Finding a supplier entails both ex ante screening and ex post adaptation costs. In spite of these hazards, we witness a deluge of outsourcing deals flowing into developing countries, where there are enormous sociocultural and legal uncertainties. To safeguard against opportunistic behavior, firms in the industry opt for specific contractual choices that could abate the expected total cost of consummating the transactions. The contractual choice that firms adopt to shield against these hazards differs with the nature of the firms, nature of the project and quality of institutions such as contract law regimes and enforcement mechanisms (Williamson, 1979). We posit that the agents would decide upon a particular type and level of complexity of contract contingent on the characteristics of the agents, project characteristics and external environment.

Inter-Firm Contractual Relations, Indian Software Industry, formal and informal ways, Transaction Cost Economics, Business Process Outsourcing, Information Technology Enabled Services, ITES, Asset specific investments, Organizational modes, Information Technology sector, Enforcement mechanisms, Time and Material contract.