Explainableness In Contractual Relationships

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Contract incompleteness is seen almost inevitable in contractual relationships due to multiple reasons such as future uncertainty, coverage of time period and choices of contract owners (Baker & Krawiec, 2006). Moreover, Goetz & Scott (1981) pointed out that long term contracts are more prone to be incompleteness because of uncertainty as to future conditions and expected level of complexity. Incompleteness regarding the contracts arises when duties, obligations or rights of the contracting parties are not specified clearly in every future state of the world so that one of them get an opportunity to renegotiate over the contract again. It has been long discussed that contract incompleteness creates inefficiencies in trading markets around…show more content…
Those are the countries where we observe weak domestic institutions such as poor judicial quality. Assume that the final good producer desires to produce complex good (differentiated good) so that its input need should be customized by the input supplier. Investment by the input supplier is relationship-specific since customized input has a higher value to the buyer than to other potential buyers (Nunn & Trefler, 2013). However, especially in emerging markets, it is hard to verify the effort that input suppliers put in producing inputs which makes contract completeness less possible between final producers and input suppliers. Hold-up problem occurs in the sense that if the final good producer try to renegotiate over the contract after relationship-specific investment has been made. This happens if the contract is imperfectly enforced, which is mostly affected by institutional quality in countries. Moreover, input supplier attempt to underinvest after ex post renegotiation is anticipated. Due to this inefficiency stemming from underinvestment, costs go up in production. This in turn affects countries’ comparative advantage through firms or industries. Different level of contract incompleteness arising from different level of institutional development among countries brings comparative advantage through the industries whose production is dependent on contract enforcement…show more content…
Their theoretical model shows the positive effects of international standards on level of perceived quality of the products. This is something that I need to put them into together to be consistent with my claim in this thesis. Rather than good judicial system as a solution to the problem of hold-up under contract incompleteness, I claim that ISO certifications are a new type of institutions that replace the domestic institutions in the emerging countries where I observe low rule of law indicator. In short, ISO certifications are considered as informal institutions that solve the problem of hold-up by replacing good domestic institutions. Consequently, consistent with my claim, ISO certifications increase product quality and decreases problems in contractual relationships between input supplier and final good producer through quality signaling, which refers to the level of technology embodied in production is perceived by final good producers. All in all, ISO is expected to work as a substitute for domestic contractual institutions in emerging markets, but with a different way as pointed out in section 4. And the two following theoretical models support my claim

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