Contract amendments: for better or for worse?

• DOI: https://doi.org/10.1108/IJPSM-06-2018-0141
• Date: 02 August 2019
• Pages: 635-652
• Published date: 02 August 2019
• Author: Deanna Malatesta,Craig Smith
• Subject Matter: Public policy & environmental management

Contract amendments:

for better or for worse?

Deanna Malatesta

School of Public and Environmental Affairs,

Indiana University Bloomington, Bloomington, Indiana, USA, and

Craig Smith

School of Government and Public Policy,

University of Arizona, Tucson, Arizona, USA

Abstract

Purpose –Public management researchers have su ccessfully leveraged theory to advance the

understanding of contracts and the different governance structures that underpin contract relationships.

Yet there is still much to learn about the implications for different governance structures. Applying insights

from property rights, the purpose of this paper is to examine the substance of initial government contracts

and their subsequent amendments in order to determine whether allocation of decision rights leads to better

or worse contract amendments.

Design/methodology/approach –The authors evaluate the text of initial contracts and their subsequent

amendments in 258 government–business relationships and focus on the implications of assigning key

decision rights to the party with most relevant knowledge expertise.

Findings –Two primary findings are presented. First, initial contracts where knowledge expertise and the

associated decision rights are co-located (i.e. integrated) are likely to be associated with ex post adjustments

that benefit both parties to the contract. Second, the authors find that this initial finding is likely a result of

government integration as opposed to supplier integration.

Originality/value –Given that we know most professional service contracts require some form of contract

amendment over time, this research helps us understand why some amendments will reinforce the

collaborative (Pareto enhancing) nature of the relationship, while others may be more one sided (rent seeking).

Unlike other theoretical approaches (e.g. transaction cost theory), property rights theory provides guidance

for such decision making.

Keywords Decision making, Contracting out, Property rights

Paper type Research paper

Empirical evidence suggests many contracts are renegotiated and amended before their

specifiedend-date[1]. Given thatamendments can be costly, it isimportant to understand why

renegotiations occur. Moreover, if amendments are unavoidable, as some theories claim, we

need to understand how the terms of the initial agreement affect subsequent renegotiations

and amendments[2]. Research on contract renegotiations and amendments has been the

subject of much attention in the economic literature but has not received much attention in

public management. This is unfortunate given thatgovernments rely heavily on outsourcing,

including for the delivery of many core services. In addition, despite ample literature

describing inherent differences between government and business, very few contract studies

consider that outcomes may differ by sector. We need to understand more about the factors

that lead to different types of amendments. As Oxley and Silverman (2008) note, we need

studies that “explicitly connect renegotiation to actual or perceived performance”(p. 231).

We investigate property rights theory (PRT) in the context of government contracts for

professional services[3]. We examine the text of initial contracts and their subsequent

amendments, focusing on how the initial allocation of decision rights affect ex post

adjustments to thecontract relationship. A key proposition of PRT concerns the allocation of

decision rights and the benefits derived from co-locating ownership of key assets, including

knowledgeexpertise, with the rights overthe use of those assets. The co-locationof ownership

International Journal of Public

Sector Management

Vol. 32 No. 6, 2019

pp. 635-652

© Emerald PublishingLimited

0951-3558

DOI 10.1108/IJPSM-06-2018-0141

Received 18 June 2018

Revised 5 March 2019

18 April 2019

Accepted 8 May 2019

The current issue and full text archive of this journal is available on Emerald Insight at:

www.emeraldinsight.com/0951-3558.htm

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Contract

amendments

and assets is referred to as “integration.”Simply put, an integrated governance regime

provides the incentive to appreciatethe assets’value. Consequently,subsequent amendments

should provide for adjustments that extend benefits. The theoretical contribution is an

evaluation of PRT’s main propositions as they relate to government contracts with providers

of professional services. Empirically, we add to the limited body of evidence on the

implications of governance choice and on differences in sector performance.

The paper proceeds as follows. The second section provides the theoretical framework. This

section clarifies PRT’s main constructs, including assets, ownership, decision rights and

integration, and connects PRT to the context of the present study –government professional

service contracts with knowledge expertise being the key asset for production. The third section

describes the research application and results. We find general support for a key claim in PRT:

the allocation of decision rights in the initial contract has implications for the substance of

amendments that follow. The fourth section is a discussion of results and implications.

Property rights: theoretical overview

The term “property right”concerns assets used in the production of goods (Barzel, 1997, p. 3).

Assets can be either tangible, as in the case of a physical building, or intangible, as in the case of

knowledge. Since professional service contracts engage professionals, the key asset used in the

production process is knowledge[4]. For example, a law office that provides the government with

legal services possesses important knowledge assets, i.e. the expertise of attorneys employed by

the firm who carry out the work. Modern PRT equates ownership with control of rights in the

deployment of specialized assets. Thus, in the language of PRT, knowledge assets (legal know-

how) are considered “owned”by the party directing the work effort under contract.

Rights of control, also called decision rights, are particularly relevant in an incomplete

contracting environment. The backdrop for outsourcing professional services includes laws

and regulations, agency policies, as well as a technology and labor market, all of which are

subject to change. This inevitable uncertainty means that contracts are incomplete as

parties cannot specify a course of action for every conceivable contingency. From this

viewpoint, contract amendments are anticipated and perhaps unavoidable.

The term “integration”in the literature refers to the locus of decision rights in relation to

key assets (e.g. Schmitz, 2006). Specifically, “integration”concentrates ownership( knowledge)

and control (decision over the use of knowledge assets), while “non-integration”separates

ownershipand control. For example,a social service agency may outsource the administration

of one of itssocial programs, a governance structureconsidered “integrated”if the government

retains decision authority overthe work done by the supplier. In such a casethe social service

agency is presumed to have the requisite knowledge to implement the program because it is

closelyassociated with the agency’smission; it is a coreservice. For another example,the same

social service agency may outsource legal services. In this case, expertise resides with the

supplier,not the agency. In fact, theagency probably outsourcesto obtain expertiseit does not

have. If the law firm has the authority to direct the legal work to be done, either explicitly or

implicitly, this is also a form of integration. Thus, integration refers to the co-location of

knowledge assets and related decision rights, whether both reside with the buyer

(government) or with the supplier (contractor). In contrast, non-integration refers to the

separationof expertise and relateddecision rights, for example, if governmentis the expert (as

in the case of a core service) but the supplier directs the work effort or, if the supplier is the

expert but the government directs the work effort[5].

Next we discuss the implications of integration for the substance of contract amendments.

Integration: a governance regime that co-locates knowledge and decision rights

An integrated governance regime that includes asset ownership and decision rights

incentivizes parties to invest and grow the assets’value. Moreover, when expert knowledge

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