The impact of the legal system and incomplete contracts on grape sourcing strategies: A comparative analysis of the South Africa and New Zealand wine industries

Abstract

The governance of buyer/seller relationships has been a central concern for managers and researchers in the field of economics for a number of years. One of the primary perspectives is that of Transaction Cost Economics, as defined by Oliver Williamson, that assumes exchange partners act with bounded rationality and opportunism. Indeed, exchange contracts designed under this paradigm are said to be ‘incomplete’ due to bounded rationality. Through a mail survey of 111 South African and 116 New Zealand wineries, we investigate why contracts are still widely used to coordinate exchange relationships while these chains are likely to be characterised by high asset specificity and high uncertainty. We argue that the effectiveness of the state’s legal system could be the primary explanation for the ubiquitous use of contracts within the wine industry. Accordingly, our study investigates the relationship between the effectiveness of the state’s legal system and governance structures while controlling for other factors such as trust (Relational Exchange theory), monitoring, incentives (Agency theory), item criticality, firm size and firm age. Employing multiple regression, we found that the more effective legal system (New Zealand) promoted the use of contracts, while the less effective legal system (South Africa) tended to rely more on trust and incentives. We also found moderate support the legal system promoting the use of the spot market, while our contention that an effective legal system discourages vertical integration was also supported. We discuss these results in cross-country comparative analysis.