Contract Law, Relational Contracts, and Reputational Networks in International Trade: An Empirical Investigation into Cross-Border Contracts in the Software Industry

Contract Law, Relational Contracts, andReputational Networks in InternationalTrade: An Empirical Investigation intoCross-Border Contracts in theSoftware Industry

Thomas Dietz

The following case study investigates the contract enforcement institutions thatenable German customers to purchase software in Asia and Eastern Europe. The casestudy shows that nation-states are hardly able to generate a legal “shadow” for cross-border business relations. The same holds true for the so-called New Lex Mercatoria.Instead, economic actors create their own informal mechanisms. Relational contracts andreputational networks are nowadays far more effective due to developments in the field ofinformation and communication technology. Overall, the importance of formal contractlaw in international trade is even smaller than is assumed by the classic theory of relationalcontracts.

INTRODUCTION

For a number of years now, there has been a lively debate in law and the social andeconomic sciences about those institutions that could provide a sufficient degree ofcontractual certainty in cross-border business transactions. The common starting pointfor this debate is the observation that state contract law cannot fulfill its function tosafeguard the performance of contractual claims in today’s globalized markets with thesame reliability that it achieves in domestic markets (Gessner 2008, 3; Rodrik 2000,179). Every state has its own contract law, which is in force within its territory.Therefore, the possibility exists that national legal systems collide once an economictransaction transcends national borders (Berman 2007, 1155; Gopalan 2004; Rühl2006, 801). From the perspective of actors interested in economic exchange, theterritorial fragmentation of law leads to three main problems. First, uncertainty can

Thomas Dietz is a Research Fellow at the Institute of European and Comparative Law at theUniversity of Oxford. His research focuses on the institutional foundations of global markets. The researchfor this article was conducted at the Collaborative Research Centre 597 “Transformations of the State” atthe University of Bremen. Generous financial support was provided by the German Research Foundation(DFG). Within the framework of the Collaborative Research Centre 597 the interviews presented in thisarticle were conducted together with Holger Nieswandt. A first draft of the article was discussed at theAnnual Meeting of the Law and Society Association, May 28–31, 2009, in Denver, and a revised versionof the article was discussed at the 22nd SASE Annual Meeting, June 24–25, 2010, in Philadelphia.I am particularly thankful to Terence C. Halliday, Errol Meidiger, Peer Zumbansen, Gregory Shaffer,Gralf Peter Calliess, Josh Whitford, Susanne K. Schmidt, Christian Joerges, Mauro Zamboni, JörgFreiling, Andreas Maurer, and Gillian K. Hadfield for their comments. Please direct correspondence [email protected].

Law & Social InquiryVolume 37, Issue 1, 25–57, Winter 2012

Law & Social Inquiry

Journal of the American Bar Foundation

© 2011 American Bar Foundation. 25

emerge about the obligations of the contractual parties, as they can be assessed differ-ently according to the law applicable. Second, it is unclear where the place of jurisdic-tion is for the solution of conflicts. Third, it is often doubtful whether judgments of onestate are actually enforced in another (Schmidtchen 1994, 274). In more abstract terms,economic globalization ends the congruency of economic and legal spaces (Stone Sweet2002, 323). The far-reaching unity of state, law, and economy is increasingly undone bythis process (Zürn 2001). In short, the uncertainty about whether prospective contrac-tual partners behave in an opportunistic or cooperative manner is far higher in globalthan in domestic markets, as in the transnational realm actors have no unitary contractlaw system at their disposal in order to enforce contracts effectively (Anderson andMarcouiller 2002, 342; Belloc 2006, 7; Rodrik 2000, 179).

Although there is a broad consensus about the specific problems of internationaleconomic transactions in the relevant literature, the proposed solutions vary signifi-cantly. Three approaches can be distinguished. The first approach presents the classicalview of contract.1 It stresses that those problems arising out of the plurality of law incross-border economic interactions are solved by dint of private international law(PIL). The PIL determines which law is applicable to a cross-border transaction.Concerning contractual certainty, cross-border transactions therefore approximatedomestic business transactions (Calliess and Zumbansen 2010; Rühl 2008, 9). Ulti-mately, the argument here is that due to working conflict-of-law norms, economic actorscan rely on state courts and enforcement authorities both in the domestic and transna-tional realm (see Berkowitz, Moenius, and Pistor 2004).

Animated by transnational law approaches, alternative views assume, on the otherhand, that the globalization of law cannot keep up with the globalization of theeconomy (Rodrik 2000, 179–80). It is even argued that the nationally caused legalfragmentation (PIL is also national law) as well as the fact that different norm systemsmeet and block each other in cross-border transactions lead to significant regulatorygaps, norm collisions, and enforcement deficits—resulting in growing problems ofcross-border business. The legal context of cross-border trade thus resembles an anar-chic state of nature rather than an area structured by law. In any case, contractualcertainty is not provided by the PIL. In fact a constitutional uncertainty exists, whichhampers, rather than enables, cross-border exchange (Schmidt-Trenz 1990, 241–44;Schmidt-Trenz and Schmidtchen 1991).

Scholars see one way out of this constitutional uncertainty as the possibility toembed cross-border transactions in the institutions of transnational law.2 Stressing thesignificance of the so-called transnational law of the new Lex Mercatoria (Berger 1999)for the safeguard of cross-border transactions, pundits free the concept of law from itsclose link to the state (see Calliess 2006, 198). According to the transnationalists, thecategorical equation of law and state obscures the view of the emergence of newprivately generated legal regimes that are based on common legal principles such as the

1. The classical view of contract sees a world of arm’s-length transactions supported by powerful statelegal institutions. A powerful state that reliably enforces contracts is an essential element of economicdevelopment (see North 1990). For a very good description of the classical view of contract, see Macneil(1978, 854).

2. As far as is known, the term “transnational law” was first used by Philip C. Jessup, a judge at theInternational Court of Justice (see Slaughter 2002, 14, citing Jessup 1956).

LAW & SOCIAL INQUIRY26

UNIDROIT principles (see Berger 1999, 40, 42; Calliess and Zumbansen 2010; Gaillard2001). Contract law on the global level is thus not created by state intervention but byprivate actors who belong to specific socioeconomic networks composed of transna-tional companies, transnational company lawyers, and arbitration houses (Stone Sweet2002, 323). In the theory of transnational law, private arbitration courts play animportant role. They apply those norms that emerged autonomously in the socialcontext of the global mercantile community and gradually specify, through their judg-ments, the legal framework of cross-border transactions (Berger 2000; Berman 1995;Calliess et al. 2007). Finally, the community of market participants safeguards theenforcement of arbitration judgments with the help of reputation (Streit and Mangels1996, 88), so that the enforcement of law by third parties functions on the basis ofprivate arrangements without the use of state coercive power.

According to the transnationalists’ theory, the easing of uncertainty occurs withinan institutional framework that functions without much state support. Hence, support-ers of this theory are opposed to those approaches that emphasize the significance ofstate PIL with regard to safeguarding the contractual fulfillment of internationalexchange processes. However, both approaches have in common the fact that they referto an institutional mechanism in which the performance of contractual agreements issafeguarded by the organizing activity of a formal higher third party.

The third approach, embodied in the relational view of contract transactions-costeconomics, game theory, and economic sociology, proposes that cross-border transac-tions can manage even without a formal regulatory framework organized by third parties(see Belloc 2006, 3);3 rather, the actors create for themselves an institutional environ-ment (see Axelrod 1984, 12) that allows them to conduct international transactions.Cross-border economic transactions are safeguarded either by stable bilateral contrac-tual relations that are based on repeated interaction4 (relational contracts) or byreputational networks consisting of several parties.5 According to Marianna Belloc(2006, 6), “[s]ocial networks enhance cooperation and trust in inter-community trade,and cross-border ties help to overcome information and imperfect contract enforcementproblems stemming from long distance between partners.” Past, present, and futurerelations are of importance. Only this way allows the contractual parties to agree onrules (relational norms), implicitly or explicitly, with which they intend to solve futureinteraction problems, to control rule compliance, and to sanction rule breaches withthe termination of business relations or with exclusion from the reputational network.6

From the viewpoint of legal sociology, the fact that business relations rest primarilyon repeated interaction, reputation, and relational norms does not mean, however, thatlaw remains without function. In the very moment in which a business relation threat-

3. Note that Steward Macaulay has shown that even within national markets, businesses often managetheir business relationships with no or little and highly selective resort to state-provided rules and dispute-resolution mechanisms (see Macaulay 1963).

4. For a sociolegal view of relational contracts, see Macneil (1971, 1985).5. The following authors, in particular, highlight the meaning of ethnic relations and networks for

international trade: Appelbaum (1998), Casella and Rauch (2002), Gould (1994), Rauch (2001), andRauch and Trindade (2002).

6. For the theoretical foundations of relational contracts, see Abreu, Pearce, and Stacchetti (1991),Axelrod (1984), Dixit (2004), and Townsent (1979).

Cross-Border Contracts in the Software Industry 27

ens to fail, the contractual arrangements, which now move into the center of therelationship as the “norm of ultimate appeal” (Llewellyn 1931, 736), had, up to then,hardly been of importance to both parties. The contract guarantees that courts (state ornonstate arbitration tribunals) can be appealed to if the business dealings fail. Thus,business relations occur in the shadow of law (Williamson 1996, 57, 122). This meansthat the involved actors know that they can be sued if they behave in an uncooperativemanner in the course of their business dealings and try to pursue their interests with theintent to deceive. However, in the shadow of formal contracts, actors cooperate on thebasis of repeated interaction, reputation, and relational norms (Hill 2009, 181). Legallyenforceable contracts and spontaneous self-organization are in interplay and, together,provide a functioning cooperative environment.

The following study highlights two aspects of this cooperative environment. First,it is shown that formal contracts and courts in the transnational realm are hardly ableto generate a “shadow” for business relations outlined above. As will be shown later, thishas structural reasons, which can primarily be attributed to economic globalization.Second, the empirical findings show that both mechanisms of spontaneous self-organization—relational contracts and reputational networks—are nowadays far moreeffective due to revolutionary developments in information and communication tech-nology. In contrast with formal systems of contract law, these mechanisms are thereforeable to follow the economy into the global realm. Overall, the significance of formallegal systems as the institutional basis for economic exchange in the transnational realmis even smaller than assumed by the classic theory of relational contracts.

THE EMPIRICAL STUDY

Cross-border software development contracts were chosen as the object ofresearch. They are processes of exchange in which one company orders another foreigncompany to develop a software application, which is designed to meet the former’sneeds (individual software). Three case studies with thirty-one total qualitative inter-views were conducted with German (interviews G-I–G-X7), Bulgarian and Romanian(interviews BR-I–BR-XI), and Indian (interviews ING-I–ING-X) experts in the soft-ware industry between February 2005 and March 2006. As will be briefly described inthe following, the software industry provides a very good example with which to assessthe relative importance of the above-mentioned public and private contract enforce-ment institutions in international trade.

First, the software industry is among the most globalized industries in the worldeconomy (Sahay, Nicholson, and Krishna 2003), and it can be assumed that, throughlearning and imitation, those contract enforcement institutions that have enabledeconomic exchange in advanced industries also enable trade in hitherto underdevel-oped industries, given that they globalize further. Second, the software industry entersinto complex contracts, which have significant conflictive capacity and therefore rely

7. The German interviews were conducted in German and translated into English by the author. TheBulgarian and Romanian interviews were conducted in English. The transcripts are in the possession of theauthor.


particularly on the existence of functioning courts and enforcement bodies (Berkowitz,Moenius, and Pistor 2004, 163–98). Third, anonymous market relations characterizethe software industry, meaning that relatively numerous transactions occur betweencompanies that are neither linked under property law nor part of common ethnic orfamily networks (Campbell-Kelly 1995). The last point is of particular importance; it isnot sufficient to merely furnish proof that transactions in cross-border trade are con-ducted with no reference to state contract law because examples of business relationsthat are based on so-called F-connections (firms, friends, and family) (Ben-Porath1980) are common in domestic as well as in global markets. However, if it can be shownthat actors alien to each other engage in mutual trade outside a company or a closelyknit social network in the international realm without falling back on state courts andenforcement bodies, this finding would, indeed, indicate that private-order contractenforcement institutions are fully able to replace the mechanism of state contract lawin international transactions. To ensure that the only transactions examined weretransactions that involved this type of impersonal exchange relations, the expertsinterviewed in this study were questioned only about those software developmentcontracts with business partners with which they had not collaborated in the past. It wasnot hard to meet this criterion due to the previously mentioned characteristics of thesoftware industry.

The selection of companies from Germany, Bulgaria/Romania, and India reflectsan important structural feature of the global software industry. Germany represents thecase of a country from the OECD world importing software. India represents the case ofan established nation in the world export market for software. Bulgaria and Romaniarepresent the case of a group of young but aspiring nations in software development.

To achieve the most comprehensive picture possible, all three case studiesinvolved a mixture of enterprises of different sizes—small (under 100 employees),medium (100 to 1,000 employees), and large (more than 1,000 employees). Further-more, interviewees with different professional backgrounds were selected. Most inter-views in each case study were conducted with either the company owner or themanaging director. In this way, we made sure to interview the person who is, in fact, incharge of the decision of whether a company engages in a cross-border transaction. Inaddition, in each case study, supplementary interviews were conducted with high-ranking managers from the quality control, sales, and legal departments. Finally, thepicture emerging from these company interviews was complemented by interviews withexperts from business associations and chambers of commerce, who possess detailedknowledge of contractual practices in cross-border exchange, since it is their dailybusiness to support companies in their search for new partners in foreign markets.

The qualitative interviews were conducted as nonstandardized expert interviews.Two particular topics were set in advance, but the interviews did not follow a bindingtopic guide. The strict insistence on a fixed set of questions outlined in a topic guidewould be rather counterproductive given the above-mentioned underdeveloped state ofresearch. The searchlight would have too narrow a focus in order to recognize poten-tially innovative contract enforcement institutions in cross-border business dealings.This approach is reasonable because, hitherto, too little scientifically proven informa-tion has been available about the research object of the contract enforcement ofglobalized exchange in order to come up with theory-guided hypotheses and to test


them with the help of quantitative methods. However, the following topics areaddressed in all interviews:

• The risks of transaction: This subject area includes questions about those risks enter-prises face when they are involved in cross-border software transactions.

• Contract law provided by the state: This subject area includes questions about thesignificance of contract law provided by the state for the emergence of cross-bordersoftware transactions.

• Private-order contract enforcement institutions: This subject area includes questionsabout the significance of the above-mentioned private institutions for cross-bordersoftware transactions.

The analysis of the interviews followed the technique of content analysis proposedby Phillip Mayring (see Mayring 2003). First, all statements regarding the relevance offormal contracts, state courts, and state enforcement authorities were extracted fromthe interview data, numbered consecutively, and organized into specific tables. Thismethod was then applied to all statements concerning the relevance of private contractenforcement institutions (relational contracts, reputational networks, and private-governance regimes). In this way, the reader can easily understand how the results andconclusions of the empirical study emerged. The tables are located at the end of eachpart of the article, respectively.

This article is part of a wider research project that inquires into both the contractenforcement institutions that enable German firms to purchase software in EasternEurope and India and the contract enforcement institutions that enable companiesfrom Eastern Europe and India to sell software in Germany. As mentioned above, thisarticle looks into the problem of transactional uncertainty in international trade fromthe perspective of German clients in particular. Thus, the ten interviews of the Germancase study stand at the center of the analysis. However, the interviews with foreignsuppliers also reveal important aspects of the institutional foundations that enableGerman firms to engage in cross-border trade, aspects that would have been missedwithout these data. Hence, the results of the Bulgarian/Romanian and Indian inter-views are incorporated in the following analysis, although to a lesser extent.

THE RISKS OF TRANSACTIONS

The analysis of the expert interviews established four main risks that Germanenterprises encounter when they order software applications from Eastern Europe orAsia: first, there is the risk that the software application ordered is not delivered on theagreed date or, second, that it does not meet the expected quality standards. Both theserisks are particularly serious if the customer has a contractual agreement with a thirdparty, the fulfillment of which requires the customer to deliver the ordered softwareapplication in advance. To avoid falling behind, the German enterprise has to makesure that the ordered software application is delivered punctually and works faultlessly.Third, due to the almost cost-free reproducibility of software products, there is a highrisk that the software supplier will resell the same or an only slightly amended versionto another enterprise—in the worst case, to a competitor. From the perspective of theGerman customer, the question arises how the intellectual property rights to the


developed software can be secured. Fourth, for the buyer of a software application, thereis the risk that the software producer obtains sensitive corporate data during softwaredevelopment, the use or distribution of which could jeopardize the business of thecustomer. Hence, the German enterprise needs a strategy with which it can prevent, asreliably as possible, the passing on of confidential information to third parties.

STATE CONTRACT LAW DOES NOT PROVIDE CONTRACTUALCERTAINTY

It has to be asked, then: What significance do German enterprises attribute to thestate contract law in the reduction of these risks? To answer, it is necessary to outline thetypical structure of a software contract.

In general, an entire project cannot be covered in a single contract, due to thecomplexity of the underlying transactions. Software transactions usually consist of anumber of contracts. These are: first, a nondisclosure agreement, which is meant toguarantee that confidential information is not passed on to third parties even before abusiness transaction takes place; second, a framework contract, which establishes thefundamental rights and obligations of the contractual parties for the duration ofthe business relationship; and, third, individual service-level agreements, which definethe exact extent of work required.

The empirical findings indicate that the actors involved usually prepare thiscontractual edifice with great care. The work required is comprehensively fixed throughthe creation of so-called requirement or performance specifications; furthermore, theframework contract defines an exact catalogue of sanctions in case foreign enterprisesfall behind with the development of software or fall short of agreed quality standards.Moreover, in most cases, it is agreed in detail what procedures have to be observed if,during a business relationship, incidents occur that were not foreseen by the parties atthe moment the contract was made (e.g., change requests, project and executivecommittee changes, or escalation procedures). Additionally, the patterns of conflictresolution (such as arbitrator, applicable law, and place of jurisdiction) are predeter-mined, in case the parties cannot agree on them once a dispute occurs.

From the perspective of legal sociology, the fact that the global software industryusually works with very elaborate contracts suggests, at first, that the involved parties,indeed, rely heavily on state enforcement authorities in order to safeguard the perfor-mance of contracts by their foreign business partners.8 State contract law would there-fore be of high significance for the generation of contractual certainty in cross-borderbusiness transactions. However, as the following will indicate, this provisional conclu-sion cannot be confirmed.

8. In his seminal 1963 article, Steward Macaulay introduced the degree of contractual planning as anindicator of the significance of state private law for the occurrence and conduct of economic transactions.In contrast to the empirical findings of this study, however, Macaulay argued that (1) “many businessexchanges reflect a high degree of planning about the four categories—description, contingencies, defectiveperformances and legal sanctions—but (2) many, if not most, exchanges reflect no planning or only aminimal amount of it, especially concerning legal sanctions and the effect of defective performances”(Macaulay 1963, 9).


Tables 1 and 2 summarize how ten German experts assessed the role of state-enforced contract law for the generation of contractual certainty in cross-border soft-ware transactions. As Table 1 shows, there are clear statements in all ten Germaninterviews that the state enforcement of contracts is insignificant for generating con-tractual certainty in cross-border software transactions (Nos. 1–18). This assessmentapplies to all four risks facing customers who purchase software applications in EasternEurope and Asia. State contract law does not guarantee that delivery deadlines are met

TABLE 1.The Insignificance of State Contract Law for the Generation of Transaction Cer-tainty from a German Perspective

Interview No. Original Passage/Paraphrase

G-I 1 So, if for example you are doing business as a German organization engagingwith a small provider in India, the contract does not give you any protection.(p. 1)

G-II 2 Contracts play of course a role in the software industry, but hardly any companyoperating in Central and Eastern Europe relies on them. (p. 4)

G-II 3 If you collaborate with a company in Russia or the Ukraine, legal issues play noprominent role. (p. 4)

G-III 4 Coercion is less effective in our business, since we have potentially already fallenbehind once we don’t get the expected quality. And to sue takes a long time.(p. 12)

G-III 5 Still we enter into an agreement, but the contract is only worth the paper it iswritten on. (pp. 20–21)

G-III 6 With regard to the uncertainty of controlling the generated resources, statecoercion plays no role. (pp. 24–25)

G-III 7 Also with regard to the uncertainty of confidential information being passed on,the enforceability of contractual claims by dint of state coercion plays no role.(p. 25)

G-IV 8 The fact that I have a contractual arrangement does not stabilize theexpectation that the other party delivers in time or that the quality is allright. (pp. 8, 9)

G-IV 9 State law is of no significance for enforcing the contractual stipulation that thesupplier has to provide free updates for a year. (p. 12)

G-V 10 The contract is of no significance for the collaboration itself. (p. 10)G-V 11 The opportunity to enforce contracts provides no certainty about product

quality. (p. 16)G-VI 12 The course of action in the past: requirement specifications and target

specifications, work delivery contracts, service contracts, “all that blah”; todaywe can say, we don’t actually want that. (p. 3)

G-VII 13 One can sign a lot of paper; one can design voluminous contracts, in the endmutual benefits only occur if one cooperates properly, even beyond anycontractual arrangements. (p. 3)

G-VII 14 The contract is only worth the paper it is written on. (p. 3)G-VII 15 We don’t really need contracts. (p. 10)G-VIII 16 In India, legal certainty does not exist. (p. 1)G-IX 17 Contracts are not really helpful. (p. 1)G-X 18 I don’t believe that contracts are the means to provide certainty; where I can say

I can rest easy. (p. 2)


(Nos. 7, 8, 11), that the ordered software is of the required quality, that there is anexclusive transfer of intellectual property rights, and, finally, that confidential informa-tion is kept secret. In the words of one interview, the software contract is “only worththe paper it is written on” (G-VII interview, p. 3; see also No. 14).

However, as Table 2 indicates, three of the ten interviewed experts do not entirelyshare this position.

Although interviews G-I, G-II, and G-X principally support the theory of theinsignificance of state law, they still indicate that state contract law plays some role incross-border transactions. Interview G-I and interview G-II argue that the “contract”(G-I interview, p. 1) and the “legal issues of cooperation” (G-II interview, p. 1) are ofno significance for smaller companies in transnational trade relations, but that they aresignificant for large multinational corporations, like, for instance, TCS (the biggestIndian software company) or SAP (the biggest German software company) (Nos. 19,20). On the other hand, interview G-X indicates that state enforceable contracts couldbe important with regard to the protection of the exclusive intellectual property rightsto the purchased software applications (No. 21).

Can these assumptions actually be reconciled with the prevailing opinion thatstate contract law is of no significance for cross-border economic exchange? Taking intoaccount the direct context of these statements contradicting the prevailing opinion, amore detailed analysis of the interviews shows that they cannot. Contracts do notgenerate contractual certainty because they ultimately can be enforced with the help ofstate enforcement bodies; instead, contracts merely function as binding communicationdocuments, which are ultimately enforced by reputation and, hence, in a private mode.Accordingly, interview G-I states, directly after the claim that “contracts provide . . . astructural framework” for the collaboration of large corporations:

If TCS found themselves in default of some contractual provisions or liable forsome payments of financial remedies, then you would have their reputationsplaying into how they would conduct themselves under the auspices of the con-

TABLE 2.The Significance of State Contract Law for the Generation of Transaction Certaintyfrom a German Perspective


G-I 19 So, if for example you are doing business as a German organization engagingwith a small provider in India, the contract does not give you any protection.But, if your organization is Deutsche Bank [big organization] and you aredoing business with TCS [biggest software provider in India], the contractforms are structural framework. (p. 1)

G-II 20 Globally active companies of a certain size have to pay particular attention tothe legal issues of cooperation. For all others, different issues are relevant.They have to generate mutual trust: if this works, then they pay far lessattention to legal issues than large-scale enterprises. (p. 1)

G-X 21 That all works out because of the contract, I don’t think so. The contract is alegal fallback option, if all conditions change. (p. 3)


tract. The chances are that they would look for remedies they could themselvesenact. This could be the provision of a service rather than a financial payment, butbeyond that TCS wants it fixed, whether it is under German law, Indian law, UKor US law, they would have to fix the issue simply because that type of publicity,negative publicity, would damage them very considerably outside of any penaltiesthat they were liable for under the contract. (G-I interview, p. 6)9

In this sense, parts of interview G-II also support the claim that the image of a companyis often taken into account when dealing with legal issues: “If we discuss larger com-panies such as SAP or Software AG in Germany, naturally, they have to give higherpriority to the legal framework of cooperation. Here, turnovers are concerned whichamount to billions; companies are concerned which have a worldwide reputation; theycannot afford to experience a flop in an international cooperation. That would damagetheir image in general” (G-II interview, p. 1).

Only interview G-X explicitly supports the idea that state enforceable contractsserve the creation of contractual certainty, although state contract law is mentionedonly as an additional, rather weak, mechanism to prevent the infringement of intellec-tual property rights in the case where employees involved in a collaboration changecompanies.

That things work out because of a contract; I don’t think so. The contract is a legalfallback option, if all conditions change. If a new management arrives, the thing ispurchased, and then someone says ok let’s sell that stuff, and when you don’t haveaccess to these people anymore, then you have to be able to say: “look, that’swhat you signed; that’s the situation, on that basis we have to talk to eachother.” . . . [Because] . . . [i]f I don’t have a contract, I can’t even try to enforce myrights. Whether I believe that this has a positive end in court depends on verymany factors indeed; however, it is pretty bad if I don’t have a contract at all; thatleaves me without any position at all. (G-X interview, p. 3)

It is also evident in this case, however, that private governance mechanisms ultimatelyplay the decisive role in preventing the misuse of intellectual property rights: “Andthen they come and say, ‘Oh, that’s a great piece of software; we can sell it everywherenow; no one will notice in Germany anyway’; then they enter the Polish, Czech,Romanian market; at some point I notice what’s happening; then they put anotherbusiness with me at risk, so they get seriously penalized. And I think that what worksis that if such a thing happens, then the community of companies knows very quickly,without me publicizing that they have stolen and sold my software” (G-X interview,p. 4).

Therefore, it can be argued that the possibility of enforcing contractual agreementswith the help of state enforcement bodies is of (nearly) no importance for German

9. Similarly, it is stated on page 7 of the same interview: “A loss of reputation—a damage to reputationwould be more damaging than a financial loss. And so, you find that big companies will absolutely not wantto go to court or arbitration or a dispute in the contract, because they don’t want the view that they are notcapable of delivering on their responsibilities.”


enterprises when they purchase software applications in typical offshore countries likeIndia, Bulgaria, or Romania. As becomes obvious in Table 3, this far-reaching insignifi-cance of state contract law appears to be based on two primary factors.

First, there is deep distrust toward the legal systems of offshore states on the part ofGerman enterprises (Nos. 22, 23, 25, 27–35, 38). The German enterprises thereforerefrain from making their contractual relations subject to a foreign jurisdiction. Thecontracts are usually drafted according to German law. German courts have jurisdiction.Interviews with the foreign suppliers also support this point. A Bulgarian expert, forexample, expressed in this context that “usually when it is a contract with an outsideperson, in the contact it is written that everything will be according to the jurisdictionof the customer” (BR-III interview, p. 3).

The fact that German law is in effect, however, does not mean that state contractlaw can fulfill its function of enforcing contracts and enabling economic cooperation.In principle, it is possible to successfully sue a foreign company for the performance ofa contract in Germany (Nos. 25, 33), yet, according to the interviewed experts thelegal title cannot be enforced reliably in offshore countries (Nos. 22, 23, 24, 25, 32, 33,35). This means that even if the contractual parties have agreed that German lawapplies, it cannot be guaranteed that foreign business partners will be effectively sanc-tioned in case of a breach of contract. In the end, state contract law remains withouteffect from the perspective of a German enterprise because the territorial confinementof law prevents a reliable enforcement of German judgments in Eastern Europe andAsia.

Second, as shown in Table 4, the experts stressed that state courts are hardly ableto contribute to conflict resolution in the area of software development, due to thetechnical complexities of the relevant subject matter. To gain an overview of thesituation in a case, the responsible judges have to rely on expert reports, whichincrease the costs of proceedings enormously. Moreover, expert reports do not alwaysbring more clarity; rather, they often intensify and conflict among experts. Giventhese difficulties, it is hardly astonishing that judges tend to “push” cases “towardsettlement” (G-VII interview, p. 5). The result is that it becomes hardly worthwhile toinvolve state courts, even for a party that thinks it is in the right. The outcome ofproceedings is too uncertain; the costs for the involved experts are too high. In short,entirely independent from the territorial confines of state law, the insignificance ofstate contract law can also be attributed to the lack of legal certainty in the area ofsoftware development.

Thus, because, on the one hand, the outcome of proceedings in state courts ishighly uncertain and causes high costs and, on the other hand, the judgment of aGerman court, if acquired, cannot reliably be enforced in typical offshore countries,German customers do not rely on state contract law when purchasing software appli-cations in offshore countries.

THE ALTERNATIVE MEANING OF CONTRACTS

At this point, one issue remains open: Why do German enterprises constructdetailed contracts, as outlined above, in order to purchase software abroad, even though


TABLE 3.Economic Globalization and the Insignificance of State Contract Law from a GermanPerspective


G-I 22 For a German company, the enforcement of contractual claims in India isextremely difficult. (p. 1)

G-II 23 The enforcement of contractual claims in Eastern Europe would take anextremely long time. (p. 4)

G-II 24 Contracts can internationally only be enforced with huge difficulty. (p. 10)G-III 25 In India it is much harder to sue [than in Germany] and which law do you

apply? If I apply Indian law, I run into the issue that an Indian court mightbe more inclined to decide in favor of an Indian company rather than aGerman one. If I choose German law, I get my right; but if I appear with thisruling in India and want to enforce it, the Indians might just laugh at me.(p. 24)

G-IV 26 Although there is a clause in the contract stipulating that property rights aretransferred, it remains uncertain whether one can take legal action to obtainthem. (p. 10)

G-VI 27 Sources received from our Indian partner, noted but unusable; they are thrownaway. We have pondered legal action, like recently with Russia. But youneed to calculate how much money you want to invest in order to get yourright. Legally, we know that we are right, but it makes no sense to pursue ourright; just try to take legal action in Russia. You will have a dispute betweenexpert witnesses, and it is not even clear which court has jurisdiction. (p. 4)

G-VIII 28 Given the judicial system in India, the chance is rather small that the case isdecided within the next decade. The courts are not very experienced in thatfield. The duration of a trial is endless. Especially in India, where proceedingsare endless, we must avoid to ever enter into a legal conflict. (p. 1)

G-VIII 29 On the one hand, it is of course great that you have an independent judiciaryin India. This is most welcome, if you compare this with other countries, likefor instance China, where we also do development. On the other hand, thetime it takes for such a judicial system to come to a decision is unacceptablefor any kind of economic activity, i.e., the average duration of proceedings isten years. If we wait that long, our office has gone bust or is closed. It is notreasonable to settle a conflict in court. (p. 1)

G-VIII 30 Hearings don’t even occur. So you have to go to court every Wednesday; thecourt deals with about 800 cases; today they handle this one and that oneand everyone else can go home; this happens week after week, so weeks goby. (p. 1)

G-VIII 31 Everyone knows that it makes no sense to take legal action; both parties knowthat. No one will get his right because there will be no verdict. (p. 2)

G-VIII 32 It will certainly not happen that a German verdict is enforced in India. (p. 2)G-IX 33 Only then you have to know that contracts are important, but the problem is

that they are ultimately not enforceable because India has no mutualassistance agreement. If you have a contract between a German and anIndian company, and it is stipulated that the Indians have to deliver at acertain point and they don’t; I cannot sue them for contractual performance.If you take action in a German court, which might even be successful,perhaps because the contract stipulated German law, it still does not helpsince the legal title cannot be enforced in India. (p. 1)


TABLE 3.(Continued)


G-IX 34 You have to take action before an Indian court, but this takes a very long time.The main proceedings take at least six years. (p. 1)

G-IX 35 In India nothing is enforced strictly. (p. 1)G-IX 36 The Indians perform a contract, because they want money; they will therefore

make an effort to accommodate the demands of the German customers.Clearly that’s their intention, but the German side should not believe thatmatters could be enforced via contract or in court. (p. 2)

G-IX 37 For the Indians, the contract is an idea that they ought to fulfill. But it’s notthe case that they have an absolute standard like the Germans. The Indiansperceive the contract first of all as a framework. They certainly try toperform the contract. If, however, insurmountable problems emerge, theywill try to engage in dialogue or to amend the contract. (p. 26)

G-X 38 If you ask me what I believe with regard to such legal disputes involvingsoftware, versions or parts of software, then I think it is very difficult toactually prove this and to prove it through all courts; in particular if we dealwith a partner who resides somewhere, where you first have to find out, howto get him. This is quite difficult. (p. 3)

TABLE 4.Technical Complexity and the Insignificance of State Contract Law from a GermanPerspective


G-III 39 If there’s a breach of contract, to then take legal action and to get damages;that’s hard to comprehend in the software industry. (pp. 20–21)

G-IV 40 Quality cannot be defined in such a detailed way that you could simply takelegal action later; you need expert witnesses, which increases costs; youcannot spend all the money the whole thing costs. (pp. 8–9)

G-VI 41 Clearly, we try to keep the courts out of this; they can’t help anyway. You endup with a dispute between expert witnesses and all comes to nothinganyway. (p. 3)

G-VII 42 First, the German judicial system is overtaxed, and, second, German districtcourt judges have no clue what they do. They tend to protract things,achieve a settlement or get at least an expert report. Since we know thatthis is one of the most expensive ways to settle a conflict, we try to avoid it.This is something we don’t do. (p. 5)

G-X 43 If you ask me what I believe concerning such legal disputes involving software,versions or parts of software, then I think it is very difficult to actually provethis and to prove it through all courts. (p. 3)


these contracts generate no contractual certainty? From an economic perspective, it ishardly sensible to use resources for the design and negotiation of contracts if theyremain ultimately without effect on transactions. What purpose does a contract fulfill,if it does not generate contractual certainty?

The experts interviewed provide some interesting insights. Table 5 shows thatenterprises need contracts in order to define their legal relationship with third partiesnot directly involved in the transaction. This can include insurance companies, banks,and tax authorities. More concretely, contracts are the basis for insurance coverage (No.44), the grant of credit (BR-II interview, p. 6),10 or the determination of a tax liability(No. 44). Contracts are therefore necessary documents for participation in modernbusiness life, independent of their presumed function—the generation of contractualcertainty. The empirical findings furthermore demonstrate that contracts can also beused to legitimize the actions of a company’s management vis-à-vis its owners (No. 47).No corporate management wants to be accused of acting without a valid contract incase a transaction with a foreign company fails. This would be seen by the owner asflawed behavior and would have negative career effects for management. Contracts aretherefore written because corporate managers “have to guard their back” (G-X inter-view, p. 3) in case things go awry (No. 48).11

10. “In Romania, the bank requires a contract when money is transferred from abroad. It wants toknow, where the money comes from” (BR-II interview, p. 6).

11. These findings can be connected to a journal article published by John Flood. Flood (2007, 35)writes that elite law firms are used by global companies for legitimization because “[w]ithout the imprimaturgranted in the documentation of the large law firm, business dealings will always appear somewhat profaneand suspect.”

TABLE 5.Alternative Meanings of Contracts


G-V 44 An important aspect of the contract was VAT. It was important to includemany details, for the insurance, etc. This cost us a lot of money. Actually, itis of no significance for the collaboration itself. (p. 10)

G-VII 45 Contracts facilitate communication. (p. 10)G-IX 46 One still needs a contract as the basis of cooperation so that everyone knows

what one talks about and what is expected. (p. 1)G-X 47 My legal status already requires me to have a contract, in order to protect

shareholders against such situations. (p. 3)G-X 48 However, if you realize a complete concept in a foreign country with foreign

developers, and the concept is marketable, which you believe anyway, andsomeone takes it and runs and develops it with small changes and is luckyenough to bring it to the market quicker than you, then you need a contractand a licensing agreement, a production contract; that in case such a thinghappens, you are sure that there is no trouble. (p. 3)


However, the most important function of the contract is as a communicationdocument (Nos. 45, 46).12 In cross-border intercultural business relationships, nocommon sociocultural norms exist that could implicitly govern the exchange beyondthe contract itself. There (still) exists no transnational business culture. At the tran-snational level, enterprises are far more dependent than in the domestic context on thedetailed explication of the behavior they expect from their business partners and onturning their expectations into the written form of a contract. In this sense, an expertstresses that although contracts do not generate contractual certainty, “one still needsa contract as the basis of cooperation so that everyone knows what one talks about andwhat is expected” (G-IX interview, p. 1).

Contracts and the private law applicable to them are means of communication,which can be more easily universalized than social norms that are reproduced inexclusive ethnic or social contexts. Contracts serve mutual communication, but not theenforcement, of legal claims.

PRIVATE CONTRACT ENFORCEMENT INSTITUTIONS ESTABLISHCONTRACTUAL CERTAINTY

The above account indicates that contracts and state contract law take on numer-ous alternative meanings, but they do not create contractual certainty for Germanenterprises ordering software applications in Eastern Europe or Asia. But if Germanenterprises cannot resort to state enforcement authorities in order to safeguard theirtransactions against opportunist behavior, how do they manage to safeguard the per-formance of contracts by their foreign offshore providers?

Relational Contracts

The Initiation of Contractual Relationships

German enterprises subject their potential business partners to a comprehensiveevaluation process in the runup to a transaction. In addition to the competence of apotential transaction partner, their reliability is checked. In other words, before atransaction starts, German enterprises choose only foreign enterprises that show a lowrisk of default. The following quote illustrates, in exemplary manner, what is meant bya reliability test: “If someone invests a certain amount of money to build up a business,he shows that he will be serious. It is the same with the companies in Romania. Usuallyafter I am contracting them, who are you, how many employees do you have, 70, ok. You

12. Here, one can also refer to a quote by the English legal sociologist Hugh Collins (1999, 15) wherehe argues: “I call the contract a form of communication system because this phrase emphasizes the point thatthe contract thinks about the relation between people in a particular way . . . it functions in humaninteractions as a distinctive way of understanding relationships. The contract constructs an image of thehuman association that reduces its complexity to the elements and trajectories that have significance withinthe contractual framework.”


have an office? ‘Yes’. That is why we have such a nice office; we have video camerasoutside, all kinds of good networks. This is an investment of two million Euros. If I putso much money in the environment, that means that I have the capability to do sucha good job. Nobody is investing two million dollars into nothing” (BR-III interview,p. 11).

As can be concluded from Table 6, the German enterprises look particularly atthree aspects of a foreign enterprise when they conduct the reliability test. First, theycheck how much a potential foreign supplier invests in the quality of its employees(Nos. 53, 54, 55, 57, 60, 61). The German enterprise is not only interested in thenumber, but also the exact qualification, of the staff of the foreign company. Apart fromuniversity degrees, German firms attribute particular importance to examination-based

TABLE 6.The Reliability Check of a Foreign Software Provider from a German Perspective


G-I 49 So, for instance, China has a black mark, when you ponder its attitude towardintellectual property protection, if you will. But this specific company,whoever it may be, has very strong security measures in place around thephysical location—the site. (p. 8)

G-I 50 They have to show you the site security measures; they have got to show youthe methods they put in place to protect things. And then in thosecircumstances you want not only to talk to the management team: you alsotalk to people who are actually responsible for those areas. (p. 8)

G-II 51 The rule is that companies with which you plan larger projects, first of all showsome examples indicating what they are capable of doing. (p. 2)

G-II 52 Trust emerges when the partners ask for a few examples of programming. (p. 2)G-II 53 The background of people is very important: how many people are there, how

are they certified, what kind of technologies do they use, what kind ofreferences are available, how is the financial situation? All aspects of thecompany are examined. (p. 7)

G-II 54 Of large significance are certificates by global players. Are the experts of thecompanies certified by Microsoft or Cisco or IBM? Did they have to docourses and did they have to do exams? How many are there in thecompany? (p. 14)

G-III 55 Concerning employees, certificates play an important role. For instance, someIndian universities are perceived as of good quality. (p. 8)

G-III 56 You should rather trust certificates by companies which operate globally andhave global standards. (p. 9)

G-IV 57 Concerning employees, certificates play an important role. (p. 6)G-IV 58 If things get serious, I travel there and then I can easily see how they are

located: the business premises. That generates a kind of certainty. (p. 16)G-IV 59 Small test tasks are awarded. (p. 17)G-V 60 A short time ago, I talked about a company in Riga. Of course, there was the

issue of how reliable they are. And they had a very crisp argument: they arecertified by IBM and develop for them. (p. 3)

G-VI 61 Partner companies invest in the training of the employees; the commitment isan indirect one, since partner companies invest in training first and thenwant to re-earn their money. (p. 1)


training certificates from multinational corporations, such as Microsoft, SAP, or IBM(Nos. 54, 55, 57, 60).

Second, they check how much a potential business partner invests in the qualityof its production processes. This evaluation is conducted based on quality standards(Nos. 54, 56, 60) but also on test projects (Nos. 51, 52, 58). Concerning the qualitystandards, there is a distinction to be made between certificates issued by professionalstandardization bodies (like ISO or SEI13) and certificates issued by well-known multi-national enterprises (like Microsoft Gold Partner or IBM Certified Partner). Thecertificates of big multinational corporations are apparently given more importancethan the quality standards of professional standardization bodies (Nos. 54, 56, 60). Asthe following interview passage exemplifies, the reason for this difference is that,although standardization bodies establish global unitary norms, national offices, whichapply different standards of accuracy in the certification process, supervise them: “Sure,I trust the certificates of globally active enterprises more than those based on globallyvalid norms, as individual monitoring bodies in individual countries supervise the latter.A certificate under the ISO 9.000 standard is, for instance, in Germany monitored bya certification center, accredited in Germany. In Italy, it is monitored by an Italian body,etc. I wouldn’t like to compare a German body with an Egyptian or Sudanese one—totake it to the extreme” (G-III interview, p. 9).

Third, they check on the extent to which the enterprise has invested in itsproduction facilities. To do this, production sites are usually visited in person in orderto review the quality of the business premises and of the technical infrastructure as wellas the investments in physical and virtual security arrangements (Nos. 49, 50, 53, 58).

The fact that a potential foreign business partner has made significant investmentsin all three areas signals to the German company the credibility that the prospectivebusiness partner is interested in long-term business success and will therefore behavecooperatively. The foreign company has met a fundamental precondition for theGerman enterprise to enter into further cooperation with private institutions.

At this point, it remains to note that the German companies make extensive useof modern information and communication technologies (ICT) during reliability testsof potential transaction partners. German companies obtain, directly through a thor-ough search of the Web sites of the potential foreign transaction partners, initialinformation on the number of employees working at a company or the number and typeof certifications a company holds. In a further step, the German company receivesadditional information, such as the specific qualifications of each employee, by sendinga detailed questionnaire to foreign providers to be completed and returned to theGerman companies. Only when these Internet-based preexaminations have been com-pleted successfully will staff members of the German enterprise visit the production sitesof the foreign provider in person in order to gain a final impression about the latter’swillingness to cooperate. The following interview passage illustrates this point in

13. The International Organization for Standardization (ISO) is a network of national standardizationinstitutions in 147 countries with its headquarters in Geneva, Switzerland. The Certification “IS0 9.000” isdecisive for the software industry. The Software Engineering Institute (SEI) is a state-financed research anddevelopment center, which is supported by the US Department of Defense and situated at Carnegie MellonUniversity. Capability Maturity Model (CMM) has become the best-known quality certification for cross-border software development. For further information, see Amberg and Wiener (2006, ch. 5).


exemplary fashion: “At the moment, many first contacts are established via the Web. Itplays a very prominent role. They do research on the Internet, and in this way learn toknow each other. Then, they will exchange information at first. Sure, at some pointthese people have to meet” (G-II interview, pp. 16–17).

The Implementation of Contractual Relationships

The phase of initiation is followed by the implementation of the transaction. Itbecomes obvious in Table 7 that at this point, software development contracts areusually divided into different stages (milestones) (Nos. 63, 65, 66, 67, 72). The finalproduct is not delivered in one piece at the end of the transaction; rather, it is spreadgradually throughout the entire development process. At the end of each milestonephase, a comprehensive test is conducted in which the German client determines, with

TABLE 7.The Significance of Self-Enforcing Contracts in the Generation of ContractualCertainty


G-II 62 Payment arrangements are far more important than legal terms. (p. 4)G-II 63 Certain payment arrangements are agreed upon. After the award of contract,

the supplier receives only a small initial payment. Payment is then madeaccording to the way in which the project proceeds. (p. 4)

G-III 64 We use non-payment as an opportunity to enforce quality standards. Thisprovides a massive lever. (p. 12)

G-III 65 Work packages are produced that can already be tested. Payment byinstallments is agreed upon. (pp. 14, 16)

G-III 66 Partition into sections and milestones offers the opportunity to intervene inorder to recognize conflicts earlier. (p. 17)

G-IV 67 We define milestones and every milestone has got its own test procedure. (p. 6)G-IV 68 The exit option is important. (pp. 9, 19)G-IV 69 If the tests are not passed, we don’t proceed. (p. 6)

70 The payment of the last milestone poses a critical risk, since the deliveredproduct can show a fault after it worked for some time. Hence, a stipulationis agreed upon that requires the supplier to provide updates free of charge fora year. State transaction law has no bearing on the enforcement of thisstipulation. However, what allows enforcing of the stipulation is the fact thatI collaborate with the supplier in other projects. Otherwise I try to pay thelast milestone as late as possible. (pp. 11–12)

G-IX 71 The Indians perform the contract, because they want to get their money fortheir service. They will therefore make an effort to satisfy the needs of theGerman customer. (p. 2)

G-X 72 You have a time axis with milestone plans. If the milestones are not met, youhave to escalate. (pp. 1–2)

G-X 73 If a milestone is not met, then you have waiting periods which amount to notmore than a few days. After two days, I can block a project, and then I cancancel it and pay only a quarter of the actual working hours. (p. 2)


the help of predefined quality criteria, whether the delivered intermediate productmeets the agreed specifications (No. 65). The German company then pays a portion ofthe contract price according to the progress of the project—either a fixed agreedmilestone payment (fixed-price contracts) or the working hours spent by the foreignsoftware producer to reach the milestone (time and material contracts). Only with thelast milestone payment is the transaction completed entirely.14

However, if the foreign supplier cannot fulfill the milestone-related quality criteriaas agreed or is late in delivering the product, the German company can suspendpayments after a short grace period and, finally, even end the business relationship atlow cost (exit clause) (No. 73). Therefore, the suppliers have to endeavor to meet thecontractual requirements in every milestone phase, as this is the only way to reach thenext level of payment. If a supplier behaves opportunistically, the prospects of futureearnings are lost when the German enterprise terminates the business relationship.Obviously, by this structuring of the contractual relationship into various milestonephases, the German companies establish a simple but highly effective means for con-trolling the actions of their providers (No. 71). In this sense, German companiesperceive “payment arrangements” as more important than “legal terms” (No. 62) andthe option to refuse to pay bills is deemed to be a “massive lever” (No. 64) to enforcecontractual claims.

In short, by structuring the business relationship in milestone phases, the transac-tion turned from a simple prisoner’s dilemma into a repeated game. The consciouslycreated shadow of the future gives the foreign supplier an incentive to reliably fulfillcontractual agreements.

The Monitoring of Contractual Relationships

Modern economic exchanges can be conducted by an enterprise either as internalproduction processes or as external market transactions. It is the central concern oftransaction cost theory (the make or buy decision) to specify the conditions underwhich it is more efficient to choose one or the other governance mode, but this need notbe of detailed concern in the following. In the context of this study, it is important tonote that the governance structures of these two transaction types, market and hierar-chy, differ fundamentally in the way they arrange the monitoring of the involved parties(see Williamson 1996).

If a transaction is handled via the market, the contract serves as the basis formonitoring—the contract determines the required services and products as well as thetime when the contractual performance is due. When this point in time arrives, one sidecan verify, through the terms of the contract, whether the transaction partner has metthe contractual obligations. In other words, the monitoring is done with regard to theachieved result and works therefore indirectly and impersonally, as the transaction

14. In contracts where small- and medium-sized foreign software companies are involved, milestonepayments usually range between 10,000 and 20,000 Euros, which is a bearable risk, even for small companies.In contracts where big companies are involved, the milestone payments can be as high as 50,000 Euros (seeDietz and Nieswandt 2009, 101–02).


partner is not directly monitored during the provision of services. In the case of aninternal company transaction, however, different units cooperate on the basis of plansthat are set by corporate management and controlled bureaucratically. Here, the per-formance of individual employees is supervised directly and personally at their work-place by their superiors.

An especially interesting finding of the empirical study is that major Germancompanies, in particular, safeguard their stake by monitoring their foreign transactionpartners not only indirectly with the help of the contractual obligations andspecifications—as would be typical for a transaction between independent enterprises—but also with other more direct control systems, which structurally correspond more tothe governance mode of hierarchy than to a market transaction (Nos. 76–83).

Table 8 reveals that the foreign providers allow their German clients direct accessto their company-internal project management systems so that German enterprises canmonitor and control the process of software development directly (Nos. 74–83).Although legally separate entities are formally concerned in this process, the involvedcompanies in this way create a common organizational structure that transcends amerely contractual relationship. A system of monitoring and reporting is establishedbetween the involved corporate units, from the level of project managers all the way upto senior management, which involves monthly or weekly reports (Nos. 78, 80) andincludes, in extreme cases, even the real-time monitoring of foreign providers—whenthe German client can watch “live” what happens on the computers of the foreignprovider (real-time controlling) (Nos. 74, 75). For example, as one expert explained:

One uncertainty of the customer is losing control. Usually he has a customer anda contract with that customer, with deadlines. He has to deliver good quality. Thenthere is a problem in the project management: You ask the project manager: “Haveyou started the project?” He says: “Yes,” and he did not. “How much have youcompleted?” “50 percent,” and so on. You lose control of deadlines. So, in the salesprocess you have to show him that you have a project management system. He canget in, you give him a password, and he can get in to check. (No. 76)

The interviews indicate very clearly that this comprehensive and direct supervi-sion of the foreign transaction partner would not be possible without the preconditioncreated in recent years by technological advances in the information and communica-tion technologies. This is reflected, for example, in the fact that monitoring andreporting is usually Web based (No. 77). The provider sets up an Internet portal wherehe or she deposits those documents required for monitoring purposes; these password-protected documents can then be accessed by the client from any point on Earth, withan available Internet connection (Nos. 76, 77, 78, 83). In addition, information thatserves the control of the transaction partner can, if necessary, be sent cheaply andquickly via the Internet or be acquired by oral reports via telephone and videoconfer-ence (Nos. 78, 83).

In short, the comprehensive technological interlink of the transaction partnersincreases the transparency on the side of the customer significantly. With this, theGerman company is able to identify immediately opportunistic behavior of the foreignprovider in the course of the contractual relationship and react with appropriate


TABLE 8.The Monitoring of a Foreign Software Provider by a German Customer


G-II 74 The monitoring of the cooperation partner poses no technological problem andis no issue anymore. These days you have methods and development toolsthat allow you to see in Germany what happens abroad every day. (p. 3)

G-II 75 Today, you are indeed able to see in Germany what momentarily happens on acomputer in Novosibirsk. (p. 16)

BR-I 76 For example, one uncertainty of the customer is losing control. Usually he hasa customer and a contract with that customer, with deadlines. He has todeliver good quality. Then there is a problem in the project management:You ask the project manager: Have you started the project? He says: Yes, andhe did not. How much have you completed? 50 percent and so on. You losecontrol of deadlines. So, in the sales process you have to show him that youhave a project management system. He can get in, you give him a password,and he can get in to check. (p. 9)

BR-VII 77 My people report exactly how they spend their working hours. We had aproject here and it cost us 50,000 euro; it was also Web-based. We made itto keep control. You can plan—you can state from the beginning that thereare phases, tasks, and so forth. That is one part. Then every memberbecomes part of a team and can see the tasks it has to fulfill. Then it has tostate the task is solved so that you can see how the project progresses. Andthere is another part, in which you can find all documents. With accessdistributed among teams, so that each team can only access the documentsthat concerns its work. Then there is defect-tracking. This means that ifthere is a defect, it gets booked who found it, how, etc. Then someone isasked to correct it. And this is done via the Internet. If you have a laptopand a small phone, you can see what you have got. The customer is able tosee this as well. The system also allows the customer to report defects he hasfound. The system provides me with control and there’s always a full alarm ifsomething is not right. If we want to win a new customer, we discuss thisE-project that allows very good control; so that he can see the progress ofthe project. (p. 14)

ING-II 78 One of the things that we make the customer visible is the early warnings orthe way the project is progressing. We use what is known as a portal for that.Governance process is what we give a lot of importance to. Because at aproject level, the governance is different. At the project level, you have theproject manager and the project team, which meets very frequently andwhich talks of line-level items. Saying: this is the activity that had to beperformed; it may get delayed because of those things. So, what is what weneed to do? The client says that I need to work with my infrastructure team,so that this comes up. Or with my business team so that we get thesequalifications. Our project manager says, “all right, I will speed up thecurrent activity on this project level.” This is a common and frequent kindof interaction, based upon weekly reports, based upon the weekly checkpointminutes. The previous minutes are read, action point seen, risks eventuallyidentified, evaluated, reviewed and out comes a report for the governanceteam and the steering team. The steering team typically is of the seniormanagement teams of both of the companies and then they can providetheir direction or take executive action where it is required. (pp. 28–29)


sanctions, even before review at the end of the respective milestone stage reveals thatthe foreign partner was not able to perform the contractual arrangements reliably. Theuncertainty related to software transactions is again reduced significantly.

The Limits of Relational Contracts

As the following interview passage illustrates, relational contracts meet the limitsof their effectiveness, despite all the extensive technological surveillance, if a businessrelationship comes close to its end: “Specifically, there is a critical risk in paying the lastmilestone, because it may turn out that the product is still faulty after it ran some timein practice” (G-IV interview, p. 11).

To avoid this risk, the contract contains a clause that obligates the provider to offercorrections to the software free of charge for a certain time (in this case, one year) afterdelivery. The difficulty is how to enforce this agreement, as the customer has lost

TABLE 8.(Continued)


ING-II 79 So, here you can go to individual reports, here you have status reports, minutesof meetings, project plan, and matrix. And then each one of these folderswill find me their documents. If I have access, I can see the whole statusreport here. (p. 37)

ING-II 80 The portal contains an early warning system. Green means time is undercontrol to schedule, cost, and budget according to schedule, there are no redor amber related risks or issues in the project and things are going fine.Amber means that there is a decision on whose responsibility it is to bring itfrom yellow to green. Red means immediate attention. Let us say thetimeline is from here to here two weeks. And at the end you have adeliverable A. Somewhere in the middle of the timeline, the projectmanagers of both sides will know whether we can make the date or not.Because of that, the portal will turn into amber or red. (pp. 37–38)

ING-II 81 If the data is not current, then somebody speaks to the project manager andsays why the latest information is not uploaded. So, always the projectmanager updates the portal at the end of the week. Therefore, there is anongoing check. (p. 39)

ING-II 82 The possibility to control starts by breaking the production process to verysmall pieces. Breaking it down to weekly time buckets, or monthly timebuckets—the most usual time bucket is a weekly time bucket. So you knowthat the project status report talks about what has been planned for thisweek, what has been achieved, and what has not been achieved. So, theclient’s project manager can control the process. (p. 41)

ING-VI 83 During the initial engagement meeting, we decide the kind of reports that theywould get. On a weekly basis, or on a monthly basis. And we also tell themhow often we will have telcons with them. Also we have customer portalswhere they can find out about the project status, what is the current state ofthe project? They can see the status of the projects and that increases theirconfidence. (pp. 9–10)


effective means of sanctioning, and therefore control of, the provider after the paymentof the last milestone.

The experts suggest, as possible solutions to this problem, either delaying thepayment of the last milestone as long as possible, in order to retain a means ofsanctioning, or continuing the repeated game by further future orders between theparties. In the following section, however, the research shows that for enforcement ofthis rectification agreement, the mechanism of reputational networks can be of crucialimportance, transcending the bilateral level.

Reputational Networks

Table 9 shows that before they begin a business relationship, German enterprisesusually consult a list of references, which identifies businesses with which a potentialtransaction partner has cooperated in the past (Nos. 85, 94, 95, 101, 98). Thesereference lists are an integral part of the Web presence of foreign providers and aretherefore directly available to German companies. In general, these reference lists areused as a starting point by German enterprises in order to do further research into theexchange history of a potential foreign business partner. They often begin by phoningor e-mailing the reference providers directly, in order to find out how a potentialtransaction partner actually behaved in past exchange situations (Nos. 86, 87, 94, 95,96, 97). This exchange of information can be very in-depth—not only the managementexchanges information on potential foreign business partners but also the personnelwho were directly involved in the technical implementation of a project (No. 85).Experts interviewed attribute particularly high significance to the references of largemultinational corporations. The reason is that in the case of large companies, theperceived risk that two players will agree strategically to draw the picture of a foreignpotential transaction partner in an all-too-positive light is smaller (Nos. 91, 96).

It is questionable at this point, however, why German customers trust at all theinformation given by other companies. The reference provider has no direct incentiveto help a company find a suitable foreign partner. To avoid conflicts, however, theinquiring company does not ask direct competitors for reference information. In addi-tion, an internal reliability control is built into the system—experts would immediatelylose their status if they disseminated false information within their industry: “If you areasked as an expert by another expert, then you even tell a competitor: this company isreally excellent. If you give false information, you can forget about your status as anexpert. Things like this spread quickly” (G-II interview, p. 14). In other words, thereference providers are themselves embedded in reputational networks, which safeguardthe reliability of their information.

Indeed, foreign providers know that their potential customers are in touch witheach other and exchange information about them: “We think that if we try to give acommitment to the customer and the chances are that we may not be able to meet, thenin the long term this causes big problems. It is a network society and word will easily goaround” (ING-III interview, p. 4; see also Table 10, Nos. 103, 106. 107, 108).

In this way, German enterprises employ a trilateral means in order to safeguardcontract performance by the foreign provider, in addition to the above-mentioned


TABLE 9.The Significance of Reputational Networks for the Generation of TransactionCertainty from a German Perspective


G-II 84 If you provide a false certificate, your expert status in the industry is gone. Thisgets around quickly. There are also networks of German companies in Russia.There is an association of companies that operate in Russia, which establishessuch network structures. There are a number of structures where suchinformation is exchanged. (pp. 14–15)

G-III 85 I ask for a list of references and would then try to talk to the referees at differentlevels (technology, quality, management). (p. 7)

G-III 86 If a collaboration has not been successful, a customer can’t include me in hisreference list. (p. 13)

G-III 87 We would not enter the market and say that we had a bad experience with apartner. You have to be very careful when you report bad experiences publicly.At meetings of the discipline and in smaller circles, one naturally tells one’smind. (p. 13)

G-III 88 If a third party reports bad experiences, we have to be careful with informationwe give. Or to assess a partner so that we don’t collaborate in the end. (p. 22)

G-IV 89 Personally, I prefer references to certificates. (p. 1)G-V 90 I went to Tallinn myself and had to find out that my possibilities are limited

when it comes to assessing things. Consequently, I looked for someone whowas better qualified, someone who had already worked with the Estonians, andsomeone I could trust because I had worked with him before. (p. 2)

G-V 91 A moment ago, I talked about the company in Riga; naturally, there was thequestion of how reliable they are. And they had a very crisp argument: theyare certified by IBM and develop for them. That brought me back into a worldI know very well. (p. 3)

G-V 92 At a trade fair, companies told us about their experience with Estonia. (p. 2)G-VI 93 In the software industry, reputation plays a highly significant role. It is destroyed

once it is misused a single time. (p. 10)G-VI 94 Reputational networks function, on the one hand, via references on the Internet

(only good projects). On the other hand, one talks about references. Concretequestions to the potential cooperation partner: “Would you mind if we talkedwith people you worked with before?” One knows, in every project you havesetbacks; question: What have they done in such circumstances? (p. 10)

G-IX 95 Only very rarely, the Indian software industry is able to show commissionedwork, due to secrecy. Accordingly, all software companies have their so-calledlists of references. They report all customers, but only if a customer does notobject. But most of the time, if things work out, you can claim you worked forTelekom or the postal service; usually the heads of the IT companies knoweach other; they call each other and ask: “You have worked with them, wasthat ok?” (p. 12)

G-X 96 Important is: Are the references verifiable? Take Nokia as a case. There is aconsumer training for mobiles listed in the references. And we asked whetherthere is anyone at Nokia able to provide some information. We followed thatup and there was a colleague in Düsseldorf who could confirm that there wereorders placed with an Indian company; he told us that they are happy withthe quality. If you talk about a major brand like Nokia, the Indians can’tsimply call them before and say, “Someone will call, could you make themhappy?”; that’s inconceivable. (p. 1)


possibility to end the business relationship (bilateral governance). In the case of breachof contract, the foreign supplier not only fears that it will lose its direct business partner,but also, against the backdrop of communicating reference networks, is aware of thedanger that it will find no other transaction partners in the future. Once the pastbehavior of a foreign supplier is known, not only by its direct partner but also by anyother potential customer, the breach of contract leads to a loss of reputation of theforeign provider within the “business community,” which ultimately renders its survivalin the market unlikely (Nos. 102, 105).

The loss of reputation is seen as such a strong threat to business success that foreignproviders only enter into a transaction if they actually believe that they can meet theexpectations of their customer with some certainty. The extreme importance of thereputational mechanism for the creation of contractual certainty is again emphasized byanother expert: “It is a very competitive work. So, delivery commitments that are madeby companies like us, if you don’t do this, it is not just a question of losing thathalf-million dollars or Euros. It is a total incredibility in the business. It’s a small world.If I work with Audi tomorrow, they will say: can you give me a reference of another largeGerman company? Now, if I have done a bad job, how can I request a reference? So, Iknow the repercussions of not delivering. Sometimes I leave it because I cannot deliver”(ING-IV interview, p. 7).

The empirical study reveals that the virtual published reference lists make itpossible for the German firms to obtain access to the experience of other firms evenwhen these firms are not part of their personal networks. Based on the supplier’sreference lists, communication networks develop that are capable of connecting firms

TABLE 9.(Continued)


G-X 97 They asked me, for instance, whether I could provide a reference for similararrangements, after we completed the project. I agreed; that’s give and take.(p. 1)

G-X 98 I would say references are the most important thing. (p. 1)G-X 99 That everything happens according to the contract can someone only claim if

he is well meaning, or he can safeguard his belief by seeking references, whichallow him insight and questions. How quick are they, are they reliable, howdo they produce the documentation of their software development, etc.? (p. 2)

G-X 100 I would never threaten a partner with an experience I made. If we reach a pointat which he doesn’t perform, then I tell him, “look, if you don’t put an effortin, I will tell everyone.” I would never do such a thing; I believe that wouldnot be ok. But if someone approaches me directly and I have a bad impressionof a company because its quality, processes, the result was a disaster, then Iwould tell. (p. 2)

G-X 101 But I would not keep a blacklist and say: hey, that and that company is a reallybad one. I also don’t know of any explicit blacklists. (p. 2)

G-X 102 And I think that what works is that if such a thing happens, then thecommunity of companies knows very quickly, without me publicizing thatthey have stolen and sold my software. (p. 4)


unfamiliar with each other. Every company in the world can check the reputation ofanother company in nearly no time. The Internet thus leads to a new form of “infor-mation pooling” and, as a result of this process, new forms of reputational networksemerge that are capable of effectively enforcing agreements in exchange even outsideclose-knit communities.

Reputational Networks and Private-Governance Regimes

As becomes obvious in Table 11, the empirical results indicate further thatGerman companies are supported, on the one hand, by foreign trade chambers and, on

TABLE 10.The Significance of Reputational Networks for the Generation of ContractualCertainty from a German Perspective


G-II 103 Russian companies learned very quickly that reputational networks exist andhow they work. (p. 15)

BR-II 104 We sent them presentations; if they want, they can verify this with thecustomers. (p. 11)

ING-I 105 The decision to go to court is definitely not driven by my ego. My decision togo to court will be purely driven by business interests. If I feel that by losingall to this client will hamper my further business objectives, it is going to bea negative mark in my record; I did not fulfill a particular client’sobligations, so obviously I will not find further clients in the same industry. Icannot use this client as a reference. I cannot risk that. I have to comeclean in this account and say, “look, I fulfilled my obligations, this is whatwas delivered according to what we have agreed upon, you have accepted.”Money is important, but is not very important compared to the otherbusiness that I can get. In this particular deal, I might lose a few thousandsof dollars, but over a period of time, I can make up this money by havingmore business leads. (p. 3)

ING-III 106 We think that if we try to give a commitment to the customer and thechances are that we may not be able to meet, and then in the long term thiscauses big problems. It is a network society and word will easily go around.(p. 4)

ING-IV 107 It is very competitive work. So, delivery, commitments that are made bycompanies like us, if you don’t do this, it is not just a question of losing thathalf-million dollars or Euros. It is a total incredibility in the business. It’s asmall world. If I work with Audi tomorrow, they will say, “can you give me areference of another large German company?” Now if have done a bad job,how can I request a reference. So, I know the repercussions of notdelivering. Sometimes I leave it because I cannot deliver. (p. 7)

ING-VII 108 What does the customer do to satisfy himself that all that I state I will deliver?Enforceability, keep it aside. If I make a mess there, the legal course may notbe of much help, except it may give some financial compensation. In anycase, you have lost something, your reputation in the market. What does themarket feel about us? (p. 8)


the other hand, by various trade associations in their quest for a suitable offshoreprovider (Nos. 102–113).

Foreign trade chambers mainly support German companies by passing on theirorder requests to foreign members at a cost and by returning offers to the Germancompanies (No. 117). However, foreign trade chambers formally have no other orderingfunction beyond this mere brokering activity. They neither publish blacklists, in which

TABLE 11.The Significance of Private-Governance Regimes for the Generation of ContractualCertainty from a German Perspective


G-II 109 For the establishing of personal contacts, network structures, like associationsand chambers of commerce, are very helpful. (p. 1)

G-II 110 Usually, trade associations are closely involved in the early phases of makingcontact. (p. 5)

G-II 111 Association-like network structures probe which companies are allowed to takepart in match-making events organized by the associations. (p. 18)

G-II 112 Via our networks, we get information very quickly about who misbehaves.(p. 19)

G-II 113 In our working groups, more than six thousand experts are involved; almostone hundred working groups exist. That’s already a rather tightly knitnetwork. (pp. 19–20)

G-II 114 Today, knowledge transfer is mainly done in physical meetings. But we are justabout to develop a knowledge management system that allows the membercompanies of the association to cooperate. Then information exchangereaches another dimension, and you are able to access the reports of thirdparties via the Internet. (p. 20)

G-III 115 The AHK does not offer reports, but provides experienced companies. (p. 28)G-IX 116 In India, about four hundred companies are members of the Indian chamber of

commerce; hence almost all important companies are covered. (p. 7)G-IX 117 The chamber of commerce supports the process as follows: The request of a

German company is anonymously sent to its Indian members; then offersarrive. The German company scrutinizes the offers and decides we want totalk with these ten companies. Then the German company visits India,meets the ten company representatives in the chamber of commerce andvisits two or three on their premises. For this service, the chamber ofcommerce requires a fee. (p. 7)

G-IX 118 Every company can become a member of the chamber of commerce; there isonly a selective process, once the companies can be put into contact withthe German partner. The chamber investigates: Are they reasonably serious;are they known; have they been active in another shape or form? (p. 8)

G-X 119 There is no systematic blacklist, because the chamber of commerce usuallydoes not become aware of the way a project progresses. There is only rarelyany feedback. Information is rather exchanged informally in IT networks.(p. 14)

G-IX 120 This is also a reputational question. In India, you have, after all, anindependent press and public judicial proceedings. If it is claimedthat-and-that company has stolen my software, then legal action follows,and you have broad press coverage. (p. 22)


the misconduct of foreign companies are documented (Nos. 101, 119), nor do theyexclude companies systematically from their organization when they have breached acontract in the course of a business relationship. The generation of contractual cer-tainty is therefore not among the official duties of foreign trade chambers.

At the informal level, a different picture emerges. Employees of foreign tradechambers informally collect important information about the transaction behavior oftheir members and pass it on to German companies in order to warn them aboutbusiness partners with a bad reputation. As one foreign trade chamber member put it:

Reputation is our strong point. We do not publish information about companies,this is not allowed. But we have this knowledge already. And the Indian companiesknow that we are also very close to the consultants. We are also very close to theGerman community, on a one to one basis. But this is nothing official, because youasked me if there is a process in place, we cannot have this. We cannot say: “Here,there is a blacklist.” This is not allowed. We cannot do that. But, the Indiancompanies know already that in different forums we can discuss this issue. And ifa German company should come to us saying: “Ok, I am going to do business withso and so company, do you think that is safe, do you have a background?” We maynot even write it down in correct words because then it comes to defamation. Butwe could always pick up the phone and tell them, “No, they have done wrongsometimes, so please watch out.” That we would still do. And we are very well knitwith the chamber of commerce in Germany, so there is a forum where we can talkabout these things. (ING-VIII interview, p. 5)

Therefore, the foreign trade chambers become an important part of the informalreference networks through which German companies control their foreign transactionpartners (Nos. 109, 115, 118).

In addition to the foreign trade chambers, various trade associations, such as theBITKOM (BITKOM 2008), support German enterprises in their quest for foreignsoftware suppliers (No. 110). A widespread means for promoting cross-border coopera-tion is the organization of contact forums, so-called match-making events, to which thetrade associations invite both targeted German and foreign companies in order tofacilitate business contacts for both sides (No. 111). Like the foreign trade chambers,however, trade associations refrain in the runup to these events from systematicallyreviewing the transaction histories of the participants in order to ensure that onlyreliable companies participate in match-making events. Accordingly, an executive ofARIES (the leading association of the Romanian software industry) confirmed that theRomanian companies are not preselected before they are allowed to come to a match-making event in Germany. An executive of BITKOM also stated that German com-panies are not preselected in the runup of a match-making event. Trade associations, atmost, probe which companies are invited to such events (No. 111). This means thattrade associations, like the foreign trade chambers, focus primarily on the initiation ofbusiness contacts—they do not create marketplaces with their own rules and arbitra-tion, as would be characteristic for a private legal system based on the principles of LexMercatoria (see Berger 1999).

The account of the importance of trade associations for the generation of contrac-tual certainty would, however, be incomplete, if it remained limited to the organization


of match-making events. Much more important is the fact that the association links itsmembers extensively. The BITKOM, for example, according to its self-description,represents “a big, powerful network and brings together the best minds and companiesin the digital world. BITKOM organizes an ongoing exchange between professionalsand managers and provides its members with platforms for cooperation among them-selves and for the contact with key customers” (BITKOM 2008).

BITKOM’s nearly one-hundred professional working groups, bring together aboutsix-thousand experts of the German IT industry (No. 116). Even if only a few workinggroups address the issue of cross-border software transactions directly, this tight networkstill implies that German companies are constantly in touch with each other. Thismeans that, via the networks of the association, German companies learn “very quickly”(G-II interview, p. 19; see also No. 112) in an informal way “who misbehaves” (G-IIinterview, p. 19; see also No. 112). Like the foreign trade chambers, the trade associa-tions also encourage to a considerable extent the informal exchange of informationamong German companies. Thus, they also become an important part of the above-mentioned informal reference networks, but without reaching the organizational degreeof a transnational private legal system.

CONCLUSION

This study examined which institutions offer a sufficient degree of contractualcertainty when German enterprises purchase software in India and Eastern Europe. Thefindings of the empirical study can be summarized and theoretically categorized asfollows.

Despite the fact that the enterprises involved usually settle on very detailedcontracts, from the perspective of German companies, state private law is of no signifi-cance for safeguarding contractual performance in cross-border software transactions.Contracts are necessary documents in order to participate in modern business life. Forthe management of an enterprise, they serve as a means of legitimization vis-à-vis itsowners, and they ease communication in intercultural contexts. Furthermore, they arenecessary for tax reasons. However, they provide no contractual certainty for Germancustomers purchasing software in Eastern Europe or Asia.

According to legal theory, the mechanisms of spontaneous self-organization are ininterplay with contractual law, thereby generating a shadow for business relations. Incase those business relations fail, state courts as well as private arbitration courts areready to sanction breaches of contract. However, up to that point, the actors collaborateon the basis of repeated interaction, reputation, and relational norms. A key finding ofthe empirical study is that contractual law in the transnational realm—be it of a stateor private nature—can hardly fulfill its function any longer as the ultimate appeal. Evenin the case where foreign business partners are in breach of contract and, therefore, thebusiness relation ends, German companies would refrain from suing since they areconvinced that the verdict cannot be enforced abroad. However, law that cannot beenforced loses its effectiveness. Thus, the software development contracts followed inthis study occur in the absence of a legal shadow protecting the business relations of theactors.


The German businesses, however, are able to ensure the contractual performanceof their foreign offshore providers through private enforcement mechanisms.

First, German customers check the reliability of a potential foreign businesspartner on the basis of specific investments before a business transaction even takesplace. Then, they divide transactions into different milestone phases. At the end ofevery milestone phase, the German enterprise can decide whether it wants to continueor to end business dealings. Thereby, the looming loss of future business opportunitieskeeps foreign suppliers cooperative and from turning opportunistic. In short, the busi-nesses themselves create the institutional context that enables them to conduct cross-border software transactions. They design the exchange in such a way that contracts arefulfilled without outside intervention.

In the interviews, it could also be noticed that systems of monitoring and reportingare applied in the global software industry, which enable German customers to monitorthe activities of their foreign transaction partners. In many cases, the German firms, viathe Internet, obtain direct access to the supplier’s computer systems, so that they cancontrol, in real time, how the foreign company develops the software product (real-timemonitoring). Due to this comprehensive virtual integration of the transaction partners,the German customers are capable of immediately deploying adequate sanctions if theforeign supplier does not fulfill its contractual obligation. In sum, the transactionpartners use modern ICT to organize the transaction so that it becomes self-enforcing(relational contracting). By dividing the transactions into different milestone phases,the involved actors turn the transaction from a simple prisoner’s dilemma into arepeated game, and the individual milestone phases are virtually monitored to controlthe process at any time.

However, German enterprises control the activities of their foreign business part-ners with not just the help of bilateral sanctions. Cross-border software transactions areembedded in overarching reputational networks, which consist of companies, foreigntrade chambers, and trade associations. Hence, there is a further—trilateral—mechanism with which German customers can safeguard the contractual performanceof foreign providers. In the case of a breach of contract, foreign providers have to fearnot only that they lose their direct business partner, but also that they may lose theirreputation and become excluded from the business community due to the informal butintensive information exchange between German enterprises, foreign trade chambers,and trade associations (trilateral sanction). Every company in the world can check thereputation of another company in nearly no time. The Internet thus leads to a new formof “information pooling” and, as a result of this process, new forms of reputationalnetworks emerge that are capable of effectively enforcing agreements even outsideclose-knit communities. In addition to relational contracts, the mechanism of reputa-tional networks is of particular significance to German enterprises in safeguarding thecontractual performance of cross-border software-transactions.

In contrast, formally organized, private systems of law, which are based on normsof the Lex Mercatoria, play no role in the provision of contractual certainty.

Moreover, German enterprises comprehensively use the opportunities offered bynew developments in information and communication technology when it comes to theinitiation or control of their foreign business relations. Due to such technical innova-tion, it can be concluded that these two informal and spontaneous institutions of


contractual enforcement—reputational networks and relational contracts—offergreater contractual certainty, reduce risk, and are more efficient than systems of formallaw (private or public) in the realm of cross-border business.15

Finally, it has to be noted that the empirical study presented above does not allowthe drawing of general conclusions about the institutional foundations of cross-bordertrade. Although the software industry represents a very good example for the study ofproblems of transactional uncertainty in global exchange processes, the selection ofdifferent industries and countries could, of course, lead to different findings. However,from the fact that the study is not representative in a strict methodological sense, it doesnot follow that the overall findings could not lead to scientific insights that transcendthe single case itself.

The ineffectiveness of public ordering in cross-border exchange cannot be attrib-uted to the special conditions of the software industry. The main reason for thenonutilization of state courts and enforcement authorities lies in the fragmentation ofnational laws in a global economy, and there is no obvious argument why the PIL shouldbe able to overcome the fragmentation problem in other branches of business. Further-more, it seems very likely that due to the absence of state-enforced contract law,economic actors will create their own institutions so as to realize possible gains fromeconomic globalization in transactional contexts other than the software industry. Inparticular, Internet-supported reputation networks and reliability tests in the runup toa transaction seem nowadays to be a common business practice.

However, without further empirical data it is hard to judge to what extent com-panies from other industries avoid the prisoner’s dilemma by dividing transactions intomilestones and by employing systems of real-time monitoring in order to control theirsuppliers. And, further research is needed to assess the exact role of private arbitrationcourts in cross-border exchange.

In addition, the overall finding could also differ with the selection of countries. Inparticular, the European Union has made significant progress in the integration ofnationally fragmented private laws in the last decade and it will be very rewarding tofind out in a future empirical study whether processes of supranational integration ofprivate laws indeed enhance the efficiency of state-enforced contracts for cross-borderexchange.

Today, my view is that globalization and technological progress lead to the emer-gence of a new form of relational economic exchange, which is mainly based on thepossibilities offered by modern ICT. The institutional infrastructure provided by states

15. Ronald J. Mann (2001) writes to this point: “If we believe that commercial enterprises in thelonger run generally design their transactions so as to minimize the cost of such information problems, thenthe parties to those transactions generally should select the mechanisms that best resolve the informationproblems at the lowest cost. Thus, two features of the current environment suggest that the current set ofinstitutions is unstable. The first of those is a general rise in the cost of legal sanctions, reflecting in theincreasing pecuniary cost of litigation as well as slowing rates of resolution of civil disputes to the courts. Thesecond is the general decrease in the cost of acquiring, processing and analyzing information. Taken togetherthose two effects presage a significant shift in the balance of institutions away from legal sanctions—whichare becoming more expensive and less effective—to non legal sanctions—which become more and moreeffective as information related cost continue to fall.” The “informalization” of private law in the globalrealm has also been observed by Gralf-Peter Calliess and Peer Zumbansen (see Calliess and Zumbansen2010).


dissolves in favor of communicatively integrated network structures in the global realm.Pursued by states, supranational legal integration hardly affects this process at all.

REFERENCES

Abreu, Dilip, David G. Pearce, and Ennio Stacchetti. 1991. Optimal Cartel Equilibria with ImperfectMonitoring. Journal of Economic Theory 39:251–69.

Amberg, Michael, and Martin Wiener. 2006. IT-Offshoring. Management Internationaler It-OutsourcingProjekte. Heidelberg: Physica-Verlag.

Anderson, James E., and Douglas Marcouiller. 2002. Insecurity and the Pattern of Trade: An EmpiricalInvestigation. Review of Economics and Statistics 84:342–52.

Appelbaum, Richard P. 1998. The Future of Law in a Global Economy. Social & Legal Studies 7:171–92.Axelrod, Robert. 1984. The Evolution of Cooperation. New York: Basic Books.Belloc, Marianna. 2006. Institutions and International Trade: A Reconsideration of Comparative

Advantage. Journal of Economic Surveys 20 (1): 3–26.Ben-Porath, Yoram. 1980. The F-Connection: Families, Friends, and Firms and the Organization of

Exchange. Population and Development Review 6 (1): 1–30.Berger, Klaus Peter. 1999. The Creeping Codification of the Lex Mercatoria. The Hague: Kluwer Law

International.—— 2000. The New Law Merchant and the Global Marketplace. A 21st Century View of Transna-

tional Commercial Law. International Arbitration Law Review 3 (4): 91–102.Berkowitz, Daniel, Johannes Moenius, and Katharina Pistor. 2004. Legal Institutions and Interna-

tional Trade Flows. Michigan Journal of International Law 26 (1): 163–98.Berman, Harold. 1995. World Law. Fordham International Law Journal 18:1617–22.Berman, Paul Schiff. 2007. Global Legal Pluralism. Southern California Law Review 80 (6): 1155–1237.BITKOM. 2008. http://www.bitkom.org/de/wir_ueber_uns/99.aspx (accessed June 2, 2008).Calliess, Gralf-Peter. 2006. Grenzüberschreitende Verbraucherverträge. Rechtssicherheit Und Gerechtigkeit

Auf Dem Elektronischen Weltmarktplatz. Tübingen: Mohr Siebeck.Calliess, Gralf-Peter, Thomas Dietz, Wioletta Konradi, Holger Nieswandt, and Fabian Sosa. 2007.

Transformations of Commercial Law: New Forms of Legal Certainty for Globalized ExchangeProcesses. In Transforming the Golden-Age Nation State, ed. Achim Hurrelmann, StephanLeibfried, Kerstin Martens, and Peter Mayer, 83–108. Basingstoke: Palgrave.

Calliess, Gralf-Peter, and Peer Zumbansen. 2010. Rough Consensus and Running Code. A Theory ofTransnational Private Law. Oxford: Oxford University Press.

Campbell-Kelly, Martin. 1995. Development and Structure of the International Software Industry1950–1990. Business and Economic History 24 (2): 73–110.

Casella, Alessandra, and James Rauch. 2002. Anonymous Market and Group Ties in InternationalTrade. Journal of International Economics 58:19–47.

Collins, Hugh. 1999. Regulating Contracts. Oxford: Oxford University Press.Dietz, Thomas, and Holger Nieswandt. 2009. The Emergence of Transnational Cooperation in the

Software-Industry. In Legal Certainty Beyond the State. Empirical Studies and Theoretical Debates onInstitutional Support for Global Economic Exchanges, ed. Volkmar Gessner, 87–106. Oxford: Hart.

Dixit, Avinash K. 2004. Lawlessness and Economics, Alternative Modes of Governance. Princeton, NJ:Princeton University Press.

Flood, John. 2007. Lawyers as Sanctifiers: The Role of Elite Law Firms in International BusinessTransactions. Indiana Journal of Global Legal Studies 14 (1): 35–66.

Gaillard, Emmauel. 2001. Transnational Law: A Legal System or a Method for Decision-Making. InThe Practice of Transnational Law, ed. Klaus Peter Berger, 53–65. The Hague: Kluwer LawInternational.

Gessner, Volkmar. 2008. Towards a Theoretical Framework for Contractual Certainty in Global Trade.In Contractual Certainty in International Trade, ed. Volkmar Gessner, 3–27. Oxford: Hart.

Gopalan, Sandeep. 2004. Transnational Commercial Law. Oxford: WS Hein & Co.


Gould, David M. 1994. Immigrant Links to the Home Country: Empirical Implications for U.S.Bilateral Trade Flows. Review of Economics and Statistics 76 (2): 302–16.

Hill, Claire A. 2009. Bargaining in the Shadow of the Lawsuit; a Social Norms Theory of IncompleteContracts. Delaware Journal of Corporate Law 34 (1): 191–220.

Jessup, Philip. 1956. Transnational Law. New Haven, CT: Yale University Press.Llewellyn, Karl N. 1931. What Price Contract? An Essay in Perspective. Yale Law Journal 40 (5):

704–51.Macaulay, Stewart. 1963. Non-Contractual Relations in Business: A Preliminary Story. American

Sociological Review 28 (1): 55–67.Macneil, Ian R. 1971. Contracts: Exchange Transactions and Relationships. Mineola: Foundation Press.—— 1978. Contracts: Adjustment of Long-Term Economic Relations under Classical, Neoclassical,

and Relational Contract Law. Northwestern University Law Review 72: 854–905.—— 1985. Reflections on Relational Contract. Journal of Institutional and Theoretical Economics

141:541–46.Mann, Ronald J. 2001. Information Technology and the Increasing Efficacy of Non-Legal Sanctions in

Financing Transactions. Vanderbilt Law Review 54:1627–65.Mayring, Phillipp. 2003. Qualitative Inhaltsanalyse. Grundlagen Und Techniken. 8. Aufl. ed. Weinheim,

Germany: Beltz.North, Douglass C. 1990. Institutions, Institutional Change and Economic Performance. Cambridge:

Cambridge University PressRauch, James E. 2001. Business and Social Networks in International Trade. Journal of Economic

Literature 39 (2): 1177–1203.Rauch, James E., and Vitor Trindade. 2002. Ethnic Chinese Networks in International Trade. Review

of Economics and Statistics 84 (1): 116–30.Rodrik, Dani. 2000. How Far Will International Economic Integration Go? Journal of Economic

Perspectives 14:177–86.Rühl, Giesela. 2006. Methods and Approaches in the Choice of Law: An Economic Perspective.

Berkeley Journal of International Law 24 (2): 801–27.—— 2008 Effizienzprobleme Bei Grenzüberschreitenden Rechtsstreitigkeiten. German Working Papers

in Law and Economics 2008, art. 17. http://www.bepress.com/gwp/default/vol2008/iss2/art17(accessed January 16, 2008).

Sahay, Sundeep, Brian Nicholson, and S. Krishna. 2003. Global It Outsourcing. Software Developmentacross Borders. Cambridge: Cambridge University Press.

Schmidt-Trenz, Hans-Jörg. 1990. Außenhandel Und Territorialität Des Recht. Baden-Baden: Nomos.Schmidt-Trenz, Hans-Jörg, and Dieter Schmidtchen. 1991. Private International Trade in the Shadow

of the Territoriality of Law: Why Does It Work? Southern Economic Journal 58:329–38.Schmidtchen, Dieter. 1994. International Contracting and Territorial Control: The Boundary Ques-

tion. Comment on B. V. Yarbrough and R. M. Yarbrough’s Article of the Same Name. Journal ofInstitutional and Theoretical Economics 150 (1): 272–78.

Slaughter, Anne-Marie. 2002. Breaking Out: The Proliferation of Actors in the International System.In Global Prescriptions, ed. Yves Dezelay and Bryant G. Garth, 12–24. Ann Arbor, MI: MichiganUniversity Press.

Stone Sweet, Alec. 2002. Islands of Transnational Governance. In On Law, Politics and Judicialization,ed. Martin M. Shapiro and Alex Stone Sweet, 323–42. Oxford: Oxford University Press.

Streit, Manfred E., and Antje Mangels. 1996. Privatautonomes Recht Und GrenzüberschreitendeTransaktionen. ORDO 47:73–100.

Townsent, Robert M. 1979. Optimal Contracts and Competitive Markets with Costly State Verifica-tion. Journal of Economic Theory 21 (2): 265–93.

Williamson, Oliver E. 1996. The Mechanisms of Governance. New York: Oxford University Press.Zürn, Michael. 2001. Sovereignty and Law in a Denationalized World. In Rules and Networks. The

Legal Culture of Global Business Transactions, ed. Richard P. Appelbaum, William L. F. Felstiner,and Volkmar Gessner, 39–71. Oxford: Hart.


Documents

Contract Law, Relational Contracts, and Reputational Networks in International Trade: An Empirical Investigation into Cross-Border Contracts in the Software Industry