Fostering incremental and radical innovation through performance based contracting in inter-organizational relationships

Awarded Best Academic Paper 2014 IPSERA Conference Anecdotal evidence suggests that performance-based contracts (PBC) may positively affect innovation in inter-organizational relationships, but our knowledge about the underlying mechanisms is limited. This study combines transaction economics and agency theory to devise and test a proposed theoretical model that explains how and under what conditions PBCs lead to certain innovation outcomes. Specifically, we investigate how the two main features of PBCs – low term specificity and rewards being tied to performance – affect incremental and radical innovation using data from 106 inter-organizational relationships in the Dutch maintenance industry. We distinguish between incremental and radical innovation, to empirically validate the premise that antecedents that are favorable for one type of innovation may be unfavorable for the other. We find that term specificity has an inverse U-shaped effect on incremental and a negative effect on radical innovation. Furthermore, pay-for-performance has a stronger positive effect on radical than on incremental innovation. Finally, opposite to our expectations, we find a positive moderation effect of the partner's degree of risk-aversion on the relationship between pay-for-performance and both types of innovation. We also found that this moderation effect is stronger for radical than for incremental innovation.