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Variations in the organization of contractual relations with private

contractors: Transactional, organizational and strategic determinants

Andrej Christian Lindholst,

Department of Political Science, Aalborg University, October, 2016

Draft prepared for presentation at annual meeting at the Danish Political Science Association,

Vejle, 2016

Early work – Must not be cited

Introduction

Systematic and large-scale involvements of the private sector in public service delivery systems

through market and contract-based arrangements, i.e. contracting out, has today become widespread

in most OECD countries as part of ongoing reform initiatives and searches for public sector

improvements (Vincent-Jones, 2000; Boyne, 2003; Greve & Ejersbo, 2005; Kettl, 2010).

The involvement of the private sector in public service delivery has been well-researched in

terms of public authorities‘ ‗make or buy‘ choices between internal service delivery and contracting

out as well as other discrete organizational alternatives, such as non-profit organizations or other

governmental providers (Boyne, 1998; Brown & Potoski, 2003; Bel & Fageda, 2009; Hefetz &

Warner, 2012; Rodrigues et al., 2012; Sundell & Lapuente, 2012; Petersen et al., 2015; Foged,

2016). Recently, the choice has also been addressed as a ‗make and buy‘ choice in terms of why

public authorities chose to rely on both internal and external delivery for a particular service or what

have been referred to as ‗concurrent sourcing‘ or ‗mixed delivery‘ (Warner & Hefetz, 2008;

Rosenberg-Hansen et al., 2011; Hefetz et al., 2014).

However, beyond the choice of make and/or buy between various discrete organisational

alternatives, some research has also highlighted a multitude of variations in how contract-based

exchange relations, i.e. the choice of buy, are organized when the private sector becomes involved

in public service delivery. Over the years research has addressed, for example, the use of different

coordinating mechanisms, such as markets, hierarchies and networks (Sarapuua & Lembera, 2015),

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the reliance on trust (Davis & Walker, 1997; Brown et al., 2007; Lamothe & Lamothe, 2012), the

importance of relational governance (Walker & Davis, 1999; Fernandez, 2009), the role of and

impact on contract management capacity (Kettl, 1993; Romzek & Johnston, 2002; Van Slyke &

Hammons, 2003), variations in instruments, approaches and arrangements (Lindholst, 2009), the

differentiated use of hard and soft contracts (Greve & Ejersbo, 2005), alignment of values,

institutions and markets (Brown et al., 2006), the importance of different design choices for

performance (Shetterly, 2000; Fernandez, 2007; Fernandez, 2009) and shifts from competitive

toward collaborative models (Sullivan & Skelcher, 2002; Entwistle & Martin, 2005) as well as

needs for development of models congruent with democratic requirements for ongoing deliberation

(Vincent-Jones, 2007) in contract-based exchange relations and contractual governance involving

the private sector.

The diverse and only partly interrelated research stream addressing variations in the

organization of contract-based exchange relations have rearranged the question of make or/and buy

into a range of sub-questions about how the buy option are organized within a public sector context.

One key recurrent sub-question or theme in the research stream is the design of and reliance on

formal contract features in contract-based exchange relations. While the importance of formal

contract features has been prompted by several scholars still relatively little is known, however,

about why public authorities opt for different formal contract designs in their exchange relations

with private contractors. The objective of this study is to explore and explain variations in formal

contracts implemented by public authorities for regulating their exchange relations with private

contractors.

The remainder of the article proceeds by firstly exploring contract theory and elaborating a

range of hypotheses on why public authorities opt for different contract designs. The hypotheses

relates to the importance for contract design of key transactional, organizational and strategic

characteristics. The hypotheses are tested on a dataset based on survey and register-based sources.

The survey-based data stems from a survey of midlevel managers in municipal road and park

departments in Danish municipalities while the register-based data stems from official municipal

accounts. Two key response variables are constructed from eight survey items which measures the

emphasis on different formal contract features in municipal exchange relations with private

providers of road and park maintenance. The two response variables refer to respectively

‗transactional‘ and ‗adaptive‘ dimensions in the formal contract framework. The main analysis is

based on two hierarchical ordinary least square regressions where hypothesized relations are

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explored through assessment of the importance of six predictors against the two response variables.

Findings from the analysis is subsequently evaluated and discussed. Finally, the conclusion

summarizes key findings, some limitations and implications for further research.

Why public authorities opt for different contract designs

This section starts out by presenting a conceptual framework for understanding contractual

relations. The framework emphasizes respectively transactional and adaptive functions in contract

based exchange relations which are reflected in various degrees in the formal contract design. The

section then develops a set of hypotheses regarding the circumstances under which respectively

transactional and adaptive functions are emphasized in formal contracts.

Overall, the theoretical framework follows the discriminating alignment hypothesis, as

stated by Williamson, (1991, p. 277), which holds that transactions, which differ in their attributes,

are aligned with governance structures, which differ in their costs and competencies, in a

discriminating way. The discriminating alignment hypothesis is also found inherent in the research

agenda by Brown et al. (2006) suggesting that effective management (and research) of service

delivery in the hollow state requires consideration (and alignment) of the characteristics of public

values (e.g. public preferences and purposes with contracting out), institutions (e.g. organizational

and legal arrangements) and service markets (e.g. cost of contracting).

Formal contracts and their transactional and adaptive functions

Contracts are essential instruments for regulating economic exchange (Milgrom & Roberts, 1992).

Seen from an institutional and organizational perspective contracting out implies formation of and

reliance on inter-organizational exchange relations regulated by a degree of formalized and legally

binding agreements, i.e. contracts, between buyers and sellers of services. Such contracts can be

designed very differently, support a variety of government functions and integrate behaviours based

on both legal (e.g. laws or court decisions) and non-legal (e.g. industry standards) institutions

(Vincent-Jones, 2000; 2007). The use of formal contracts in exchange relations can, for example,

range from very short and simple agreements, stated in a one-page document to bulky and detailed

sets of documents including, for example, technical specifications, juridical matters, liabilities, or

descriptions of project organization.

Contracts furthermore have multiple functions in the regulation of inter-organizational

exchange relations. Sociological accounts of contract theory have emphasized the core function of

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the contract, not through its characteristics as a legally binding agreement, but as a mechanism for

‗projecting exchange into the future‘ which govern most modern real-life exchange relations

(Macneil, 1974; 1980). Accordingly, agency theory and transaction cost theory has emphasised the

need to structure contracts in cost minimising ways as mechanisms for safeguarding exchange

relations from various risks and hazards arising from a number of transactional (e.g. unforeseen

contingencies and asset specificity) and behavioural (e.g. bounded rationality and opportunism)

characteristics. Contract theory (including transaction cost theory) also emphasizes the function of

the contract as a mechanism in ongoing exchange relations for guiding coordination between

partners and adapting exchanges to internal and external change (Schepker et al., 2014). For the

purpose of this paper the corresponding formal contract features which support the two key

functions identified by contract theory are referred to as transactional contract features (TCF) and

adaptive contract features (ACF).

Transactional characteristics

The importance of transactional characteristics of economic exchange for optimal choice of contract

design has long been highlighted within economic perspectives on economic organization (Milgrom

& Roberts, 1992). In particular, standard assumptions on bounded rationality (which render most

contracts incomplete) and opportunism as basic characteristics of human actions explicate the need

to build-in various contractual safeguards in exchange relations. Under these two assumptions it is

the human capacity for conscious foresight (as a third assumption) that allows parties to an

exchange relation to design contractual agreements purposefully to mitigate potential hazards.

Accordingly to Williamson: “Parties to a contract who look ahead, recognize potential hazards,

work out the contractual ramifications, and fold these into the ex ante contractual agreement

obviously enjoy advantages over those who are myopic or take their chances and knock on

wood.”(2000, p. 601). Several attributes of an economic exchange (the transaction) actualize the

need to use foresight and design contractual agreements in concordance. In a ‗truncated‘ analysis,

Williamson (1991) emphasize three critical attributes in terms of frequency, uncertainty and asset

specificity of involved transactions as sources of contractual hazards and co-determinants of

efficient contractual arrangements. In particular, increasing complexity, in terms of foreseen and

unforeseen contingences an exchange relation needs to handle, increases the need to build in further

contractual features – or shift to vertical integration (Milgrom & Roberts, 1992). Similarly, in the

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literature on contracting out in the public sector ‗complexity‘ has also been associated with needs to

detail further contractual features (Brown et al., 2016).

Based on the arguments above, it is found that greater complexity in the transactional

attributes of an exchange relation requires incorporation of additional contractual features which

regulates contingencies. Contractual features may take the form of more detailed specifications of

technical requirements and service descriptions, more encompassing monitoring and sanctioning

systems or juridical clauses. Greater complexity may, furthermore, also lead to the need for the

contract to facilitate information sharing, communication and collaboration as well as detail the

parties‘ roles and responsibilities in order to provide rational planning, mitigate risks resulting from

uncertainty and adapt to unforeseen contingencies (Schepker et al., 2014).

First hypothesis (H1): Greater complexity in the involvement of private contractors is positively

associated with emphasis on more elaborative formalized transactional contract features (H1a) and

adaptive contract features (H1b).

Organisational characteristics

One defining feature of public management reforms in the last three decades is the introduction of

organisational models based on features such as arm-length principles, disaggregation, use of

service standards, performance targets and monitoring systems (Hood, 1991). One requirement for

organizational models based on such features is the formalization of market-like exchange relations

between internal organizational units.

However, municipalities may combine external and internal service provision and

implement different mixes of organizational models in search of exploitations of the advantages –

and avoidances of disadvantages – of each model (Parmigiani, 2007; Rosenberg-Hansen et al.,

2011; Hefetz et al., 2014). According to Williamson (1991), one comparative advantage of

organizational models based on hierarchical relations is the relatively easy access to continuous

adaptation (of service provisions) to internal and external change. However, the drawback is a more

costly and resource-demanding mode of organization. On the other hand, organizational models

based on market-based relations have their advantage in ensuring cost-efficient modes of

organization – but if implemented at the extreme – at the expense of capabilities to undertake

continuous adaptations within the contract.

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Those municipalities where market based-models of coordination is implemented in a

comparatively fuller scale in external as well as internal relations may therefore need to develop

adaptive features within their exchange relations to a higher degree than those municipalities where

a more pronounced mix of hierarchy and market-based is implemented. In the former case, the

municipality must combine both transactional and adaptive features in their exchange relations with

external (as well as internal) service providers. In the latter case, the municipality can exploit the

adaptive capabilities of a hierarchical organisation of the internal service provision while still

exploiting the advantages of market-based external relations. In this case, the municipality only

need to develop transactional features (for competitive and safeguarding purposes) in their

exchange relations with external service providers.

Second hypothesis (H2): Differences in hierarchical integration of in-house operational capabilities

is not associated with differences in formalized transactional contract features in external exchange

relations.

Third hypothesis (H3): A low (or no) hierarchical integration of in-house operational capabilities is

positively associated with more formalized adaptive contract features in external exchange

relations.

The capability view on organizations sees organizations as a set of embedded capabilities in terms

of skills and routines which are not easily transferred across organizational boundaries (Nelson &

Winter, 1973; Nelson & Winter, 1982; Becker, 2004). Congruently, it can be argued that contracts

and the choice of contracts do not come ‗out of nowhere‘ and elaborating and managing a contract

requires involvement of specialized expertise – or ―contract design capabilities‖ (Mayer & Argyres,

2004; Argyres & Mayer, 2007). The development of management capacity and expertise in

contracting processes in the public sector has similarly been highlighted by Kettl (1993) and Van

Slyke and Hammons (2003). The argument here is that lack of such capabilities, i.e. expertise,

would render an organization inapt to use formal contracts as a governance mechanism for

regulating exchange relations as well as inapt to elaborate and adapt contractual frameworks to

particular needs. It follows that higher degrees of internally organized contracting expertise should

result in a greater reliance on formal contract features in exchange relations.

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Fourth hypothesis (H4): Greater internal contracting expertise is positively associated with higher

emphasis on more elaborate formal transactional and adaptive contract features.

Alternatively or as an augmentation to elaborating contract frameworks through reliance on internal

expertise a municipality may also rely on involvement of specialized expertise from external

advisors or consultants. Organizational analysis based on sociological accounts of institutionalism

(DiMaggio & Powell, 1983) highlights the role of management consultants in the diffusion of new

ideas and concepts within organizational fields. In particular, management consultants, as

professional actors, carry organizational models between organizations which not only disseminate

the use of certain standards within an organizational field, but also contribute to local adaption,

improvisation and translation (Furusten, 2009). Following the arguments above, it can be assumed

that involvement of external expertise may help the organisation to import new ideas and concepts

and tailoring formal contract frameworks to the needs of the organisation.

Fifth hypothesis (H5): Greater involvement of external expertise is positively associated with higher

emphasis on an overall more elaborative formal contract framework.

Strategic purpose of contracting out

The conventional understanding in the literature on contracting out in the public sector has framed

the contract as a set of features shaped to fit the purpose of maximizing economic effects from

competition, i.e. minimizing overall costs (Donahue, 1989; Domberger & Jensen, 1997; Greve &

Ejersbo, 2005). Contract features associated with specification and accountability has in particular

been highlighted as important. Emphasis on low cost as contracting objective may result in

increasing problems with other important contractual objectives such as service quality in terms of

‗quality-shading‘ (Hart et al., 1997). Higher degrees of contractual completeness are argued to limit

the potential for opportunism and improve performance (Shelanski & Klein, 1995; Macher &

Richman, 2008). Following the arguments above, it is argued emphasis on low cost as contracting

objective is associated with more elaborate transaction contract features. The reason is that

emphasis on transactional features supports low costs as a contracting objective by enhancing an

effective use of competition as well as mitigating the accentuated contractual hazards from quality-

shading effects.

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Sixth hypothesis (H6): greater emphasis on low maintenance costs as purpose for contracting out is

positively associated with more elaborative transactional contract features.

In contrast to the conventional approach to contracting out, organized around the logic of

competition, approaches organized around a collaborative logic have been introduced throughout

the 2000s and 2010s. In contrast to the purpose inherent in the conventional approach, the purpose

of implementing a collaborative logic in contracting out is associated with transformation,

development and governance rather than provision of standard services at lowest possible cost

(Sullivan & Skelcher, 2002; Entwistle & Martin, 2005). From the viewpoint of contract theory

(Vincent-Jones, 2007), the support of a collaborative logic in an exchange relations entails a

different set of formal contract features. In particular the formal contract must be designed to

support ongoing interactions between the contracting parties.

Seventh hypothesis (H7): greater emphasis on development/learning as purpose for contracting out

is positively associated with more elaborative adaptive contract features.

Overall, the seven hypotheses address the importance of key transactional (H1), organizational (H2-

H5) and strategic (H6-H7) characteristics for municipalities‘ emphasis on respectively transactional

and adaptive contract features in their exchange relations with private contractors.

Methods

Context of study

The national context of the study is the municipal park and road sector in Denmark. The municipal

sector in Denmark is organised in 98 municipalities with holds decentralized responsibilities for

various social and technical services. Contracting choices within a particular service area is usually

– and by tradition – delegated to each municipality, but cohesive instruments for promotion of

private sector involvement, such as binding targets for the percent of budget spends on private

contractors and compulsory use of private contractors for some services, have to some degree been

implemented by central government policies.

The municipal park and road sector in Denmark has since the early 1990s undergone

significant organizational changes driven by public management reforms (Lindholst et al., 2016).

Municipal park and road departments, formerly organised as hierarchies with integrated

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responsibilities for planning, management and operations, have been disaggregated into

organizational units with separated responsibilities. In the same token, operational responsibilities

for respectively park and road services have been merged and integrated within the same units,

competitive tendering and contracting out have become widespread and common service and

contract standards have been developed. Common standards in support of conventional

(transactional) approaches to contracting out became available in the 1990s while, common

standards in support of collaborative (partnership) approaches became available in the 2000s.

According to national statistics, the level of contracting out of park and road maintenance was in

2015 around 40 % measured by the share of budget spending on private contractors – a level

significantly higher than the overall average for all municipal services (26 %). The economic

significance of park and road services equals approximately 4 % of all expenditures on municipal

services in Denmark.

Key characteristics of park and road services, in terms of their relatively ease of

specification and measurability, are furthermore found in a few studies to render the two services

relatively well-suited for contracting out vis-à-vis other services (Brown & Potoski, 2005; Levin &

Tadelis, 2010; Hefetz & Warner, 2012). Detailed case-studies, however, have also shown that

contract implementation is complex, challenging and involves very different managerial strategies

(Lindholst & Bogetoft, 2011).

Data

Data-wise the main analysis in the study draws on a combination of items from a larger survey in

combination with register-based data. The survey was carried out in the period 2014-2015 and

contained more than 65 main questions related to planning, organisation, management and

performance of internal (i.e. organized in-house) and external arrangements (e.g. contracts with for-

profit organizations) for delivery of maintenance services in the municipal park and road sector in

Denmark. The survey was sent out to mid-level managers in park and road departments in all 98

Danish municipalities and returned a total response-rate of useable entries of 77 % (equal to 75

municipalities) of which 89 % (equal to 67 municipalities) indicated that they used private

contractors in some degree for the provision of park and road maintenance services. The full dataset

was found to be representative for all Danish municipalities according to size, geographical location

and expenditures on private contractors for provision of park and road maintenance.i The register-

based data comprised municipal accounts on expenditures on private contractors for maintenance

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operations typically organized as part of the responsibilities of municipal park and road

departments.

Variables

Details of the construction of all variables in the study, including formulation and measurement of

survey items as well as data used for register based variables, are reported in Table 1.

Table 1. Construction of variables

Variable Construction Survey items b / data sources

Measurement scale

Transactional contract features (TCF)

Composite index, 4 survey items (Alpha = .870)

Specify on a scale of 0 to 10 the degree to which the following content is central in your relation with private contractor(s) for maintaining parks and green spaces and/ or roads:

Formalized and written legal clauses (e.g. a signed contract).

Performance specifications – describing overall goals, functionality and guidelines for operation and development.

Prescriptive specifications – based on quantities, instructions and performance measures.

Formal sanctions (e.g. financial penalties) for noncompliance.

0-10 a

Adaptive contract features (ACF)

Composite index, 4 survey items (Alpha = .764)

Specify on a scale of 0 to 10 the degree to which the following content is central in your relation with private contractor(s) for maintaining parks and green

spaces and/ or roads:

Agreement on close collaboration and joint planning of operations and development.

Agreement for contractors to involve / liaise directly with citizens and users.

Agreement on extended economic framework with incentives for investments, optimisations or improvements.

Competence requirements (e.g. professional affiliation or qualification).

0-10 a

Transactional complexity

Proxy variable based on calculations of annual expenditure (DKK) on private provision of park and road maintenance services

Data source: Statistics Denmark. Distribution of underlying data for value of economic value is strongly left skewed. Data is transformed into natural logarithmic (LN) values. Descriptives for original data: mean = DKK 45.2 mill, min-max = DKK 4.6 – 271.5 mill.

LN

Dept. responsibilities as provider

Dummy variable based on a single survey item

What role does your department have, and which functions are they responsible for?

Practical delivery (e.g. contractor role / day to day maintenance)

0=no, 1=yes

Internal contracting capability

Composite index, 4 survey items (Alpha = .810)

Specify on a scale of 0 to 10 the degree to which you think that the following statements describe your department's capacity to manage private contractor(s)

We have sufficient organisational resources (e.g. time and staff)

We have sufficient experience and expertise

We have sufficient methods and systems (e.g. quality standards, GIS and ICT systems)

Our management practices and procedures are sufficient.

0-10 a

External advice / consultants

Single survey item Specify on a scale of 0 to 10 the degree to which you think that the following methods are used when you procure maintenance services:

Advice from external consultants/advisors

0-10 a

Contracting purpose: Low costs

Single survey item Specify on a scale of 0 to 10 the degree to which you find that the following purposes are a key part of the municipality’s considerations for using private contractors for the services your department has responsibility for:

The purpose is to ensure low maintenance cost.

0-10 a

Contracting purpose: Development/learning

Composite, 2 survey items (Alpha = .843)

Specify on a scale of 0 to 10 the degree to which you find that the following purposes are a key part of the municipality’s considerations for using private contractors for the services your department has responsibility for:

Develop services and areas.

Develop our methods and routines.

0-10 a

a Item(s) measured on an 11-point response scale with end anchors where 0 = ‘not at all’ and 10 = ‘very high degree’.

b Translates from Danish.

The study includes two response variables which measure the level of respectively transactional and

adaptive features in formalized contract frameworks found within the context of park and road

maintenance in Danish municipalities. The two response variables are composite constructs based

on eight survey items (see Table 1 for wording). The eight survey items were derived from

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inspection of available contract standards available in the Danish park and road sectors as well as

aligned with earlier research on prevalent contract features in the park and road sector (Lindholst,

2009). Four items were constructed to measure transactional features and four items were

constructed to measure adaptive features. The internal consistency (reliability) of the two constructs

was checked by inspection of values for Cronbach‘s alpha. The alpha value was good for items

included in the first factor (alpha = .870) while moderate for items included in the second factor

(alpha =.764). Values for alpha could furthermore not be improved by removing any items included

in the two extracted factors. A principal component analysis (PCA) was carried out with the aim to

check for discriminant validity of the two composite constructs (see appendix for diagnostics). Main

results from the analysis are shown in Table 2. Two components with eigenvalues above 1

explained a total of 67 % of the total inter-item variance. The first component, labeled „formalized

transactional contract features‟ (TCF), explained approximately 53 % of the variance while the

second component, ‗formalized adaptive contract features‟ (ACF), explained approximately 14 %

of the variance. The correlation between the two components‘ scores was .501.

Table 2. Principal component analysis for 8 survey items on formalized contract features: Factor loadings and communalities

Survey items a

Primary factor loadings and communalities b

Formalized transactional contract features (TCF)

Formalized adaptive contract features (ACT)

Communalities

Juridical clauses / agreement (§§) .930 .791

Service specification based on functionality and purpose .679 .650

Service specification based on quantities, instruction and performance measures

.917 .771

Formal sanctions in case of non-compliance .777 .749

Formal collaboration and joint planning (.301) .562 .577

Contractor’s involvement / contact with users .774 .600

Economic incentives for investment, improvements and optimization .898 .710

Competence requirements .668 .523

a See Table 1 for translated wording og survey items.

b N = 64 (list-wise) Two components extracted with oblimin rotation (Eigenvalues > 1). Factor loadings below .3 are not shown. Secondary factor

loadings in brackets. Solution extracted in 6 iterations.

The degree of transactional complexity in a municipality‘s relations with its private contractors is

operationalized by a register-based measure for the absolute economic value of the municipality‘s

involvement of private contractors (expenditure on private contractors). Larger economic

involvements in the park and road sector commonly include a greater number of works – as well as

different types of work – to be carried out, more work sites distributed across a given geography,

needs for more unilateral as well as bilateral planning and coordination, greater risks, higher levels

of required capital investments (staff, site location, machinery, production facilities and so on), a

greater number of sub-contractors and support functions, a greater number of potential stakeholders

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(e.g. landowners or utility companies), more contingencies which need to be addressed and so on –

all aspects which adds up to a greater transactional complexity which need to be managed and

coordinated in the contractual relation. Data for the size of expenditure on private contractors was

calculated from available municipal accounts (register-based) on park and road maintenance. The

calculation included responsibilities for all maintenance services typically delegated to municipal

park and road departments in Denmark, including different types of parks and open spaces as well

as transport infrastructure.

The variable for the level of hierarchical integration is measured by two single binary items

indicating whether a department held operational responsibilities as internal provider of park and

road maintenance services. The variable corresponds to two different levels of hierarchical

organizational integration of operational responsibilities. Park and road departments with no

responsibilities correspond to situations with low (or no) integration while those with

responsibilities corresponds to a situation with a relatively higher level of hierarchical integration.

The variable for internal contracting capability was constructed from four single items each

measuring the sufficiency of different aspects of a department‘s contract management capability.

The variable has a high inter-item reliability (alpha = .810) which could not be improved by

removal of any single item. The variable for involvement of external expertise is measured by a

single survey item addressing the degree to which advice from external consultants/advisors is used

by the municipality in procurement of park and road services.

The variables for contracting purposes are measured by different items in the same survey

question. The variable for low maintenance cost as contracting purpose is measured by a single item

while the variable for development/learning is a composite construct based on two survey items

(alpha = .843).

Data analysis

An initial analysis explores findings based on descriptive statistics as well as bivariate associations

between all variables. The study‘s main analysis relies on two multivariate analyses based on

hierarchical OLS (ordinary least square) regressions. The first multivariate analysis explores the six

predictors‘ importance for the level of transactional contract features (TCF). The second

multivariate analysis explores the six predictors‘ importance for the level of adaptive contract

features (ACF). Diagnostics for heteroscedasticity and collinearity as well as for influential outliers

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were carried out. No influential outliers were found and inspection for heteroscedasticy and

collinearity found no substantial issues.

Model evaluation

Biases potentially inherent in survey-based research (Podsakoff et al., 2003) were sought minimized

through ex ante remedies as well as post hoc tests were carried out to gauge eventual influence of

any substantial amount of common method variance. Ex ante remedies in the design phase

included: use of input from pilot test for design and exact wording of survey items, selection of

respondents due to their supposed insights in the survey‘s main topic, as well as anonymity and

confidentiality at the level of respondents and municipalities. Furthermore, the two response

variables did not rely on sensitive self-reported performance evaluations (Meier & O'Toole, 2013).

Finally, the survey data was combined with register-based data on municipal expenditures (for one

predictor).

Harman‘s single factor test was used for post hoc check of common method variance. The

test was carried out with all survey based variables included in respectively the analysis with

transactional contract features and the analysis with adaptive contract features as response variables.

In both tests, all survey based constructs were included in un-rotated principal component analyses

in order to gauge the influence of any substantial common method variance. In both tests, the

analysis resulted in three distinct components with eigenvalues greater than 1.0 rather than a single

dominant factor. No components in the two analysis accounted for more than 26 % percent of the

total variance. Statistics furthermore indicated a poor fit of the data for the two principal component

analyses (Kaiser-Meyer-Olkin measure for sampling adequacy < .500). The post hoc statistics

indicate that (a substantial amount of) common method variance is not likely to be present and

confound the interpretation of findings.

Findings

Table 3 provides an overview over descriptives and bivariate correlations for all variables included

in the final analysis. The values for standard deviations for the two response variables, transactional

and adaptive contract features, indicate substantial inter-municipal variations. The mean values for

the two variables also indicate that the average emphasis on transactional contract features is

substantial higher (mean = 7.5) than the emphasis on adaptive contract features (mean = 4.9).

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Table 3. Descriptive and bivariate correlation matrix

Variables Descriptives Bivariate correlations (Pearson’s)

N Min-Max Mean S.D. 1 2 3 4 5 6 7 8

1. Transactional contract features

57 2.0–10.0 7.5 2.1 -

2. Adaptive contract features

57 .5–10.0 4.9 2.0 .527 ** -

3. Transactional complexity (LN)

58 8.4–12.5 10.4 .7 .370 ** .324 * -

4. Hierarchical integration of operational resp.

58 0–1 .67 .5 ÷.234 † ÷.256 † ÷.042ns -

5. Internal contracting capability

58 3.3–10.0 6.9 1.6 .315 * .205 ns .265 * ÷.039 ns -

6. Use of external advice / consultants

58 0–10 6.2 2.5 .300 * .236 † ÷.203 ns ÷.072 ns ÷.045 ns -

7. Contracting purpose: Low costs

58 0–10 7.5 2.0 .079 ns ÷.152 ns ÷.194 ns ÷.299 * ÷.169 ns .061 ns -

8. Contracting purpose: Development/learning

58 0.0–8.5 5.0 2.1 .052 ns .370 ** .132 ns .082 ns .067 ns .014 ns ÷.022 ns -

N (listwise) = 56

Significance levels: † p < .1, * p < .05, ** p <.01, ns = non-significant.

The underlying data used as proxy for measuring the level of transactional complexity

shows a huge variation in the size of expenditure among Danish municipalities on maintenance

services provided by private contractors. The average expenditure is DKK 45.2 million (equal to €6

million), but the variation ranges from a minimum of DKK 4.6 million (equal to €600,000) to a

maximum of DKK 271.5 million (equal to €36.4 million). Overall, the underlying data is

characterized by a strong right skewness, i.e. a few municipalities have very high values for

expenditure compared to the majority.

About two-third of the municipalities have park and road departments with direct

responsibility as internal provider of maintenance services. The other one-third has either no direct

responsibility for internal provision or the municipality use private contractors for provision of all

park and road maintenance services. The underlying survey data also shows that 8 out of the 58

municipalities (equal to 14 percent) contract out all park and road maintenance services (‗total

contracting‘). The remaining 50 municipalities have a combination of in-house and external service

provision, i.e. a degree of concurrent contracting.ii Only 11 out of the 50 municipalities, which use a

degree of concurrent contracting, have park and road departments with no direct responsibilities as

municipal provider of park and road services. Overall, the data indicate that the majority of Danish

municipal park and road departments have integrated direct operational responsibilities and have

direct access to internal operational expertise through hierarchy.

The mean values for the level of internal contracting capabilities and use of external advice /

consultants are almost similar (respectively 6.9 and 6.2). However, the variation measured by

standard deviations for the use of external advice / consultants (S.D. = 2.5) are substantial higher

15

than for the variations in the level of internal contracting capabilities (S.D. = 1.6). The values for

the (high) variation in the involvement of external advice / consultants indicates that some

municipalities only use external advice / consultants in a very limited extent while other

municipalities relies more heavily on external advice / consultants.

The mean values for the contracting purposes related to respectively low maintenance costs

(mean = 7.5) and development/learning (mean = 5.0) differs substantially and on the average low

maintenance cost has a substantial greater emphasis as contracting purpose compared to

development/learning as contracting purpose. While, the difference is unsurprising given the

general framing of contracting out in public policies as a strategy to reduce costs of public service

provision, there are, however, substantial variations among municipalities in the emphasis of both

purposes as well as the mean value for development/learning as contracting purpose indicates that

development/learning is not unimportant. In particular some municipalities have a relatively high

emphasis on development/learning as contracting purpose.

The bivariate correlations indicate several potential associations of theoretical interest.

While the overall level of transactional and adaptive contract features differs they are still strongly

correlated (Pearson‘s = .527, p <. 01), i.e. higher levels of adaptive contract features are associated

with higher levels of transactional contract features. The finding supports the understanding of the

two contractual dimensions as interwoven (and not mutually exclusive). The two response variables

are furthermore substantially correlated with several, but not all, predictors. Higher levels of

expenditure are significantly associated with higher levels of respectively transactional and adaptive

contract features, i.e. municipalities which have a higher absolute economic value in their

engagement with private contractors also implement more elaborate contract frameworks than

municipalities which have a lower value. Departments which have direct responsibilities as provider

of maintenance services also implement significantly lower levels of both transactional and adaptive

contract features in their exchange relations with private contractors. A higher level of internal

contract management capacity is positively associated with higher levels of transactional contract

features but is not significantly associated with the level of adaptive contract features. The bivariate

analysis also indicates that a higher level of internal contracting capabilities is significantly

associated with municipalities which spend more money on private contractors. The bivariate

association is congruent with earlier research which found support for an association between a

higher administrative capacity and higher contracting levels (Bhatti et al., 2009; Foged, 2016). A

higher level of use of external advice / consultants is indicated to be positively associated with

16

higher levels of both transactional and adaptive contract features. Low cost as contracting purpose

is not significantly associated with the level of neither transactional nor adaptive contract features.

A higher emphasis on low cost as contracting purpose is, however, significantly associated with

departments with less or no hierarchical integration of operational responsibilities. The finding

indicates that low cost is a more pronounced contracting purpose in municipalities which either

contract out all their services as well as in municipalities where the park and road department does

not have direct responsibilities as in-house provider. A higher emphasis on development as

contracting purpose is significantly associated with higher levels of adaptive contract features, but is

not significantly associated with the level of transactional contract features.

The next step in the analysis uses two hierarchical OLS regressions. The study‘s main

results are presented in Table 4. The first multivariate analysis explores the six predictors‘

importance for the level of transactional contract features (TCF) while the second analysis explores

the six predictors‘ importance for the level of adaptive contract features (ACF). Both multivariate

analyses are organised as hierarchical OLS regressions where predictors are introduced in blocks

into the regression (model A – C for TCF and model D – F for ACF).

Table 4. Hierarchical OLS regressions for level of formal transactional and adaptive contract features

Transactional contract features (TCF) adaptive contract features (ACF)

Predictor variables

Model A Model B Model C Model D Model E Model F

Unstandardized beta-coefficients (β) and standard errors

Transactional complexities (expenditures, LN)

1.020 (.347) ** 1.067 (.331) ** 1.137 (.342) ** .857 (.347) * .939 (.356) * .715 (.334) *

Hierarchical integration of operational resp. (0=low, 1=high)

÷ .946 (.530) † ÷ .771 (.479)

ns ÷ .599 (.510) ns ÷ 1.019 (.528)

† ÷ .918 (.509) † ÷ 1.300 (.493) *

Internal contracting capabilities (0-10)

– .278 (.144) † .297 (.146) * – .146 (.158)

ns .104 (.148) ns

Advice from external consultants (0-10)

– .311 (.094) ** .311 (.095) ** – .234 (.100) * .225 (.092) *

Contracting purpose: Low cost (0-10)

– – .134 (.124) ns – – ÷ .184 (.119)

ns

Contracting purpose: Development/learning (0-10)

– – ÷ .008 (.108) ns – – .329 (.105) **

Model summaries

n 57 57 57 57 57 57

Constant ÷ 2.541 ns

÷ 6.978 † ÷ 8.920 * ÷ 3.450

ns ÷ 6.782

† ÷ 4.058

ns

F-value 6.136 ** 7.444 ** 5.078 ** 5.236 ** 4.515 ** 5.566 **

VIF MAX 1.002 1.125 1.185 1.003 1.150 1.202

R2 / Adjusted R

2 .185 / .155 .364 / .315 .379 / .304 .162 / .131 .258 / .201 .400 / .328

Notes: Significance levels: † p < .1, * p < .05, ** p <.01, ns = non-significant.

17

The results indicate that five out of six predictors are important in some degree for

predicting the level of formalized contract framework. The importance furthermore differs between

prediction of respectively the levels of transactional and adaptive contract features.

Transactional complexity, measured by the absolute level of expenditure on private

contractors, is found to be important for both types of contract features in all models (A-F). The

analysis indicates that higher degrees of transactional complexity are associated with higher levels

of both transactional and adaptive contract features. Comparing the sizes of the beta-coefficients

indicates that importance of transactional complexity is slightly more pronounced for the level of

transactional contract features (β = 1.137 in model C) than the level of adaptive contract features (β

= .715) in model C). The predictor is measured by a logarithmic (natural scale) which implies that

the effect is more pronounced for absolute differences between relatively smaller economic

involvements (e.g. DKK 1 and 10 mill.) compared to differences between relatively larger

economic involvements (e.g. DKK 10 and 100 mill.).

Whether the department had a role as internal service provider (operational responsibilities)

is found to be important only for the level of adaptive contract features. The analysis indicates that

municipalities where the park and road department has no or a low degree of hierarchical

integration of operational responsibilities also have a higher level of adaptive contract features

implemented in their exchange relations with private contractors.

Likewise, departments which have a higher degree of hierarchical integration of operational

responsibilities, have significantly lower levels of adaptive contract features implemented in their

exchange relations with private contractors. The mean difference of 1.3 (measured on a scale from 0

to 10), between the two groups (low and high level of hierarchical integration) found in model F can

be interpreted as a relative large difference given the mean score of 4.9 for all municipalities.

Both internal and external expertise for drawing up contracts is found to be important for the

level of formal contract framework. Greater internal contracting capabilities are found to be

important for higher levels of transactional contract features but unimportant for differences in the

level of adaptive contract features. Involvement of external expertise is found to be important for

higher levels of both transactional and adaptive contract features. The finding indicates that Danish

municipalities have a degree of internal expertise for setting up transactional contract features, but

they mainly rely on involvement of external expertise for setting up adaptive contract features.

Differences in the municipalities‘ emphasis on low maintenance cost as purpose for

contracting out are found to be unimportant for differences in the level of both transactional and

18

adaptive features. Higher emphasis on development/learning as contracting purpose is, however,

found to be important for the level of adaptive contract features. The finding indicates that the level

of transactional contract features is independent from differences in the emphasis on the two

contracting purposes while the level of adaptive contract features varies with the emphasis on the

level of development/learning as contracting purpose. The finding indicates that the level of

emphasis on contracting purpose in some degree is reflected in formal contract design.

Discussions

Overall, the analysis supports the argument on the importance of transactional complexity for the

level of formalized contract design in implemented in public authorities‘ exchange relations with

their private contractors. The analysis supports the assumption that higher levels of contractual

complexity are associated with higher levels of both transactional and adaptive contract features.

The study‘s first hypothesis is supported by empirical findings.

The analysis partially supports the argument that hierarchical disaggregation will result in

more elaborate formal contract frameworks. The argument is only supported in the analysis of

adaptive contract features where it was found that separation, in terms of no direct operational

responsibilities, is associated with more elaborative adaptive contract features. The study‘s second

hypothesis is therefore not supported while the third hypothesis is supported by empirical findings.

The analysis supports arguments based on an organisational capability perspective on the

importance of specialized expertise for elaboration of formalized contract frameworks. The findings

indicate that it is important to differentiate between internal and external expertise. Both types of

expertise is found to be important for implementation of more elaborate transactional contract

features, however, only involvement of external expertise is found to be important for

implementation of more elaborate adaptive contract features. The findings indicate that some

Danish municipalities have developed a degree of internal capabilities for implementing a

conventional approach as part of their contracting capabilities while they rely on involvement of

external expertise for setting up more elaborate adaptive contract features. The study‘s fourth and

fifth hypotheses are therefore supported by empirical findings.

Finally, the analysis partially support the arguments based on the role of strategic intend for

the organization of exchange relations. The conventional purpose for contracting out, measured by

the importance of ensuring low maintenance cost was not found to be associated with the level of

formalized contract framework. However, greater emphasis on development/learning was found to

19

be associated with higher levels of collaborative contract features. The finding indicates that

municipalities implement some contract features with particular purposes in mind. Overall, the

study‘s sixth hypothesis is not supported while the seventh hypothesis finds empirical support.

A key contribution from the study is that ‗contracting out‘ is not just ‗contracting out‘. With

reference to the longstanding ‗make or buy‘ puzzle – also recently complemented by a ‗make and

buy‘ puzzle – in theories of economic organization as well as organisation of public service

delivery, the present study strongly suggests that the organization of the formal contractual features

of the ‗buy‘ option should be regarded as a puzzle in itself. Contracting out is not ‗just‘ contracting

out as a single discrete alternative within the overall organization of public service delivery. Formal

contract features of contracting out differ consistently – and by and large as indicated by theory –

across circumstances.

In addition, the implemented contract features go beyond conventional wisdom about

contracting out. Earlier research has ‗merely‘ scratched the surface of this puzzle by, for example,

describing the extent of variations (e.g. Walker and Davis, 1999, Lindholst, 2009), provided

conceptual frameworks for understanding variations (e.g. Greve and Ejersbo, 2006) or discussed the

comparative merits of different contract designs (e.g. Vincent-Jones, 2007).

The study supports the ramifications of the discriminatory alignment hypothesis implying

that municipalities align their contractual framework implemented in exchange relations with

private contractors in rational ways according to specific transactional, organizational and strategic

characteristics. Municipalities exhibit ‗rational‘ behaviours (at least they act in accordance with

theoretical expectations) in the choice of formal contract design.

A few studies have prompted concurrent sourcing or mixed service delivery as a possible

strategy for the organisation of public service delivery. The current study adds to this literature by

confirming the hypothesized assumptions on the exploitation of the comparative advantages of

respectively organizing maintenance operations through a combination of internal hierarchy and

external market-based relations.

Transactional characteristics has in most studies of contracting out been confined to a few

key dimensions (e.g. measurability and ease of specification) and the importance for contracting

levels across a range of public services. The current study emphasises that difference in

transactional characteristics within a particular setting too has importance for the organization of

contracting out in terms of the design of the formal contract. The current study found that increased

20

contracting challenges, in terms of the level of complexity, can be handled through formal contract

design as alternative to the make and buy option.

The study also highlights that (low) cost objectives are not the only relevant objectives to

observe when municipalities contract out. The conventional wisdom on the raision d‘entre of

contracting out as a mechanism for ensuring low cost as well as the need to align contract features

according to this objective will not be equally relevant for all instances of contracting out. This

study highlighted that contracting out also is designed and implemented with the aim to pursue

objectives related to development/learning.

Conclusions

Key findings

The study explores several characteristics which help explain why municipalities opt for different

contract designs. Overall, the study finds support for most of the suggested hypotheses. The

findings indicate that municipalities to a large extent acts in rational ways (or at least in

concordance with the theoretical reasoning) in their use of contracts in exchange relations with

private contractors. A more encompassing contract design is implemented when the involved

complexities of the transactions increases, contract design is to a certain extent aligned with

contracting purposes as well as contract designs are aligned with the advantages and disadvantages

of the chosen internal organisation (i.e. the level of hierarchical integration of internal provision).

Reliance on and the level of contract in exchange relations are furthermore dependent on the level

of internal expertise and involvement of external expertise.

Limitations

The study is based on a limited empirical basis. Firstly, the context of the study is limited to private

involvement in provisions of road and park maintenance services in Danish municipalities.

Secondly, the data for construction of response and predictor variables, except for one predictor, is

drawn from a single survey based on self-reported items. The limited number of cases in the final

analysis also limits the number of potential predictor variables.

Future research

The present study adheres to three main groups of explanatory characteristics: transactional,

organizational and strategic. All characteristics are found to have some importance for predicting

21

differences in key contractual features. However, research would benefit from exploring the

importance of further dimensions related to each explanatory characteristic. The range of potential

contract designs a public authority can adopt may depend on available possibilities within a

particular context in terms of, for example, institutional support, legal regulations, stage of market

development or sector specific design options. It would therefore be of interest to explore whether

the logics underlying design choices are similar or differ across, for example, sector and country

contexts. Research comparing for example hard and soft services would be able to explore the

importance for contract design of additional factors such as differences in political and citizen

interest. Such research may also assess the effect of institutional development or advancement of

different contracts within different service sectors.

A major research stream in studies on contracting out in the public sector is concerned with

overall outcomes and performance, in particular economic and quality effects. However, the present

study finds that differences in contract design is associated with variations in contracting purposes

different than cost concerns. Studies of economic effects may benefit from control for variations in

contracting purpose as well as contract design. In particular, contract design as part of the overall

organisation of the involvement of private contractors in public service delivery may to some

degree be a result of variations in the emphasis of other purposes than ensuring low costs. To put it

simple, not all contracts are designed with the sole purpose of minimizing costs. This finding should

be important for research on particular cost effects from contracting out as omission of purpose

would be a likely confounding variable blurring the understanding of when contracting out is used

as a cost minimizing strategy in public service delivery.

As an extension of the argument above it would be important to evaluate other performance

dimensions of contracting out aligned with local authorities‘ choice of strategic purpose, e.g. do

strategies and corresponding contract designs based on development and learning objectives result

in improved development and learning?

22

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Appendix

Diagnostics of principal component analysis

The ‗factorability‘ of the eight items, i.e. suitability of factor analysis, was initially assessed by

standard criteria. Statistics indicate that application of factor analysis on the eight survey items was

appropriate. The ratio between the total number of available cases for factor analysis (N = 64,

listwise) and the number of items (8) is reasonable for explorative factor analysis (a ratio > 5) but

not ideal (a ratio > 20). All items are correlated to several other items in some degree (>.4),

indicating that all items share some common variance with other items, and anti-image correlations

(diagonals) are all well above the recommended minimum of .500 (>= .746). Kaiser-Meyer-Olkin

of sampling adequacy is .833 (well above the recommend minimum value of .500) and Barlett‘s test

of sphericity is also significant (x2 (28) = 228.216, p < .001).

i Technical report is available upon request.

ii Concurrent sourcing is conceptually defined as sourcing of the same (i.e. similar) service to both internal and external

production (Parmaggio, 1997), but has in some studies been operationalized as a percentage of budgets spend on private

vendors within various service areas. It should be noted, that a formally defined service area contains various tasks that

requires different (i.e. dissimilar) skills and routines.