Trust, Investment and Competition: Theory and Evidence from German Car Manufacturers

Abstract

Based on data from a comprehensive benchmarking study on buyer-supplier

relationships in the German automotive industry, we show that more trust in a

relationship is associated with higher idiosyncratic investment by suppliers and

better part quality|but also with more competition among suppliers. Both associations

hold only for parts involving comparatively unsophisticated technology,

and disappear for parts involving sophisticated technology. We rationalize all these

observations by means of a relational contracting model of repeated procurement

with non-contractible, buyer-specific investments. In relationships involving higher

trust, buyers are able to induce higher investment and more intense competition

among suppliers|but only when the buyer has the bargaining power. This ability

disappears when the bargaining power resides with the supplier(s).