Contract structure and performance: The role of milestone payments in IT technology development agreements

Abstract

We study one of the important elements of contract structure--milestone payments in information technology development contracts. Outsourced technology development generally involves information asymmetry, conflicts of interest, and relationshipspecific efforts. Therefore, contractual opportunism such as adverse selection, moral hazard and shirking are among the major concerns for technology development partners. The paper examines how the structure of milestone payments reduces contractual uncertainty and opportunism and therefore decreases the likelihood of contract cancellation. Using data from over 350 technology development contracts across 14 countries we show that contracts with longer contract duration, high level of task uncertainty and complexity, and high dependence on developer's proprietary technology are more likely to structure milestone payments and appropriate structure of milestone payments reduces the probability of contract cancellation.