Drawing on transaction cost economics (TCE), social capital theory and social exchange theory, this study develops a framework on how formal contracts, social capital, and social exchange as governance mechanisms impact on project and relationship performance of large construction projects in developing countries with unstable environment. The framework is tested using survey data from 84 Iranian large construction projects. Partial Least Square (PLS) analyses indicate the joint contribution of social capital and social exchange to relationship performance. Despite this positive effect of social capital and social exchange, formal contracts deteriorate relationship performance echoing the substitute role of relational mechanisms to contractual mechanisms. Further, the study suggests that while contractual arrangements do not have any significant effects on project performance in such unstable environments with ineffective legal systems, social capital may be the sole contributor to achieving project objectives. The study paves the road for more research on governance issues in various contexts with special attention to cultural, political and economic differences.

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