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Social Preferences and Relational Contracting: An Experimental Investigation

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  • Wu, Steven Y.
  • Roe, Brian E.

Abstract

The form and regulation of contracts is of increasing importance to agricultural economists as farmers and agribusinesses increasing rely on contracts rather than markets to acquire inputs and sell outputs. We focus on the differences between the joint and individual surplus achievable under complete versus incomplete or relational contracts, where the latter are contracts that are not verifiable by a third party and must rely upon threat of termination in order to entice mutually satisfactory performance. Using an experimental market similar to Brown, Falk, and Fehr [Brown, M., A. Falk, and E. Fehr. “Relational Contracts and the Nature of Market Interactions, Econometrica, 72 (2004):747-780] we replicate the general results found by these authors, including the qualitative findings that complete contracts dominate incomplete contracts in terms of social surplus generated and that incomplete contracts significantly deviate from the minimal levels of social surplus predicted by equilibrium models featuring purely self-interested agents. We extend the Brown, Falk, and Fehr results in a fundamental way: we explicitly link individual outcomes in relational contracts (e.g, surplus, prices, quality) to the nature of subjects'’ social preferences, which were measured by a separate experimental protocol that was implemented prior to the experimental trading session. We find subjects with other-regarding preferences enter into relational contracts that generate levels of social surplus similar to the surplus generated under complete contracts. Furthermore, subjects with other-regarding preferences tend to locate others with similar preferences and enter into long-term trading relationships that generate these higher surplus levels. We discuss the ramifications of the results for current regulatory efforts aimed at agricultural contracts.

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Bibliographic Info

Paper provided by American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association) in its series 2005 Annual meeting, July 24-27, Providence, RI with number 19215.

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Date of creation: 2005
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Handle: RePEc:ags:aaea05:19215

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Keywords: Marketing;

References

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  1. Fehr, Ernst & Kirchsteiger, Georg & Riedl, Arno, 1995. "Gift Exchange and Reciprocity in Competitive Experimental Markets," Economics Series 14, Institute for Advanced Studies.
  2. Friedman,Daniel & Sunder,Shyam, 1994. "Experimental Methods," Cambridge Books, Cambridge University Press, number 9780521456821, April.
  3. Fehr, Ernst & Schmidt, Klaus M., 1998. "A Theory of Fairness, Competition and Cooperation," CEPR Discussion Papers 1812, C.E.P.R. Discussion Papers.
  4. Klein, Benjamin & Crawford, Robert G & Alchian, Armen A, 1978. "Vertical Integration, Appropriable Rents, and the Competitive Contracting Process," Journal of Law and Economics, University of Chicago Press, vol. 21(2), pages 297-326, October.
  5. Ernst Fehr & Simon G�chter, 2000. "Fairness and Retaliation: The Economics of Reciprocity," Journal of Economic Perspectives, American Economic Association, vol. 14(3), pages 159-181, Summer.
  6. John A. List, 2006. "The Behavioralist Meets the Market: Measuring Social Preferences and Reputation Effects in Actual Transactions," Journal of Political Economy, University of Chicago Press, vol. 114(1), pages 1-37, February.
  7. Jonathan Levin, 2000. "Relational Incentive Contracts," Working Papers 01002, Stanford University, Department of Economics.
  8. David K Levine, 1997. "Modeling Altruism and Spitefulness in Experiments," Levine's Working Paper Archive 2047, David K. Levine.
  9. Brown, Martin & Falk, Armin & Fehr, Ernst, 2003. "Relational Contracts and the Nature of Market Interactions," IZA Discussion Papers 897, Institute for the Study of Labor (IZA).
  10. Hardman Moore, John & Hart, Oliver, 1985. "Incomplete Contracts and Renegotiation," CEPR Discussion Papers 60, C.E.P.R. Discussion Papers.
  11. Holmstrom, Bengt R. & Tirole, Jean, 1989. "The theory of the firm," Handbook of Industrial Organization, in: R. Schmalensee & R. Willig (ed.), Handbook of Industrial Organization, edition 1, volume 1, chapter 2, pages 61-133 Elsevier.
  12. Ernst Fehr & Simon Gachter & Georg Kirchsteiger, 2001. "Reciprocity as a Contract Enforcement Device," Levine's Working Paper Archive 563824000000000143, David K. Levine.
  13. Guth, Werner & Schmittberger, Rolf & Schwarze, Bernd, 1982. "An experimental analysis of ultimatum bargaining," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 367-388, December.
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