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Let's Talk: How Communication Affects Contract Design

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  • Jordi Brandts
  • Gary Charness
  • Matthew Ellman

Abstract

We study experimentally how the ability to communicate affects the frequency and effectiveness of flexible and inflexible contracts in a bilateral trade context where sellers can adjust trade quality after observing a post-contractual cost shock and a discretionary buyer transfer. In the absence of communication, we find that rigid contracts are more frequent and lead to higher earnings for both buyer and seller. By contrast, in the presence of communication, flexible contracts are much more frequent and considerably more productive, both for buyers and sellers. Also, both buyer and seller earn considerably more from flexible with communication than rigid without communication. Our results show quite strongly that communication, a normal feature in contracting, can remove the potential cost of flexibility (disagreements caused by conflicting perceptions). We offer an explanation based on social norms.

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Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 648.

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Date of creation: Jun 2012
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Handle: RePEc:bge:wpaper:648

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Keywords: Communication; contracts; perceptions and cooperation;

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  1. Matthew Ellman & Paul Pezanis-Christou, 2007. "Organisational structure, communication and group ethics," UFAE and IAE Working Papers, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC) 682.07, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  2. Charness, Gary & Rabin, Matthew, 2001. "Understanding Social Preferences with Simple Tests," Department of Economics, Working Paper Series, Department of Economics, Institute for Business and Economic Research, UC Berkeley qt4qz9k8vg, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  3. Charness, Gary & Oprea, Ryan & Friedman, Dan, 2012. "Continuous Time and Communication in a Public-goods Experiment," University of California at Santa Barbara, Economics Working Paper Series qt5404914p, Department of Economics, UC Santa Barbara.
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