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Discretionary Latitude and Relational Contracting

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  • Wu, Steven Y.

    ()
    (Purdue University)

  • Roe, Brian E.

    ()
    (Ohio State University)

Abstract

We use economic experiments to examine the nature of relational trading under a menu of incomplete contracts ranging from the repeat purchase mechanism of Klein and Leffler (1981) to highly incomplete contracts that are completely unenforceable by third-parties. Our results suggest that, with barriers to complete contracting, increasing the degree of contractual incompleteness can enhance efficiency. Intuitively, more incomplete contracts provide parties with greater discretionary latitude to reward and punish unenforceable performance factors. Moreover, trading under moderately incomplete contracts is characterized by efficiency wages, rent sharing and high levels of cooperation, whereas fully incomplete contracts that permit maximum discretion yield trading patterns that are closer what is observed under a perfectly complete contract. Our results are consistent with the theory of strategic ambiguity of Bernheim and Whinston (1998) and can be rationalized by a simple model of relational contracting that embeds different degrees of discretionary latitude.

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Bibliographic Info

Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 2879.

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Length: 47 pages
Date of creation: Jun 2007
Date of revision:
Handle: RePEc:iza:izadps:dp2879

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Keywords: cooperation; experimental economics; implicit incentives; relational contracts; incomplete contracts;

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References

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Cited by:
  1. Brown, Martin & Falk, Armin & Fehr, Ernst, 2011. "Competition and Relational Contracts: The Role of Unemployment as a Disciplinary Device," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University 359, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  2. Alexander, Corinne & Ivanic, Rasto & Rosch, Stephanie & Tyner, Wallace & Wu, Steven Y. & Yoder, Joshua R., 2012. "Contract theory and implications for perennial energy crop contracting," Energy Economics, Elsevier, Elsevier, vol. 34(4), pages 970-979.
  3. Schieffer, Jack & Wu, Steven Y., 2010. "Naughty or nice? Punishment and the interaction of formal and informal incentives in long-term contractual relationships," MPRA Paper 20891, University Library of Munich, Germany.

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