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Relational Contracts and the Nature of Market Interactions

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Author Info
Brown, Martin (University of Zurich)
Falk, Armin () (University of Zurich and IZA Bonn)
Fehr, Ernst (University of Zurich and IZA Bonn)

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Abstract

We provide evidence that long-term relationships between trading parties emerge endogenously in the absence of third party enforcement of contracts and are associated with a fundamental change in the nature of market interactions. Without third party enforcement, the vast majority of trades are initiated with private offers and the parties share the gains from trade equally. Low effort or bad quality is penalized by the termination of the relationship, wielding a powerful effect on contract enforcement. Successful long-term relations exhibit generous rent sharing and high effort (quality) from the very beginning of the relationship. In the absence of third-party enforcement, markets resemble a collection of bilateral trading islands rather than a competitive market. If contracts are third party enforceable, rent sharing and long-term relations are absent and the vast majority of trades are initiated with public offers. Most trades take place in one-shot transactions and the contracting parties are indifferent with regard to the identity of their trading partner.

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Publisher Info
Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 897.

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Length: 59 pages
Date of creation: Oct 2003
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Handle: RePEc:iza:izadps:dp897

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Related research
Keywords: relational contracts; implicit contracts; market interaction; involuntary unemployment; repeated transaction; fairness preferences;

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Find related papers by JEL classification:
D2 - Microeconomics - - Production and Organizations
D4 - Microeconomics - - Market Structure and Pricing
C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
C9 - Mathematical and Quantitative Methods - - Design of Experiments

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