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Competition and Relational Contracts: The Role of Unemployment as a Disciplinary Device

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  • Martin Brown
  • Armin Falk
  • Ernst Fehr

Abstract

When unemployment prevails, relations with a particular firm are valuable for workers. As a consequence, a worker may adhere to an implicit agreement to provide high effort, even when performance is no third-party enforceable. But can implicit agreements - or relational contracts - also motivate high worker performance when the labor market is tight? We examine this question by implementing an experimental market in which there is an excess demand for labor and the performance of workers is not third-party enforceable. We show that relational contracts emerge in which firms reward performing workers with wages that exceed the going market rate. This motivates workers to provide high effort, even though they could shirk and switch firms. Our results thus suggest that unemployment is not a necessary device to motivate workers. We also discuss how market conditions affect relational contracting by comparing identical labor markets with excess supply and excess demand for labor. Long-term relationships turn out to be less frequent when there is excess demand for labor compared to a market characterized by unemployment. Surprisingly though, this does not compromise market performance.

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Bibliographic Info

Paper provided by Swiss National Bank in its series Working Papers with number 2008-07.

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Length: 60 pages
Date of creation: 2008
Date of revision:
Handle: RePEc:snb:snbwpa:2008-07

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Keywords: relational contracts; involuntary unemployment;

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References

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  1. Peter AUER & Sandrine CAZES, 2000. "The resilience of the long-term employment relationship: Evidence from the industrialized countries," International Labour Review, International Labour Organization, International Labour Organization, vol. 139(4), pages 379-408, December.
  2. Roe, Brian E. & Wu, Steven Y., 2009. "Do the Selfish Mimic Cooperators? Experimental Evidence from Finitely-Repeated Labor Markets," IZA Discussion Papers 4084, Institute for the Study of Labor (IZA).
  3. Ai, Chunrong & Norton, Edward C., 2003. "Interaction terms in logit and probit models," Economics Letters, Elsevier, Elsevier, vol. 80(1), pages 123-129, July.
  4. James Andreoni & Marco Castillo & Ragan Petrie, 2003. "What Do Bargainers' Preferences Look Like? Experiments with a Convex Ultimatum Game," American Economic Review, American Economic Association, American Economic Association, vol. 93(3), pages 672-685, June.
  5. Flabbi, Luca & Ichino, Andrea, 2001. "Productivity, seniority and wages: new evidence from personnel data," Labour Economics, Elsevier, Elsevier, vol. 8(3), pages 359-387, June.
  6. James L. Medoff & Katharine G. Abraham, 1980. "Experience, Performance, and Earnings," NBER Working Papers 0278, National Bureau of Economic Research, Inc.
  7. Martin Brown & Armin Falk & Ernst Fehr, 2004. "Relational Contracts and the Nature of Market Interactions," Econometrica, Econometric Society, Econometric Society, vol. 72(3), pages 747-780, 05.
  8. Wu, Steven Y. & Roe, Brian E., 2007. "Discretionary Latitude and Relational Contracting," IZA Discussion Papers 2879, Institute for the Study of Labor (IZA).
  9. Steffen Huck & Andrew J. Seltzer & Brian Wallace, 2011. "Deferred Compensation in Multiperiod Labor Contracts: An Experimental Test of Lazear's Model," American Economic Review, American Economic Association, American Economic Association, vol. 101(2), pages 819-43, April.
  10. Hoyt Bleakley & Ann E. Ferris & Jeffrey C. Fuhrer, 1999. "New data on worker flows during business cycles," New England Economic Review, Federal Reserve Bank of Boston, Federal Reserve Bank of Boston, issue Jul, pages 49-76.
  11. Urs Fischbacher, 2007. "z-Tree: Zurich toolbox for ready-made economic experiments," Experimental Economics, Springer, Springer, vol. 10(2), pages 171-178, June.
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Citations

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Cited by:
  1. Bartling, Björn & Fehr, Ernst & Schmidt, Klaus M., 2012. "Use and Abuse of Authority," Discussion Papers in Economics, University of Munich, Department of Economics 14243, University of Munich, Department of Economics.
  2. Klaus M. Schmidt, 2011. "Social Preferences and Competition," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 43, pages 207-231, 08.
  3. Robert Dur & Jan Tichem, 2012. "Social Relations and Relational Incentives," Tinbergen Institute Discussion Papers, Tinbergen Institute 12-054/1, Tinbergen Institute.
  4. Charness, Gary & Du, Ninghua & Yang, Chun-Lei & Yao, Lan, 2013. "Promises in contract design," European Economic Review, Elsevier, Elsevier, vol. 64(C), pages 194-208.
  5. Werner, Peter & Bolton, Gary & Ockenfels, Axel, 2013. "How managerial wage transparency may reduce shareholder returns Evidence from an experiment," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order, Verein für Socialpolitik / German Economic Association 79766, Verein für Socialpolitik / German Economic Association.
  6. Martin G. Kocher & Wolfgang J. Luhan & Matthias Sutter, 2012. "Testing a forgotten aspect of Akerlof’s gift exchange hypothesis: Relational contracts with individual and uniform wages," Working Papers, Faculty of Economics and Statistics, University of Innsbruck 2012-02, Faculty of Economics and Statistics, University of Innsbruck.
  7. Fehr, Ernst & Brown, Martin & Zehnder, Christian, 2008. "On Reputation: A Microfoundation of Contract Enforcement and Price Rigidity," IZA Discussion Papers 3655, Institute for the Study of Labor (IZA).
  8. Bartling, Björn & Fehr, Ernst & Schmidt, Klaus M., 2013. "Use and abuse of authority: A behavioral foundation of the employment relation," Munich Reprints in Economics, University of Munich, Department of Economics 20126, University of Munich, Department of Economics.
  9. Robert Dur & Jan Tichem, 2012. "Social Relations and Relational Incentives," Tinbergen Institute Discussion Papers, Tinbergen Institute 12-054/1, Tinbergen Institute.
  10. Dur, Robert & Tichem, Jan, 2013. "Altruism and Relational Incentives in the Workplace," IZA Discussion Papers 7363, Institute for the Study of Labor (IZA).
  11. Schram, Arthur & Brandts, Jordi & Gërxhani, Klarita, 2010. "Information, bilateral negotiations, and worker recruitment," European Economic Review, Elsevier, Elsevier, vol. 54(8), pages 1035-1058, November.
  12. Vogt, Nora & Reeson, Andrew F. & Bizer, Kilian, 2013. "Communication, competition and social gift exchange in an auction for public good provision," Ecological Economics, Elsevier, Elsevier, vol. 93(C), pages 11-19.

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