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Let'S Talk: How Communication Affects Contract Design

Author

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  • Jordi Brandts
  • Matthew Ellman
  • Gary Charness

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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Suggested Citation

  • Jordi Brandts & Matthew Ellman & Gary Charness, 2016. "Let'S Talk: How Communication Affects Contract Design," Journal of the European Economic Association, European Economic Association, vol. 14(4), pages 943-974, August.
  • Handle: RePEc:bla:jeurec:v:14:y:2016:i:4:p:943-974
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    File URL: http://hdl.handle.net/10.1111/jeea.2016.14.issue-4
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    References listed on IDEAS

    as
    1. Gary Charness & Matthew Rabin, 2002. "Understanding Social Preferences with Simple Tests," The Quarterly Journal of Economics, Oxford University Press, vol. 117(3), pages 817-869.
    2. Oliver Hart & John Moore, 2008. "Contracts as Reference Points," The Quarterly Journal of Economics, Oxford University Press, vol. 123(1), pages 1-48.
    3. Matthew Ellman & Paul Pezanis-Christou, 2010. "Organizational Structure, Communication, and Group Ethics," American Economic Review, American Economic Association, vol. 100(5), pages 2478-2491, December.
    4. Ernst Fehr & Oliver Hart & Christian Zehnder, 2011. "Contracts as Reference Points--Experimental Evidence," American Economic Review, American Economic Association, vol. 101(2), pages 493-525, April.
    5. Oprea, Ryan & Charness, Gary & Friedman, Daniel, 2014. "Continuous time and communication in a public-goods experiment," Journal of Economic Behavior & Organization, Elsevier, vol. 108(C), pages 212-223.
    6. W. Bentley MacLeod, 2007. "Reputations, Relationships, and Contract Enforcement," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 595-628, September.
    7. Eric Maskin & John Moore, 1999. "Implementation and Renegotiation," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 39-56.
    8. Ernst Fehr & Oliver Hart & Christian Zehnder, 2011. "How do informal agreements and renegotiation shape contractual reference points?," ECON - Working Papers 043, Department of Economics - University of Zurich.
    9. Cooper, Russell, et al, 1990. "Selection Criteria in Coordination Games: Some Experimental Results," American Economic Review, American Economic Association, vol. 80(1), pages 218-233, March.
    10. Charness, Gary & Dufwenberg, Martin, 2010. "Bare promises: An experiment," Economics Letters, Elsevier, vol. 107(2), pages 281-283, May.
    11. Avner Ben-Ner & Louis Putterman & Ting Ren, 2007. "Lavish Returns on Cheap Talk: Non-binding Communication in a Trust Experiment," Working Papers 2007-15, Brown University, Department of Economics.
    12. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817.
    13. Andreoni, James, 1990. "Impure Altruism and Donations to Public Goods: A Theory of Warm-Glow Giving?," Economic Journal, Royal Economic Society, vol. 100(401), pages 464-477, June.
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    Citations

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    Cited by:

    1. Alain Cohn & Tobias Gesche & Michel André Maréchal, 2018. "Honesty in the Digital Age," CESifo Working Paper Series 6996, CESifo Group Munich.
    2. Gary Charness & Francesco Feri & Miguel A. Meléndez-Jiménez & Matthias Sutter, 2019. "An Experimental Study on the Effects of Communication, Credibility, and Clustering in Network Games," Discussion Paper Series of the Max Planck Institute for Research on Collective Goods 2019_08, Max Planck Institute for Research on Collective Goods.
    3. repec:eee:eecrev:v:95:y:2017:i:c:p:195-214 is not listed on IDEAS
    4. Manuel Munoz-Herrera & Ernesto Reuben, 2019. "Business culture: The role of personal and impersonal business relationships on market efficiency," Working Papers 20190027, New York University Abu Dhabi, Department of Social Science, revised Jun 2019.
    5. Andrey Fradkin, 2012. "Do Online Marketplaces Become More Efficient Over Time?," Working Papers 12-24, NET Institute.
    6. Jordi Brandts & David J. Cooper, 2018. "Truth Be Told An Experimental Study of Communication and Centralization," Working Papers 1046, Barcelona Graduate School of Economics.
    7. Gilles Grandjean & Marco Mantovani & Ana Mauleon & Vincent Vannetelbosch, 2014. "Whom are you talking with? An experiment on credibility and communication structure," Working Papers 285, University of Milano-Bicocca, Department of Economics, revised Oct 2014.
    8. repec:eee:jeborg:v:149:y:2018:i:c:p:74-87 is not listed on IDEAS
    9. Jordi Brandts & Valeska Groenert & Christina Rott, 2012. "The Impact of Advice on Women's and Men's Selection into Competition," Working Papers 663, Barcelona Graduate School of Economics.
    10. repec:eee:gamebe:v:109:y:2018:i:c:p:544-564 is not listed on IDEAS
    11. repec:eee:pubeco:v:156:y:2017:i:c:p:34-47 is not listed on IDEAS
    12. Jordi Brandts & Valeska Groener & Christina Rott, 2012. "The impact of advice on women's and men's selection into competition," UFAE and IAE Working Papers 912.12, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
    13. repec:eee:soceco:v:77:y:2018:i:c:p:78-87 is not listed on IDEAS
    14. Hatzigeorgiou, Andreas & Karpaty, Patrik & Kneller, Richard & Lodefalk, Magnus, 2016. "Do Immigrants Spur Offshoring? Firm-Level Evidence," Working Papers 2016:7, Örebro University, School of Business.
    15. Charness, Gary & Cobo-Reyes, Ramón & Jiménez, Natalia & Lacomba, Juan A. & Lagos, Francisco, 2017. "Job security and long-term investment: An experimental analysis," European Economic Review, Elsevier, vol. 95(C), pages 195-214.
    16. Kunte, Sebastian & Wollni, Meike & Keser, Claudia, 2014. "Making it personal: breach and private ordering in a contract farming experiment," GlobalFood Discussion Papers 186136, Georg-August-Universitaet Goettingen, GlobalFood, Department of Agricultural Economics and Rural Development.
    17. Hoppe, Eva I. & Schmitz, Patrick W., 2018. "Hidden action and outcome contractibility: An experimental test of moral hazard theory," Games and Economic Behavior, Elsevier, vol. 109(C), pages 544-564.
    18. repec:aea:aecrev:v:107:y:2017:i:7:p:1731-52 is not listed on IDEAS

    More about this item

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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