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Let’s talk: How communication affects contract design

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  • Charness, Gary
  • Brandts, Jordi
  • Ellman, Matthew

Abstract

We study experimentally how the ability to communicate affects the frequency andeffectiveness of flexible and inflexible contracts in a bilateral trade context where sellers canadjust trade quality after observing a post-contractual cost shock and a discretionary buyertransfer. In the absence of communication, we find that rigid contracts are more frequent andlead 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 andsellers. Also, both buyer and seller earn considerably more from flexible with communicationthan rigid without communication. Our results show quite strongly that communication, a normalfeature in contracting, can remove the potential cost of flexibility (disagreements caused byconflicting perceptions). We offer an explanation based on social norms.

Suggested Citation

  • Charness, Gary & Brandts, Jordi & Ellman, Matthew, 2012. "Let’s talk: How communication affects contract design," University of California at Santa Barbara, Economics Working Paper Series qt6z24s6rv, Department of Economics, UC Santa Barbara.
  • Handle: RePEc:cdl:ucsbec:qt6z24s6rv
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    References listed on IDEAS

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    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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    Cited by:

    1. repec:eee:eecrev:v:95:y:2017:i:c:p:195-214 is not listed on IDEAS
    2. 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.
    3. repec:eee:jeborg:v:149:y:2018:i:c:p:74-87 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. 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.
    7. repec:eee:gamebe:v:109:y:2018:i:c:p:544-564 is not listed on IDEAS
    8. repec:eee:pubeco:v:156:y:2017:i:c:p:34-47 is not listed on IDEAS
    9. 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.
    10. Alain Cohn & Tobias Gesche & Michel André Maréchal, 2018. "Honesty in the Digital Age," CESifo Working Paper Series 6996, CESifo Group Munich.
    11. Hatzigeorgiou, Andreas & Karpaty, Patrik & Kneller, Richard & Lodefalk, Magnus, 2016. "Do Immigrants Spur Offshoring? Firm-Level Evidence," Ratio Working Papers 282, The Ratio Institute.
    12. GRANDJEAN, Gilles & MANTOVANI, Marco & MAULEON, Ana & VANNETELBOSCH, Vincent, 2014. "Whom are you talking with ? An experiment on credibility and communication structure," CORE Discussion Papers 2014042, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    13. 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," CESifo Working Paper Series 7659, CESifo Group Munich.
    14. 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.
    15. repec:aea:aecrev:v:107:y:2017:i:7:p:1731-52 is not listed on IDEAS
    16. 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).
    17. Jordi Brandts & David J. Cooper, 2018. "Truth Be Told An Experimental Study of Communication and Centralization," Working Papers 1046, Barcelona Graduate School of Economics.
    18. repec:eee:soceco:v:77:y:2018:i:c:p:78-87 is not listed on IDEAS

    More about this item

    Keywords

    Social and Behavioral Sciences; experimental; contracts; bilateral trade; cost shock; discretionary buyer transfer;

    JEL classification:

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

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