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Let’s talk: How communication affects contract design

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

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.

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Paper provided by Department of Economics, UC Santa Barbara in its series University of California at Santa Barbara, Economics Working Paper Series with number qt6z24s6rv.

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Date of creation: 16 Jun 2012
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Handle: RePEc:cdl:ucsbec:qt6z24s6rv
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  1. Charness, Gary & Dufwenberg, Martin, 2010. "Bare promises: An experiment," Economics Letters, Elsevier, vol. 107(2), pages 281-283, May.
  2. Ernst Fehr & Oliver D. Hart & Christian Zehnder, 2008. "Contracts as Reference Points - Experimental Evidence," NBER Working Papers 14501, National Bureau of Economic Research, Inc.
  3. Gary Charness & Matthew Rabin, 2002. "Understanding Social Preferences With Simple Tests," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 817-869, August.
  4. Fehr, Ernst & Hart, Oliver & Zehnder, Christian, 2011. "How Do Informal Agreements and Renegotiation Shape Contractual Reference Points?," IZA Discussion Papers 6095, Institute for the Study of Labor (IZA).
  5. Charness, Gary & Oprea, Ryan & Friedman, Dan, 2012. "Continuous Time and Communication in a Public-goods Experiment," University of California at Santa Barbara, Economics Working Paper Series qt5404914p, Department of Economics, UC Santa Barbara.
  6. Cooper, Russell, et al, 1990. "Selection Criteria in Coordination Games: Some Experimental Results," American Economic Review, American Economic Association, vol. 80(1), pages 218-33, March.
  7. Oliver Hart & John Moore, 2006. "Contracts as Reference Points," NBER Working Papers 12706, National Bureau of Economic Research, Inc.
  8. Matthew Ellman & Paul Pezanis-Christou, 2007. "Organisational structure, communication and group ethics," UFAE and IAE Working Papers 682.07, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  9. 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 464-77, June.
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