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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.

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  • 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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    Cited by:

    1. Petra Nieken & Patrick W. Schmitz, 2023. "Contracting under asymmetric information and externalities: an experimental study," Experimental Economics, Springer;Economic Science Association, vol. 26(5), pages 989-1021, November.
    2. Hatzigeorgiou, Andreas & Karpaty, Patrik & Kneller, Richard & Lodefalk, Magnus, 2016. "Immigrant Employment and the Contract Enforcement Costs of Offshoring," Working Papers 2016:7, Örebro University, School of Business, revised 01 Feb 2022.
    3. Jordi Brandts & Valeska Groenert & Christina Rott, 2015. "The Impact of Advice on Women's and Men's Selection into Competition," Management Science, INFORMS, vol. 61(5), pages 1018-1035, May.
    4. Charness, Gary & Gneezy, Uri & Henderson, Austin, 2018. "Experimental methods: Measuring effort in economics experiments," Journal of Economic Behavior & Organization, Elsevier, vol. 149(C), pages 74-87.
    5. Gary Charness & David J. Cooper & Zachary Grossman, 2020. "Silence is golden: team problem solving and communication costs," Experimental Economics, Springer;Economic Science Association, vol. 23(3), pages 668-693, September.
    6. Jordi Brandts & David J. Cooper, 2020. "Managerial Leadership, Truth-Telling, and Efficient Coordination," Working Papers 1211, Barcelona School of Economics.
    7. 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.
    8. Bartling, Björn & Grieder, Manuel & Zehnder, Christian, 2017. "Competitive pricing reduces wasteful counterproductive behaviors," Journal of Public Economics, Elsevier, vol. 156(C), pages 34-47.
    9. Sebastian Kunte & Meike Wollni & Claudia Keser, 2017. "Making it personal: breach and private ordering in a contract farming experiment," European Review of Agricultural Economics, Oxford University Press and the European Agricultural and Applied Economics Publications Foundation, vol. 44(1), pages 121-148.
    10. Alain Cohn & Tobias Gesche & Michel André Maréchal, 2022. "Honesty in the Digital Age," Management Science, INFORMS, vol. 68(2), pages 827-845, February.
    11. David Frydlinger & Oliver D. Hart, 2019. "Overcoming Contractual Incompleteness: The Role of Guiding Principles," NBER Working Papers 26245, National Bureau of Economic Research, Inc.
    12. GRANDJEAN, Gilles & MANTOVANI, Marco & MAULEON, Ana & VANNETELBOSCH, Vincent, 2014. "Whom are you talking with ? An experiment on credibility and communication structure," LIDAM Discussion Papers CORE 2014042, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    13. Gary Charness & Francesco Feri & Miguel A. Meléndez-Jiménez & Matthias Sutter, 2023. "An Experimental Study on the Effects of Communication, Credibility, and Clustering in Network Games," The Review of Economics and Statistics, MIT Press, vol. 105(6), pages 1530-1543, November.
    14. Grieco, Daniela & Bripi, Francesco, 2022. "Participation of charity beneficiaries," Journal of Economic Behavior & Organization, Elsevier, vol. 199(C), pages 1-17.
    15. Du, Ninghua & Shahriar, Quazi, 2018. "Cheap-talk evaluations in contract design," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 77(C), pages 78-87.
    16. Erkut, Hande & Reuben, Ernesto, 2023. "Social networks and organizational helping behavior: Experimental evidence from the helping game," Discussion Papers, Research Unit: Market Behavior SP II 2023-203, WZB Berlin Social Science Center.
    17. Huang, Lingbo & Xiao, Erte, 2021. "Peer effects in public support for Pigouvian taxation," Journal of Economic Behavior & Organization, Elsevier, vol. 187(C), pages 192-204.
    18. Kunte, Sebastian & Wollni, Meike, 2015. "Risky Environments, Hidden Knowledge, and Preferences for Contract Flexibility: An Artefactual Field Experiment," GlobalFood Discussion Papers 205914, Georg-August-Universitaet Goettingen, GlobalFood, Department of Agricultural Economics and Rural Development.
    19. 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.
    20. 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.
    21. Simin He & Theo Offerman & Jeroen van de Ven, 2017. "The Sources of the Communication Gap," Management Science, INFORMS, vol. 63(9), pages 2832-2846, September.
    22. Andrey Fradkin, 2012. "Do Online Marketplaces Become More Efficient Over Time?," Working Papers 12-24, NET Institute.
    23. Oliver Hart, 2017. "Incomplete Contracts and Control," American Economic Review, American Economic Association, vol. 107(7), pages 1731-1752, July.
    24. Jordi Brandts & David J. Cooper, 2018. "Truth Be Told An Experimental Study of Communication and Centralization," Working Papers 1046, Barcelona School of Economics.
    25. Tore Ellingsen & Eirik Gaard Kristiansen, 2022. "Fair and Square: A Retention Model of Managerial Compensation," Management Science, INFORMS, vol. 68(5), pages 3604-3624, May.

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    Keywords

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