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Discretionary Latitude and Relational Contracting

Author

Listed:
  • Wu, Steven Y.

    () (Purdue University)

  • Roe, Brian E.

    () (Ohio State University)

Abstract

We use economic experiments to examine the nature of relational trading under a menu of incomplete contracts ranging from the repeat purchase mechanism of Klein and Leffler (1981) to highly incomplete contracts that are completely unenforceable by third-parties. Our results suggest that, with barriers to complete contracting, increasing the degree of contractual incompleteness can enhance efficiency. Intuitively, more incomplete contracts provide parties with greater discretionary latitude to reward and punish unenforceable performance factors. Moreover, trading under moderately incomplete contracts is characterized by efficiency wages, rent sharing and high levels of cooperation, whereas fully incomplete contracts that permit maximum discretion yield trading patterns that are closer what is observed under a perfectly complete contract. Our results are consistent with the theory of strategic ambiguity of Bernheim and Whinston (1998) and can be rationalized by a simple model of relational contracting that embeds different degrees of discretionary latitude.

Suggested Citation

  • Wu, Steven Y. & Roe, Brian E., 2007. "Discretionary Latitude and Relational Contracting," IZA Discussion Papers 2879, Institute for the Study of Labor (IZA).
  • Handle: RePEc:iza:izadps:dp2879
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    References listed on IDEAS

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    Cited by:

    1. Martin Brown & Armin Falk & Ernst Fehr, 2012. "Competition And Relational Contracts: The Role Of Unemployment As A Disciplinary Device," Journal of the European Economic Association, European Economic Association, vol. 10(4), pages 887-907, August.
    2. Schieffer, Jack & Wu, Steven Y., 2010. "Naughty or nice? Punishment and the interaction of formal and informal incentives in long-term contractual relationships," MPRA Paper 20891, University Library of Munich, Germany.
    3. Alexander, Corinne & Ivanic, Rasto & Rosch, Stephanie & Tyner, Wallace & Wu, Steven Y. & Yoder, Joshua R., 2012. "Contract theory and implications for perennial energy crop contracting," Energy Economics, Elsevier, vol. 34(4), pages 970-979.

    More about this item

    Keywords

    cooperation; experimental economics; implicit incentives; relational contracts; incomplete contracts;

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law

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