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The Threat of Exclusion and Relational Contracting

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  • Brown, Martin
  • Serra-Garcia, Marta

Abstract

Relational contracts have been shown to mitigate moral hazard in labor and credit markets. A central assumption in most theoretical and experimental studies is that, upon misbehaving, agents can be excluded from their current source of income and have to resort to less attractive outside options. This threat of exclusion is unrealistic in many environments, and especially in credit and investment contexts. We examine experimentally the emergence and time structure of relational contracts when the threat of exclusion is weakened. We focus on bilateral credit relationships in which strategic default is possible. We compare a weak exclusion treatment in which defaulting borrowers can reinvest borrowed funds, to a strong exclusion treatment in which defaulting borrowers must liquidate borrowed funds. We find that under weak exclusion more relationships break down in early periods and credit relationships are more likely to “start small”.

Suggested Citation

  • Brown, Martin & Serra-Garcia, Marta, 2011. "The Threat of Exclusion and Relational Contracting," Discussion Papers in Economics 12287, University of Munich, Department of Economics.
  • Handle: RePEc:lmu:muenec:12287
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    File URL: https://epub.ub.uni-muenchen.de/12287/1/BSG_The%20Threat%20of%20Exclusion_2014_04_09.pdf
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    References listed on IDEAS

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    Cited by:

    1. Giorgia Barboni & Tania Treibich, 2012. "(Just) first time lucky ?the impact of single versus multiple bank lending relationships on firms and banks'behavior," Documents de Travail de l'OFCE 2012-26, Observatoire Francais des Conjonctures Economiques (OFCE).

    More about this item

    Keywords

    Relational contracts; Starting small; Debt enforcement;

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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