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Institutions and Contract Enforcement

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  • Armin Falk
  • David Huffman
  • W. Bentley MacLeod

Abstract

We provide evidence on how two important types of institutions -- dismissal barriers, and bonus pay -- affect contract enforcement behavior in a market with incomplete contracts and repeated interactions. Dismissal barriers are shown to have a strong negative impact on worker performance, and market efficiency, by interfering with firms' use of firing threat as an incentive device. Dismissal barriers also distort the dynamics of worker effort levels over time, cause firms to rely more on the spot market for labor, and create a distribution of relationship lengths in the market that is more extreme, with more very short and more very long relationships. The introduction of a bonus pay option dramatically changes the market outcome. Firms are observed to substitute bonus pay for threat of firing as an incentive device, almost entirely offsetting the negative incentive and efficiency effects of dismissal barriers. Nevertheless, contract enforcement behavior remains fundamentally changed, because the option to pay bonuses causes firms to rely less on long-term relationships. Our results show that market outcomes are the result of a complex interplay between contract enforcement policies and the institutions in which they are embedded.

Suggested Citation

  • Armin Falk & David Huffman & W. Bentley MacLeod, 2008. "Institutions and Contract Enforcement," NBER Working Papers 13961, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:13961
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    Cited by:

    1. Charness, Gary & Du, Ninghua & Yang, Chun-Lei & Yao, Lan, 2013. "Promises in contract design," European Economic Review, Elsevier, vol. 64(C), pages 194-208.
    2. Corgnet, Brice & Hernán-González, Roberto & Rassenti, Stephen, 2015. "Firing threats: Incentive effects and impression management," Games and Economic Behavior, Elsevier, vol. 91(C), pages 97-113.
    3. repec:eee:eecrev:v:103:y:2018:i:c:p:125-149 is not listed on IDEAS
    4. Dohmen, Thomas, 2014. "Behavioral labor economics: Advances and future directions," Labour Economics, Elsevier, vol. 30(C), pages 71-85.
    5. Brown, Martin & Serra-Garcia, Marta, 2011. "The Threat of Exclusion and Relational Contracting," Discussion Papers in Economics 12287, University of Munich, Department of Economics.
    6. repec:eee:eecrev:v:95:y:2017:i:c:p:195-214 is not listed on IDEAS
    7. Elwyn Davies & Marcel Fafchamps, 2017. "When No Bad Deed Goes Punished: Relational Contracting in Ghana versus the UK," NBER Working Papers 23123, National Bureau of Economic Research, Inc.
    8. repec:eee:jeborg:v:147:y:2018:i:c:p:76-94 is not listed on IDEAS
    9. Brice Corgnet & Joaquín Gómez-Miñambres & Roberto Hernán-González, 2015. "Goal Setting and Monetary Incentives: When Large Stakes Are Not Enough," Management Science, INFORMS, vol. 61(12), pages 2926-2944, December.
    10. Charness, Gary & Kuhn, Peter, 2011. "Lab Labor: What Can Labor Economists Learn from the Lab?," Handbook of Labor Economics, Elsevier.
    11. Englmaier, Florian & Segal, Carmit, 2016. "Morale, Relationships, and Wages: An Experimental Study," Annual Conference 2016 (Augsburg): Demographic Change 145662, Verein für Socialpolitik / German Economic Association.
    12. Kopányi-Peuker, Anita & Offerman, Theo & Sloof, Randolph, 2018. "Team production benefits from a permanent fear of exclusion," European Economic Review, Elsevier, vol. 103(C), pages 125-149.
    13. 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.
    14. Jordi Brandts & Brice Corgnet & Roberto Hernán-González & José M. Ortiz & Carles Solà, 2018. "A ‘threat’ is a ‘Threat’: Incentive Effects of Firing Threats with Varying Degrees of Performance Information," Working Papers 1023, Barcelona Graduate School of Economics.

    More about this item

    JEL classification:

    • C9 - Mathematical and Quantitative Methods - - Design of Experiments
    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts

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