On Reputation: A Microfoundation of Contract Enforcement and Price Rigidity
University of Zurich - Department of Economics
University of St. Gallen - Swiss Institute of Banking and Finance
University of Lausanne
IZA Discussion Paper No. 3655
We study the impact of reputational incentives in markets characterized by moral hazard problems. Social preferences have been shown to enhance contract enforcement in these markets, while at the same time generating considerable wage and price rigidity. Reputation powerfully amplifies the positive effects of social preferences on contract enforcement by increasing contract efficiency substantially. This effect is, however, associated with a considerable bilateralisation of market interactions, suggesting that it may aggravate price rigidities. Surprisingly, reputation in fact weakens the wage and price rigidities arising from social preferences. Thus, in markets characterized by moral hazard, reputational incentives unambiguously increase mutually beneficial exchanges, reduce rents, and render markets more responsive to supply and demand shocks.
Number of Pages in PDF File: 33
Keywords: wage rigidity, price rigidity, relational contracts, reciprocity, reputation
JEL Classification: D82, J3, J41, E24, C9
Date posted: August 27, 2008
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