Promise, Trust and Betrayal: Costs of Breaching an Implicit Contract
Southern Economic Journal (forthcoming)
29 Pages Posted: 12 Jun 2019 Last revised: 27 Nov 2020
Date Written: May 26, 2019
Abstract
We study the cost of breaching an implicit contract in a goods market. Young and Levy
(2014) document an implicit contract between the Coca-Cola Company and its consumers. This
implicit contract included a promise of constant quality. We offer two types of evidence of the
costs of breach. First, we document a case in 1930 when the Coca-Cola Company chose to avoid
quality adjustment by incurring a permanently higher marginal cost of production, instead of a
one-time increase in the fixed cost. Second, we explore the consequences of the company’s 1985
introduction of “New Coke” to replace the original beverage. Using the Hirschman’s (1970) model
of Exit, Voice, and Loyalty, we argue that the public outcry that followed New Coke’s introduction
was a response to the implicit contract breach.
Keywords: Implicit Contract, Cost of Breaching a Contract, Cost of Breaking a Contract, Invisible Handshake, Customer Market, Long-Term Relationship, Price Rigidity, Sticky Prices, Nickel Coke, Coca-Cola, Secret Formula
JEL Classification: A14, E12, E31, K10, L14, L16, L66, M30, N80
Suggested Citation: Suggested Citation