Let's Talk: How Communication Affects Contract Design

53 Pages Posted: 19 Jul 2012

See all articles by Jordi Brandts

Jordi Brandts

Instituto de Analisis Economico (CSIC) Barcelona

Gary Charness

University of California, Santa Barbara (UCSB) - Department of Economics

Matthew Ellman

Institut d'Anàlisi Econòmica (CSIC); Barcelona Graduate School of Economics (Barcelona GSE)

Date Written: July 19, 2012

Abstract

We study experimentally how the ability to communicate affects the frequency and effectiveness of flexible and inflexible contracts in a bilateral trade context where sellers can adjust trade quality after observing a post-contractual cost shock and a discretionary buyer transfer. In the absence of communication, we find that rigid contracts are more frequent and lead to higher earnings for both buyer and seller. By contrast, in the presence of communication, flexible contracts are much more frequent and considerably more productive, both for buyers and sellers. Also, both buyer and seller earn considerably more from flexible with communication than rigid without communication. Our results show quite strongly that communication, a normal feature in contracting, can remove the potential cost of flexibility (disagreements caused by conflicting perceptions). We offer an explanation based on social norms.

Keywords: contract design, communication, experiments

JEL Classification: C910

Suggested Citation

Brandts, Jordi and Charness, Gary and Ellman, Matthew, Let's Talk: How Communication Affects Contract Design (July 19, 2012). CESifo Working Paper Series No. 3883, Available at SSRN: https://ssrn.com/abstract=2112945 or http://dx.doi.org/10.2139/ssrn.2112945

Jordi Brandts (Contact Author)

Instituto de Analisis Economico (CSIC) Barcelona ( email )

UAB Campus
E-08193 Bellaterra
Spain

Gary Charness

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

2127 North Hall
Santa Barbara, CA 93106
United States
805-893-2412 (Phone)
805-893-8830 (Fax)

Matthew Ellman

Institut d'Anàlisi Econòmica (CSIC) ( email )

UAB Campus
IAE-CSIC
E-08193 Bellaterra, Barcelona 08193
Spain
0034935806612 (Phone)

Barcelona Graduate School of Economics (Barcelona GSE) ( email )

Ramon Trias Fargas, 25-27
Barcelona, Barcelona 08005
Spain

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