The Threat of Exclusion and Implicit Contracting

87 Pages Posted: 9 Nov 2016

See all articles by Martin Brown

Martin Brown

University of St. Gallen

Marta Serra-Garcia

University of California, San Diego (UCSD) - Rady School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: September 29, 2016

Abstract

Implicit contracts can mitigate moral hazard in labor, credit and product markets. The enforcement mechanism underlying an implicit contract is the threat of exclusion: the agent fears that he will lose future income if the principal breaks off the relationship. This threat may be very weak in environments where an agent can appropriate income-generating resources provided by the principal. For example, in credit markets with weak creditor protection borrowers may be able to appropriate borrowed funds and generate investment income without requiring further loans. We examine implicit contracting in a lending experiment where the threat of exclusion is exogenously varied. We find that weak exclusion undermines implicit contracting: it leads to a more frequent breakdown of credit relationships as well as to smaller loans.

Keywords: economics, microeconomic behavior, behavior and behavioral decision making, finance, corporate finance, implicit contracting

JEL Classification: C730, G210, O160, F210, F340

Suggested Citation

Brown, Martin and Serra-Garcia, Marta, The Threat of Exclusion and Implicit Contracting (September 29, 2016). CESifo Working Paper Series No. 6092. Available at SSRN: https://ssrn.com/abstract=2866807

Martin Brown

University of St. Gallen ( email )

Unterer Graben 21
St. Gallen, CH-9000
Switzerland

Marta Serra-Garcia (Contact Author)

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

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