Networked Markets and Simple Relational Contracts

40 Pages Posted: 9 Oct 2017 Last revised: 19 Aug 2022

See all articles by Mathieu V. Leduc

Mathieu V. Leduc

Paris School of Economics (PSE) / Université Paris 1

Date Written: July 1, 2022

Abstract

Empirical studies of commercial relationships between firms reveal that (i) suppliers encounter situations in which they can gain in the short run by acting opportunistically and (ii) good conduct is sustained not exclusively by formal contracts but through informal relationships and the expectation of future business. In such relationships, the need to offer each supplier a large enough share of future business to deter cheating limits the number of supply relationships each buyer can sustain. The market thus becomes networked, with trade restricted to durable relationships. This article proposes a simple dynamic model to examine the structure of such overlapping relational contracts in equilibrium. Due to exogenous stochastic shocks, suppliers are not always able to make good on their promises even if they wish to and thus links are constantly dissolving, leading to a destruction of social capital. New links are forming to take their place, but restoring social capital takes time due to search frictions. This creates a novel way for shocks to be persistent and also suggests new connections between the theory of relational contracting, on the one hand, and the macroeconomic analysis of recessions, on the other.

Keywords: Simple Relational Contracts, Shock Persistence, Principal-Agent Problems, Repeated Games, Social Capital

JEL Classification: D00, D8, C7, L14

Suggested Citation

Leduc, Mathieu V., Networked Markets and Simple Relational Contracts (July 1, 2022). Available at SSRN: https://ssrn.com/abstract=3049512 or http://dx.doi.org/10.2139/ssrn.3049512

Mathieu V. Leduc (Contact Author)

Paris School of Economics (PSE) / Université Paris 1 ( email )

48 boulevard Jourdan
Paris, 75014
France

HOME PAGE: http://sites.google.com/site/mattvleduc/

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