Promise, Trust and Betrayal: Costs of Breaching an Implicit Contract

32 Pages Posted: 12 Jun 2019

See all articles by Daniel Levy

Daniel Levy

Bar-Ilan University - Department of Economics; Emory University - Department of Economics; Rimini Center for Economic Analysis

Andrew T. Young

Texas Tech University - Rawls College of Business

Date Written: May 26, 2019

Abstract

We study the cost of breaching an implicit contract in a goods market, building on a recent study that documented the presence of such a contract in the Coca-Cola market, in the US, during 1886‒1959. The implicit contract promised a serving of Coca-Cola of a constant quality (the “real thing”), and of a constant quantity (6.5oz in a bottle or from the fountain), at a constant nominal price of 5¢. We offer two types of evidence. First, we document a case that occurred in 1930, where the Coca-Cola Company chose to incur a permanently higher marginal cost of production, instead of a one-time increase in the fixed cost, to prevent a quality adjustment of Coca-Cola, which would be considered a breach of the implicit contract. Second, we explore the consequences of the Company’s 1985 decision to replace the original Coke with the “New Coke.” Using the model of Exit, Voice, and Loyalty (Hirschman 1970), we argue that the unprecedented public outcry that followed the New Coke’s introduction, was a response to the Company’s breaching of the implicit contract. We document the direct and quantifiable costs of this implicit contract breach, and demonstrate that the indirect, although unquantifiable, costs in terms of lost customer goodwill were substantial.

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

Levy, Daniel and Young, Andrew T., Promise, Trust and Betrayal: Costs of Breaching an Implicit Contract (May 26, 2019). Available at SSRN: https://ssrn.com/abstract=3394578 or http://dx.doi.org/10.2139/ssrn.3394578

Daniel Levy (Contact Author)

Bar-Ilan University - Department of Economics ( email )

Ramat-Gan, 5290002
Israel
+972 3 531-8345 (Phone)
+972 3 738-4034 (Fax)

HOME PAGE: http://econ.biu.ac.il/en/levy

Emory University - Department of Economics ( email )

1602 Fishburne Drive, Suite 306
Rich Building
Atlanta, GA 30322-0001
United States

HOME PAGE: http://economics.emory.edu/home/people/faculty/Levydaniel.html

Rimini Center for Economic Analysis ( email )

Wilfrid Laurier University
75 University Ave W.
Waterloo, Ontario N2L3C5
Canada

HOME PAGE: http://rcea.org/

Andrew T. Young

Texas Tech University - Rawls College of Business ( email )

Lubbock, TX 79409
United States

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