Relational Contracts and the Nature of Market Interactions

59 Pages Posted: 18 Nov 2003

See all articles by Martin Brown

Martin Brown

University of St. Gallen

Armin Falk

briq - Institute on Behavior & Inequality

Ernst Fehr

University of Zurich - Department of Economics

Date Written: October 2003

Abstract

We provide evidence that long-term relationships between trading parties emerge endogenously in the absence of third party enforcement of contracts and are associated with a fundamental change in the nature of market interactions. Without third party enforcement, the vast majority of trades are initiated with private offers and the parties share the gains from trade equally. Low effort or bad quality is penalized by the termination of the relationship, wielding a powerful effect on contract enforcement. Successful long-term relations exhibit generous rent sharing and high effort (quality) from the very beginning of the relationship. In the absence of third-party enforcement, markets resemble a collection of bilateral trading islands rather than a competitive market. If contracts are third party enforceable, rent sharing and long-term relations are absent and the vast majority of trades are initiated with public offers. Most trades take place in one-shot transactions and the contracting parties are indifferent with regard to the identity of their trading partner.

Keywords: relational contracts, implicit contracts, market interaction, involuntary unemployment, repeated transaction, fairness preferences

JEL Classification: D2, D4, C7, C9

Suggested Citation

Brown, Martin and Falk, Armin and Fehr, Ernst, Relational Contracts and the Nature of Market Interactions (October 2003). IZA Discussion Paper No. 897. Available at SSRN: https://ssrn.com/abstract=459587

Martin Brown

University of St. Gallen ( email )

Unterer Graben 21
St. Gallen, CH-9000
Switzerland

Armin Falk (Contact Author)

briq - Institute on Behavior & Inequality

Schaumburg-Lippe-Straße 5-9
Bonn, 53113
Germany

HOME PAGE: http://www.briq-institute.org/

Ernst Fehr

University of Zurich - Department of Economics ( email )

Blümlisalpstrasse 10
Zuerich, 8006
Switzerland
+41 1 634 3709 (Phone)
+41 1 634 4907 (Fax)

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