Discretionary Latitude and Relational Contracting

47 Pages Posted: 12 Jul 2007

See all articles by Steven Y. Wu

Steven Y. Wu

Ohio State University (OSU) - Department of Agricultural, Environmental & Development Economics; IZA Institute of Labor Economics

Brian E. Roe

Ohio State University (OSU) - Department of Agricultural, Environmental & Development Economics

Date Written: June 2007

Abstract

We use economic experiments to examine the nature of relational trading under a menu of incomplete contracts ranging from the repeat purchase mechanism of Klein and Leffler (1981) to highly incomplete contracts that are completely unenforceable by third-parties. Our results suggest that, with barriers to complete contracting, increasing the degree of contractual incompleteness can enhance efficiency. Intuitively, more incomplete contracts provide parties with greater discretionary latitude to reward and punish unenforceable performance factors. Moreover, trading under moderately incomplete contracts is characterized by efficiency wages, rent sharing and high levels of cooperation, whereas fully incomplete contracts that permit maximum discretion yield trading patterns that are closer what is observed under a perfectly complete contract. Our results are consistent with the theory of strategic ambiguity of Bernheim and Whinston (1998) and can be rationalized by a simple model of relational contracting that embeds different degrees of discretionary latitude.

Keywords: relational contracts, implicit incentives, experimental economics, cooperation, incomplete contracts

JEL Classification: C91, D23, D84, D86, J33, K12

Suggested Citation

Wu, Steven Yu-Ping and Roe, Brian E., Discretionary Latitude and Relational Contracting (June 2007). IZA Discussion Paper No. 2879. Available at SSRN: https://ssrn.com/abstract=999376

Steven Yu-Ping Wu (Contact Author)

Ohio State University (OSU) - Department of Agricultural, Environmental & Development Economics ( email )

2120 Fyffe Rd
Columbus, OH 43210-1067
United States
614-247-7494 (Phone)

HOME PAGE: http://www-agecon.ag.ohio-state.edu/people/display.cfm?User_ID=wu412

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Brian E. Roe

Ohio State University (OSU) - Department of Agricultural, Environmental & Development Economics ( email )

2120 Fyffe Rd
Columbus, OH 43210-1067
United States
614-688-5777 (Phone)

HOME PAGE: http://https://aede.osu.edu/our-people/brian-e-roe

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