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Let'S Talk: How Communication Affects Contract Design

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  • Jordi Brandts
  • Matthew Ellman
  • Gary Charness

Abstract

We study experimentally how the ability to communicate affects the frequency and effectiveness of flexible and inflexible contracts in a bilateral trade context where sellers can adjust trade quality after observing a post-contractual cost shock and a discretionary buyer transfer. In the absence of communication, we find that rigid contracts are more frequent and lead to higher earnings for both buyer and seller. By contrast, in the presence of communication, flexible contracts are much more frequent and considerably more productive, both for buyers and sellers. Also, both buyer and seller earn considerably more from flexible with communication than rigid without communication. Our results show quite strongly that communication, a normal feature in contracting, can remove the potential cost of flexibility (disagreements caused by conflicting perceptions). We offer an explanation based on social norms.
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Suggested Citation

  • Jordi Brandts & Matthew Ellman & Gary Charness, 2016. "Let'S Talk: How Communication Affects Contract Design," Journal of the European Economic Association, European Economic Association, vol. 14(4), pages 943-974, August.
    • Handle: RePEc:bla:jeurec:v:14:y:2016:i:4:p:943-974
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    File URL: http://hdl.handle.net/10.1111/jeea.2016.14.issue-4
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    References listed on IDEAS

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    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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