Let's Talk: How Communication Affects Contract Design

Recognition Program

Authors: Jordi Brandts, Gary Charness and Matthew Ellman

Journal of the European Economic Association, Vol. 14, No 4, 943-974, August, 2016

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.

This paper originally appeared as Barcelona GSE Working Paper 648
This paper is acknowledged by the Barcelona GSE Research Recognition Program