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The Threat of Exclusion and Implicit Contracting

Martin Brown () and Marta Serra-Garcia
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Martin Brown: Swiss Institute of Banking and Finance, University of St. Gallen, CH-9000 St. Gallen, Switzerland

Management Science, 2017, vol. 63, issue 12, 4081-4100

Abstract: Implicit contracts can mitigate moral hazard in labor, credit, and product markets. The enforcement mechanism underlying an implicit contract is the threat of exclusion: the agent fears that he will lose future income if the principal breaks off the relationship. This threat may be very weak in environments where an agent can appropriate income-generating resources provided by the principal. For example, in credit markets with weak creditor protection, borrowers may be able to appropriate borrowed funds and generate investment income without requiring further loans. We examine implicit contracting in a lending experiment where the threat of exclusion is exogenously varied. We find that weak exclusion undermines implicit contracting: it leads to a more frequent breakdown of credit relationships as well as to smaller loans. Data, as supplemental material, are available at https://doi.org/10.1287/mnsc.2016.2572 . This paper was accepted by John List, behavioral economics .

Keywords: economics; microeconomic behavior; behavior and behavioral decision making; finance; corporate finance; implicit contract (search for similar items in EconPapers)
Date: 2017
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Working Paper: The Threat of Exclusion and Implicit Contracting (2016) Downloads
Working Paper: The Threat of Exclusion and Implicit Contracting (2016) Downloads
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