Contracting when enforcement is weak: evidence from an audit study

Rajkamal Iyer and Antoinette Schoar

Review of Finance, 2024, vol. 28, issue 5, 1513-1536

Abstract: How are contracts structured in the presence of relationship-specific investments when legal enforcement is weak? Using a new audit methodology, we show that simple financial contracts in combination with social norms and reputation concerns can sustain relationship-specific transactions. Wholesalers in the market for pens in India use upfront payments rather than increased risk premiums to mitigate risks arising from relationship-specific investments. Upfront payments for printed pens cover only 40 percent of the production costs, highlighting the importance of upfront payments as a screening device. Ex-post, renegotiation is more likely for printed pens, but in a substantial fraction of cases, renegotiation fails.

Keywords: Incomplete Contracting; Contract Enforcement; Audit Study (search for similar items in EconPapers)
JEL-codes: D61 D86 (search for similar items in EconPapers)
Date: 2024
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