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Discretionary Latitude and Relational Contracting

Steven Wu () and Brian Roe

No 2879, IZA Discussion Papers from Institute of Labor Economics (IZA)

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: cooperation; experimental economics; implicit incentives; relational contracts; incomplete contracts (search for similar items in EconPapers)
JEL-codes: C91 D23 D84 D86 J33 K12 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2007-06
New Economics Papers: this item is included in nep-exp
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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