CREED Seminars Amsterdam

Speaker(s)
Gary Charness (UC Santa Barbara, United States)
Date
Thursday, 20 June 2013
Location
Amsterdam

We study experimentally how communication changes the relative frequency and effectiveness of contracts types where sellers choose unenforceable trade quality after observing a post-contractual cost shock. Without communication, we find that rigid contracts (where the price cannot be changed) are slightly more frequent and lead to higher earnings for both buyer and seller. By contrast, with free-form communication, flexible contracts (where the buyer can voluntarily increase the price paid) are much more frequent and yield higher earnings, both for buyers and sellers. Also, both buyer and seller earn considerably more from flexible contracts with communication than from rigid ones without communication. A treatment with a form of restricted communication finds little effectiveness, although earnings for sellers with flexible contracts are slightly higher. Our results show quite strongly that free-form communication, a normal feature in contracting, can remove the potential cost of flexibility (disagreements caused by conflicting perceptions). Analysis of the free-form communication content shows that the underlying factors that facilitate this effect are clarification of the amount to be added to the price after a cost shock and establishing a good personal rapport through communication. (joint work with Jordi Brandts, and Matthew Ellman)