How does a change in outside options affect relational contracting outcomes? Experimental evidence and implications for agricultural contracting

Abstract

AbstractWe use experiments, guided by theory, to examine how an exogenous decrease in the value of an agent's outside option (e.g., a proxy for a reduction in alternative contracting opportunities) affects relational contracting across two institutional environments. In the pure relational contracting environment, principals respond to a reduction in agents' outside option by restructuring contracts to offer fewer payment guarantees. This exposes agents to more counter‐party risk and their actual profits fell well short of promised profits. This is mitigated when contracting institutions permit formal contracts to coexist with relational contracts. Extensive margin and intensive margin efficiency are mostly unaffected.