Restoring Interfirm Relationships Following Contract Violations: a Tce Perspective

Medha Raj (University of Southern California)
Kyle J. Mayer (University of Southern California)
Beverly Rich (University of Southern California)

Abstract : We augment work on Transaction Cost Economics (TCE) and contract violations with insights from psychological work on conflict management to examine the causes and consequences of contract violations in repeat exchange relationships. We argue that contract violations occur not only because of bounded rationality or self-interest seeking behavior with guile (opportunism), but also from simple self-interest seeking behavior without guile, and that this distinction is important in understanding how future contracts are written in response to violations. Furthermore, we propose that following contract violations, effective governance in repeat exchange relationships depends on the non-violating party’s beliefs about 1) whether expectations were aligned between the exchange partners and 2) the violating party’s intent. We develop propositions on the underlying causes of different types of violations, concerns raised by each violation, as well as the mechanisms by which exchange partners can improve the design of subsequent contracts to reduce the likelihood of future conflict(s). In doing so, we add to the extant literature on the micro-foundations of strategy by providing a comprehensive picture of the different types of contract violations as well as the future governance changes required to maintain exchange relationships.

Platform-mediated Reputation Systems in the P2p Economy and Incentives to Provide Service Quality

Maria Alessandra Rossi (University of Siena)
Marcello Basili (University of Siena)

Abstract : In the P2P economy (or ‘sharing economy’, or ‘collaborative economy’), platforms generally use reputation systems to actively perform a ‘regulatory’ role, in particular by exercising the power to exclude from access to the platform users whose online rating/reputation falls below a given threshold. The paper aims to analyse through a theoretical model the effect of the design of this specific type of online rating system on users/providers’ incentives to ensure a high level of service quality. We propose that users/providers’ incentives to provide service quality can be analysed as an optimal choice problem with a two arguments utility function, where reputation can be considered as an independent variable in the list of arguments of users/providers’ utility function. We find that current P2P reputation mechanisms are not incentive compatible because of the joint existence of two features: (1) they involve price/earnings insensitive to performance; and (2) reputation is not portable across platforms, so that users/providers can switch continuously among different platforms. In presence of these two conditions, the structure of users/providers’ inter-temporal preferences may create incentives to deplete their reputation according to their rate of substitution between income and reputation, as long as they can relatively easily switch to a different platform. Indeed, users/providers may choose a dissipative (so-called ‘bang-bang’) strategy involving the depletion of reputation and the jump to a different platform. This suggests that the design of P2P reputation systems may be improved either by making earnings dependent on performance or, alternatively, by making reputation portable across platforms.

The Extrinsic Motivation of Freedom at Work

Teck Yong Tan (Columbia University)

Abstract : Why does a worker become more efficient when given freedom at work? Under incomplete contracts, a worker faces a ratchet effect of innovating when he is closely monitored: if the worker uncovers a more efficient production method, the firm, being aware of it, raises the future performance requirement; anticipating this, the worker never tries to innovate. When given freedom at work instead, the worker accrues private information about his innovation. The resulting information asymmetry generates information rent which feeds back as the worker’s incentive to innovate and improve efficiency. This paper studies how a firm’s strategic ignorance influences its incentive structure which has to simultaneously induce effort from the worker and endogenously generate asymmetric information against the firm. The resulting mechanism provides a novel rationale to why relationships are sometimes characterized by weak incentives and low-scale production at the early stages.

On the Performance of Piece-rate Incentive Schemes: Some Explicit Solutions Beyond the Uniform Distribution

Masahiro Watabe (Rissho University)

Abstract :  This paper examines the performance of piece-rate incentive scheme relative to the fully optimal contract in a principal-agent problem under moral hazard and adverse selection. A firm compensates heterogeneous workers based on uncertain outcomes of the worker's skill (private information) and effort.  Firstly, the paper considers the question of the shape of the fully optimal compensation scheme when workers are heterogeneous in terms of skills. I provide a version of the taxation principle that converts the full optimal contract as a direct revelation mechanism into a nonlinear wage schedule as an indirect mechanism. The theorem also establishes a necessary and sufficient condition for the optimality of piece-wise linear compensation scheme, and it is shown that any incentive scheme involving a linear part never optimal.  Secondly, I argue the performance of the optimal piece-rate incentive scheme. I employ the incremental gain relative to the optimal fixed wage. I provide two primary observations. Firstly, a possibility of bunching influences the performance of piece-rate incentive scheme drastically. The optimal piece-rate incentive scheme can secure "more than" three-fourths (75 percent) of the maximized expected profit under the fully optimal contract if there is no bunching in the fully optimal contract. On the other hand, if there is a bunching and private information is distributed uniformly, the piece-rate incentive scheme can secure "at most" 75 percent of the profit secured by the fully optimal contract. Under a non-uniform distribution, the performance of the optimal piece-rate incentive scheme can secure substantially "more than" 75 percent of the expected profit secured by the fully optimal contract. The sufficient condition for that is fully characterized by the first-order stochastic dominance shift parameter.