How Effective Are Relational Incentive Contracts? Evidence from Foreign Entrepreneurs in Russia

Abstract: We present novel evidence on the use and impact of relational contracting between owners and managers of entrepreneurial firms. Our empirical observations support the intuition that relational contracts are particularly important for foreign entrepreneurs because of the heightened obstacles that these entrepreneurs face in directly observing managers’ efforts and/or in accessing the courts to enforce formal contracts. Our results are also consistent with theoretical arguments that relational contracts are most effective when owners and managers place a high value on future dealings (e.g., when expected profits and/or growth are high), and short-run gains from opportunistic action are limited (e.g., because return volatility is low). Finally, our empirical setting allows us to isolate the impact of changes to agents’ outside options on the effectiveness of relational employment contracts. The study thus adds to our understanding of foreign entrepreneurship and the salience of contracting concerns in entrepreneurs’ governance decisions, and also contributes to ongoing efforts aimed at redressing the imbalance between empirical and theoretical work in the field of relational contracting.