Relational Contracts in the Market: the Lure of Relationships

Abstract: In many labor situations third parties cannot verify whether workers and firms adhered to their pre-trade promises. In such situations, long-term self-enforcing contracts may emerge endogenously to allow for an efficiency-improving solution to the agency problem. We implement such a situation in the lab by allowing workers and firms to interact repeatedly in a market without third-party enforcement. In this setting, persistently different human resource policies emerge endogenously: we find (long-term) relationships characterized by generous surplus sharing and spot-interactions with little to no rent for the workers. Efficiency, i.e. exerted effort, is comparable across the different policies. Hence, spot-interactions are at least as profitable for firms engaging in such practices. Analyzing individual level data, we document that firm and worker behavior is individually rational and that both firms and workers are “lured” by the possibility of entering a relationship and that individual histories play a significant role in explaining the observed behavior. In control treatments, we show that neither limited firm commitment nor structural unemployment alone are sufficient to generate the above described patterns.