Clarity in Relational Contracts: Rules Vs. Principles

Abstract: Recent work in organizational economics stresses the importance of clarity in relational contracts as a reason behind the persistent performance differences that we observe between seemingly similar enterprises. Even though the conditions necessary to establish cooperation through relational contracts are straightforward in theory, in practice establishing a relational contract poses a number of difficult challenges. Specifically, trading parties face the clarity problem: they need to establish mutual understanding about the content of the relational contract and they need to succeed in adapting this mutual understanding to new situations when the environment changes. We hypothesize that building the relational contract on general principles, rather than relying on specific but narrow rules, helps achieve clarity and improves performance in repeated games with uncertainty about the future, and report results from an experiment assessing this hypothesis.