Implicit Contracting Close to Anonymity
Abstract: Implicit contracts enforced by repeated interaction or reputation both require stability in the economic environment that simply is not present in a large number of transactions that exhibit limited reliance on external enforcement. Although instability of the environment forces contractual arrangements that are closer to the anonymity of market exchange, this instability leaves open an important avenue for contractual enforcement. This paper presents one class of such environments and shows how a simple mechanism can give rise to Pareto-improving implicit contracting. The key assumption is that in one-period relationships benefits and costs can arise which are extremely asymmetric; minimal cost to one party can cause large increases in the value of the transaction to the other party. We provide several motivating examples, such as new product development, the relationship between the journal editor/researcher and the expansion of trade to new, potentially unknown, partners.