On the determinants and consequences of informal contracting

Abstract

As documented by Macauley and others, informal contracts are pervasive in modern economies. Yet, systematic empirical evidence on them is still limited. In this paper, we provide a framework to investigate the determinants and consequences of informal contracting. First, we present an illustrative model that organizes key predictions from the theoretical literature. Next, we discuss selected empirical works that shed light on the model's relevance and testability. Overall, we find combined support for most theoretical predictions from the model, and we observe that significant progress has been made over time at measuring key determinants of informal contracting such as the parties’ discount factor and fallback option. We conclude by discussing strategies for testing theoretical predictions for which conclusive evidence is still missing.

Relational Contracting in Developed Economies: Lessons From Slot Exchanges in the US Airline Industry

“…An example of this literature is presented in Gillan et al (2009), showing that S&P 500 companies that are more likely to survive in the long run due to good financial conditions tend to rely more on informal compensation agreements for their CEOs compared to companies whose time horizon is more uncertain. Another example is Gil and Marion (2013), showing that Californian contractors post more aggressive offers in highway repair bids when more future projects are announced by the local public authorities, implying that the future interactions between the focal contractor and its network of subcontractors are more likely. A more systematic review and critical discussion of these and other published studies, as well as yetunpublished papers, can be found in Zanarone (2017, 2018).…”

“…Another example is Gil and Marion (2013), showing that Californian contractors post more aggressive offers in highway repair bids when more future projects are announced by the local public authorities, implying that the future interactions between the focal contractor and its network of subcontractors are more likely. A more systematic review and critical discussion of these and other published studies, as well as yetunpublished papers, can be found in Zanarone (2017, 2018).…”

“…Common challenges in the existing studies are: the limited institutional evidence on whether relational contracts are being used and why; the indirect nature of the outcome measures used to test for the performance of relational contracts; and the difficulty of measuring key parameters in economic models of relational contracting, such as the intertemporal discount rate or the parties' fallback option following termination of an informal agreement (Gil and Zanarone, 2018).…”

“…Third and finally, because the US airline industry is heavily regulated and subject to heavy monitoring and compliance, the US Government, and in particular the US Department of Transportation, collects a lot of information that is either directly made available to the public or can be obtained upon Freedom of Information Act (FOIA) request. While the actual informal dimension of transactions may not be recorded, every other dimension is and, therefore, it becomes easier to detect agent behaviour that falls outside the boundaries of what is formally contracted upon (Gil and Zanarone, 2018).…”

Non‐performance Pay and Relational Contracting: Evidence from CEO Compensation

“…In a cross-sectional study, Gillan et al (2009) argue that roughly half of the S&P 500 CEOs work without any explicit employment contracts and that even explicit contracts often leave details about future compensation levels to the discretion of the board. Moreover, an emerging body of empirical work provides support for relational contracting but this work has focused on inter-firm (supply) relationships rather than intra-firm (employment) relationships (McMillan and Woodruff, 1999;Banerjee and Duflo, 2000;Johnson et al, 2002;Gil, 2013;Gil and Marion, 2013;Zanarone, 2013;Barron et al, 2015;Calzolari et al, 2015;Gil and Zanarone, 2015;Macchiavello and Morjaria, 2015). Our study contributes to this literature by exploring how relational contracts can affect CEO compensation, focusing on the key role played by luck's persistence and highlighting a connection between relational contracting and pay-for-luck.…”