Reference Points, Social Norms, and Fairness in Contract Renegotiations

Abstract

How does an ex-ante contract affect behavior in an ex-post renegotiation game? We address this question in a canonical buyer-seller relationship with renegotiation. Our paper provides causal experimental evidence that an initial contract has a highly significant and economically important impact on renegotiation behavior that goes beyond the effect of contracts on bargaining threat points. We compare situations in which an initial contract is renegotiated to strategically equivalent bargaining situations in which no ex-ante contract was written. The ex-ante contract causes sellers to ask for markups that are 45% lower than in strategically equivalent bargaining situations without an initial contract. Moreover, buyers are more likely to reject given markups in renegotiations than in negotiations. These effects do not depend on whether the contract was written under competitive or monopolistic conditions. Our results provide strong evidence supporting the hypothesis that contracts serve as reference points that shape and coordinate the expectations of the contracting parties. Abstract: How does an ex ante contract affect behavior in an ex post renegotiation game? We address this question in a canonical buyer-seller relationship with renegotiation. Our paper provides causal experimental evidence that an initial contract has a highly significant and economically important impact on renegotiation behavior that goes beyond the effect of contracts on bargaining threat points. We compare situations in which an initial contract is renegotiated to strategically equivalent bargaining situations in which no ex ante contract was written. The ex ante contract causes sellers to ask for markups that are 45% lower than in strategically equivalent bargaining situations without an initial contract. Moreover, buyers are more likely to reject given markups in renegotiations than in negotiations. These effects do not depend on whether the contract was written under competitive or monopolistic conditions. Our results provide strong evidence supporting the hypothesis that contracts serve as reference points that shape and coordinate the expectations of the contracting parties.

How Do Informal Agreements and Revision Shape Contractual Reference Points?

“…Brandts et al (2013) explore the role of contractual reference points in a setup without ex-ante competition and show that informal agreements may have a larger impact in purely bilateral environments. Hoppe and Schmitz (2011), Bartling and Schmidt (2014), and Iyer and Schoar (2012) report evidence consistent with our finding that opportunistic renegotiations are perceived as unfair and trigger lots of shading. We discuss these papers in much more detail after the presentation of our results (see Section 5).…”

Market Interaction and Pro‐Social Behavior: An Experimental Study

“… Bartling and Schmidt () similarly study bargaining with and without an ex ante contract, but where strategy spaces are equivalent entering the bargaining phase. They find that ex ante contracts act as a strong reference points in bargaining outcomes.…”

Let the Market Decide: An Experimental Study of Competition and Fairness

“…Our paper is also related to experimental studies by Fehr et al (2009Fehr et al ( , 2011, who confirm Hart & Moore's (2008) hypothesis that a competitively negotiated ex-ante contract provides a reference point for ex-post trade (see also Bartling & Schmidt, 2014). Fehr et al take a competitive environment as given and focus on the impact of the buyer's choice between a rigid and a flexible contract on sellers' ex-post counterproductive behavior.…”