Contracts between private parties are ubiquitous. The relationships between buyers and sellers, employers and employees, lenders and debtors are all shaped by the contracts they write. Rather than existing in isolation, however, private contracts often have real and profound effects on third parties (i.e., generate externalities or spillovers). This raises important public policy questions about the appropriate role for the regulation of private contracts. While the theoretical economics literature on contracting with externalities is well-developed, there is little empirical work on the topic. This project will examine the private design of contracts and their social welfare effects in a laboratory setting with human subjects paid according to their performance.
The first project considers a class of inter- firm strategic environments. Business contracts often include clauses that restrain the ability of parties to deal with others in the future. Examples include exclusive dealing contracts, damages provisions, minimum commitments, and non-tocompete clauses. While these contractual arrangements serve the important role of protecting relationship-specific investment and mitigating exposure to risk, they may also adversely affect competition. The second project addresses intra-firm team production environments where the private contracts affect the magnitude and distribution of profits, and might affect social welfare. This research will make several important contributions to the literature. First, the findings will shed light on equilibrium selection in strategic settings where the theoretical implications are ambiguous. Second, the work will provide empirical evidence of the effects of behavioral factors, such as social preferences, moral considerations, social proximity, loss aversion and framing. Finally, the non-invasive software developed for these studies will contribute to the understanding of decision-making processes in complex strategic environments.
The current methodological approach underscores the importance of combining experimental and behavioral observation with theoretical modeling. This work will enhance understanding of the social welfare effects of private contractual arrangements, and thus help inform policy makers.
