Reference Points, Social Norms, and Fairness in Contract Renegotiations

Björn Bartling
University of Zurich – Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Klaus M. Schmidt
Ludwig Maximilian University of Munich – Faculty of Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

March 17, 2014

Forthcoming: Journal of the European Economic Association

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.

Reference Points, Social Norms, and Fairness in Contract Renegotiations

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