DP7434 Relational Contracts and Competitive Screening

Author(s): Giacomo Calzolari, Giancarlo Spagnolo
Publication Date: August 2009
Keyword(s): auctions, collusion, contract duration, efficiency wages, implicit and incomplete contracts, Limited enforcement, Loyalty, Multi-tasking, Negotiation, Non-contractible quality, Performance bonus, Procurement, Relational contracts, Reputation, Screening
JEL(s): C73, D86, L14
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=7434

We study the tension between competitive screening and contract enforcement where a principal trades repeatedly with one among several agents, moral hazard and adverse selection coexist, and non-contractible dimensions are governed by relational contracting. We simultaneously characterize optimal relational contracts and competitive screening policies which are interdependent. When non-contractible dimensions are important, the principal optimally restricts competitive screening to a subset of 'loyal' agents, giving up performance bonuses and, when such dimensions are crucial, negotiates an indefinitely renewable contract with one agent. To enhance enforcement, explicit contract duration is also reduced. However, these policies facilitate collusion among agents, which induces an additional trade-off between reputational forces and collusion. When non-contractible dimensions are very important this last trade-off may disappear, as collusion allows more efficient enforcement of better performance.