Let’s Talk: How Communication Affects Contract Design

We study experimentally how communication changes the effectiveness of contract types when sellers choose unenforceable quality after a possible cost shock. Communication potentially removes conflicting perceptions that may otherwise plague flexible contracts. Indeed, we find that introducing free-form communication sharply reverses an advantage of rigid contracts in favor of flexible contracts, which then deliver much higher earnings. Control treatments that avoid selection effects reveal a strong parallel shift from rigid to flexible. Chat content analysis identifies clarification of post-shock transfers, promises, and personal rapport as key correlates of high earnings, with clarification working only in conjunction with flexible contracts. A communication channel restricted to clarifying transfer plans also favors use of flexible contracts, but mildly compared to chat.Brandts acknowledges financial support from the Antoni Serra Ramoneda (UAB, Catalunya Caixa) Research Chair, the Spanish Ministry of Economics and Competitiveness (Grant: ECO2011-29847-C02- 01) and the Generalitat de Catalunya (Grant: 2014 SGR 510) and Ellman acknowledges the Spanish Ministry of Economics and Competitiveness (Grant: ECO2014-59959) and the Generalitat de Catalunya (Grant: 2014 SGR 510).Peer reviewe