Review of Finance Vol. 28 No. 5 2024
Contracting when enforcement is weak: evidence from an audit study
Abstract
How are contracts structured in the presence of relationship-specific investments when legal enforcement is weak? Using a new audit methodology, we show that simple financial contracts in combination with social norms and reputation concerns can sustain relationship-specific transactions. Wholesalers in the market for pens in India use upfront payments rather than increased risk premiums to mitigate risks arising from relationship-specific investments. Upfront payments for printed pens cover only 40 percent of the production costs, highlighting the importance of upfront payments as a screening device. Ex-post, renegotiation is more likely for printed pens, but in a substantial fraction of cases, renegotiation fails.
- DOI
- 10.1093/rof/rfae019
- Volume
- 28
- Issue
- 5
- Pages
- 1513-1536
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref