Networked markets and relational contracts

Matt Elliott, Benjamin Golub, Matt V. Leduc*

*Corresponding author for this work

Research output: Chapter in Book/Report/Conference proceedingConference contribution

Abstract

Empirical studies of commercial relationships between firms reveal that (i) suppliers encounter situations in which they can gain in the short run by acting opportunistically—for example, delivering a lower quality than promised after being paid; and (ii) good conduct is sustained not exclusively by formal contracts but through informal relationships and the expectation of future business. In such relationships, the need to offer each supplier a large enough share of future business to deter cheating limits the number of supply relationships each buyer can sustain. The market thus becomes networked, with trade restricted to durable relationships. We propose and analyze a simple dynamic model to examine the structure of such overlapping relational contracts in equilibrium. Due to exogenous stochastic shocks, suppliers are not always able to make good on their promises even if they wish to, and so links are constantly dissolving and new ones are forming to take their place. This induces a Markov process on networks. We study how the stationary distribution over networks depends on the parameters—most importantly, the value of trade and the probability of shocks. When the rate at which shocks hit increases, as might happen during an economic downturn, maintaining incentive compatibility with suppliers requires promising each more future business and this necessitates maintaining fewer relationships with suppliers. This results in a destruction of social capital, and even if the rate of shocks later returns to its former level, it can take considerable time for social capital to be rebuilt because of search frictions. This creates a novel way for shocks to be persistent. It also suggests new connections between the theory of relational contracting, on the one hand, and the macroeconomic analysis of recessions, on the other.

Original languageEnglish (US)
Title of host publicationWeb and Internet Economics - 13th International Conference, WINE 2017, Proceedings
EditorsNikhil R. Devanur, Pinyan Lu
PublisherSpringer Verlag
Pages402
Number of pages1
ISBN (Print)9783319719238
StatePublished - 2017
Externally publishedYes
Event13th International Conference on Web and Internet Economics, WINE 2017 - Bangalore, India
Duration: Dec 17 2017Dec 20 2017

Publication series

NameLecture Notes in Computer Science (including subseries Lecture Notes in Artificial Intelligence and Lecture Notes in Bioinformatics)
Volume10660 LNCS
ISSN (Print)0302-9743
ISSN (Electronic)1611-3349

Other

Other13th International Conference on Web and Internet Economics, WINE 2017
CountryIndia
CityBangalore
Period12/17/1712/20/17

ASJC Scopus subject areas

  • Theoretical Computer Science
  • Computer Science(all)

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