The limits of communication - Incomplete Contracting under Uncertainty
Recent findings in behavioral economics document that communication improves efficiency when strategic interaction is plagued by contractual incompleteness. However, little is known about the effect of communication when there is also uncertainty in the economic environment. We investigate the effect of communication under economic uncertainty by studying a stochastic trust game framed in a credit context. In this game the investment income of borrowers (second-mover) and thus their ability to repay the lenders (first-mover) is random. We implement a treatment in which the borrower can send text messages to the lender and compare it to a treatment without communication. We benchmark our findings against the effect of communication in a similar trust game with deterministic borrower investment income. In the deterministic setting we find that communication has a significant positive effect on credit volumes and repayment rates, thus increasing the average payoffs for both lenders and borrowers. By contrast, in the stochastic trust game communication does not improve repayment rates or payoffs. When the borrowers income and ability to repay is stochastic, they are more likely to renege on promises to repay than when their income is deterministic.