Contracts, Conflicts and Communication
The existing literature emphasizes that free-form communication among trading partners increases efficiency by facilitating cooperation and coordination and/or by reducing conflicts. In this paper we study a contracting situation in which competition tends to create considerable payoff inequality in favor of the buyer. Inequality poses a threat to efficiency, because sellers who end up with a small share of the surplus tend to engage in inefficient, counterproductive behavior. In the absence of communication buyers succeed in reducing conflicts by proposing rigid contracts in which the price is fixed ex ante and cannot be adapted ex post. The downside of contractual rigidity is that efficient trade is prevented in some states of the world. Our experiment tests whether the availability of free-form communication allows the parties to find a superior solution in which contractual flexibility prevails and buyers use communication to forestall conflicts. We find that this is not the case. The communication technology is predominantly used for influence activities through which sellers try to obtain a larger share of the surplus. These influence activities further increase the potential for conflicts, because sellers who fail to influence buyers respond more harshly to low prices. As a consequence, buyers minimize conflicts and maximize profits if they choose rigid contracts and refuse to communicate. Finally, additional experimental treatments show that an increase in information asymmetries further reduces the use of communication and increases the relative profitability of rigid contracts.