Building an Equilibrium: Rules Versus Principles in Relational Contracts

Abstract

Effective organizations are able to adapt members’ strategies to unforeseen change in an efficient manner. We study when relational contracts enable organizations to achieve this. Specifically, in a novel experiment we explored the hypothesis that basing a relational contract on general principles rather than on specific rules is more successful in achieving efficient adaptation. In our Baseline condition, we indeed observe that, compared to pairs who relied on specific rules, those who articulated general principles achieved significantly higher performance after change occurred. Underlying this correlation, we also find that pairs with principle-based agreements were more likely both to expect and to take actions that were consistent with what their relational contract prescribed. To investigate whether there is a causal link between principle-based agreements and performance, we implemented a “Nudge” intervention intended to foster principle-based relational contracts. The Nudge succeeded in causing more pairs to articulate principles, but the intervention failed to increase performance after the shock because many of the pairs induced to articulate principles then did not take actions that were consistent with their relational contracts. In short, our results suggest that (1) principle-based relational contracts may improve organizational performance, but also that (2) high-performing relational contracts may be difficult to build.