How does Relationship-Based Governance Accommodate New Entrants? Evidence from the Cycle Rickshaw Rental Market

Abstract

A large theoretical and empirical literature suggests that the salience of network-based ties in contract enforcement under relation-based governance systems limits market expansion. This paper illustrates the incorporation of new agents into market exchange under conditions of informal contract governance using a case study of the cycle-rickshaw rental market in a city in central India. Our analytical model formalizes features of this market through a higher penalty of default for migrants that introduces a gap between the ex ante risk for out-of-network agents and the ex post risk. The model predicts a sorting equilibrium such that migrants are more likely to participate in the rental contract. We test this prediction using primary survey data with multi-dimensional measures of migrant status and find that it is a significant predictor of rental contract participation, even controlling for credit access and other variables that moderate the rickshaw driver's ability to own a cycle-rickshaw.