How Effective are Relational Incentive Contracts? Evidence from Entrepreneurial Firms in Russia

Abstract

We present novel evidence on the use and impact of relational contracting between owners and managers of entrepreneurial firms. Our empirical observations support the intuition that relational contracts are particularly important for foreign entrepreneurs because of the obstacles that they face in observing managers’ efforts and enforcing formal contracts. Our results are also consistent with theoretical arguments that relational contracts are most effective when owners and managers place a high value on future dealings (expected profits and growth are high), and short-run gains from opportunistic action are limited (return volatility is low). Finally, our empirical setting allows us to isolate the impact of changes to agents’ outside options on the effectiveness of relational contracts. The study adds to our understanding of foreign entrepreneurship and the salience of contracting concerns in entrepreneurs’ governance decisions, and contributes to ongoing efforts at redressing the imbalance between empirical and theoretical work on relational contracting.