Modeling the Antecedents of Preferences for Incomplete Contracts in Bilateral Trade: An Experimental Investigation

Abstract

Contracts constitute an important control mechanism. Their design is influenced by the preferences of the contracting parties in addition to firm-level economic transaction costs. This study conducts an experiment to explore the antecedents of preferences or a more incomplete or complete in a trade setting. Results from an experiment indicate that the preference for a complete versus an incomplete contract depends on the perceived riskiness of the incomplete contract, which is influenced by the perceived bargaining power and fairness preferences (namely, distributive and procedural fairness) of the contracting parties. A supplemental analysis of expected trade outcomes confirms that individuals do not choose between incomplete and complete contracts randomly. In other words, we find evidence that suggest that choosing the completeness of a contract is a form of risk-taking and the preference for a more incomplete contract is positively influenced by the perceived power and distributive fairness preference of the contracting parties and negatively influenced by the procedural fairness preferences. Finally, consistent with prior research, we find evidence of self-interested views of fairness and that fairness preferences do not affect expected trade outcomes.