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On Reputation: A Microfoundation of Contract Enforcement and Price Rigidity


Fehr, Ernst; Brown, Martin; Zehnder, Christian (2008). On Reputation: A Microfoundation of Contract Enforcement and Price Rigidity. Working paper series / Institute for Empirical Research in Economics No. 384, University of Zurich.

Abstract

We study the impact of reputational incentives in markets characterized by moral hazard problems. Social preferences have been shown to enhance contract enforcement in these markets, while at the same time generating considerable wage and price rigidity. Reputation powerfully amplifies the positive effects of social preferences on contract enforcement by increasing contract efficiency substantially. This effect is, however, associated with a considerable bilateralisation of market interactions, suggesting that it may aggravate price rigidities. Surprisingly, reputation in fact weakens the wage and price rigidities arising from social preferences. Thus, in markets characterized by moral hazard, reputational incentives unambiguously increase mutually beneficial exchanges, reduce rents, and render markets more responsive to supply and demand shocks.

Abstract

We study the impact of reputational incentives in markets characterized by moral hazard problems. Social preferences have been shown to enhance contract enforcement in these markets, while at the same time generating considerable wage and price rigidity. Reputation powerfully amplifies the positive effects of social preferences on contract enforcement by increasing contract efficiency substantially. This effect is, however, associated with a considerable bilateralisation of market interactions, suggesting that it may aggravate price rigidities. Surprisingly, reputation in fact weakens the wage and price rigidities arising from social preferences. Thus, in markets characterized by moral hazard, reputational incentives unambiguously increase mutually beneficial exchanges, reduce rents, and render markets more responsive to supply and demand shocks.

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Additional indexing

Item Type:Working Paper
Communities & Collections:03 Faculty of Economics > Department of Economics
Working Paper Series > Institute for Empirical Research in Economics (former)
Dewey Decimal Classification:330 Economics
Language:English
Date:August 2008
Deposited On:29 Nov 2011 22:47
Last Modified:07 Dec 2017 10:16
Series Name:Working paper series / Institute for Empirical Research in Economics
ISSN:1424-0459
Official URL:http://www.econ.uzh.ch/wp.html

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