Ex Post (in)efficient Negotiation and Breakdown of Trade

Abstract

One of the central assumptions of incomplete contract theories is that the contract parties will engage in ex post efficient renegotiation in the case of unforeseen shocks. However if parties to the trade are concerned about reputation or norms against price gauging, efficient renegotiation might break down. To test these ideas, we conduct a field experiment among tailoring stores in Chennai, a city in Southern India. We send trained auditors acting as customers to tailor stores and place an order to be picked up in several days. The customer then returns the next day to ask for an urgent completion of the order within one day, which gives the tailors an opportunity to renegotiate the contract. We find that overall tailors do not use the increase in their bargaining power to ask for a higher price. In 44% of the cases they fill the urgent order but do not ask for any increased pay. In the remaining 56% of the cases trade breaks down, i.e. tailors refuse to fill the order. Instead in these cases they offer customers that they can take back the material for the stitching back to find another tailor. But they never ask for additional compensation. However, when offered a higher price the majority of tailors were happy to fill the urgent order. This result suggests that without the customer offering the mark up tailors forego an efficient renegotiation option and trade breaks down. When comparing customers from out of state versus local ones we still find a strong resistance to ask for higher prices in the case of an urgent order. We can also rule out that in this market the equilibrium behavior of a buyer does not require that they voluntarily offer a premium for urgent services. We find that average customers do not offer a premium and in fact there is breakdown of trade. We conjecture that either norms or reputational concerns prevent tailors from proactively suggesting a mark up for urgent delivery. These results put into questions the notion that ex post renegotiation can easily be achieved.