Can Relational Contracts Survive Stochastic Interruptions? Experimental Evidence

This paper tests the robustness of the "two-tiered market" in which efficient bilateral contracts emerge between firms and workers (Brown, Falk and Fehr, 2004). Our experiment introduces stochastic interruptions in firms' ability to offer contracts. Involuntarily laid off workers are eager to be reemployed; they are not selective about job offers and do not shirk. Firms' preference for these "temp workers" induces all workers to compete harder to enter relational contracts. Wages in low-tier markets rise dramatically, suggesting the stigma of unemployment is removed. The results show that interruptions may shorten relational contracts without harming market efficiency.