Relational Contracts in Well-Functioning Markets : Evidence from China's Vegetable Wholesale

Relational contracting (RC) is an important yet little understood governance of transactions that provides more stability than the spot market and more flexibility than vertical integration. Employing transaction data on a large vegetable wholesale market in China, we study RC alongside a well-functioning spot market. Motivated by the stylized facts found in repeated transactions — higher supply assurance for buyers, a conceptual model is set up to depict the dynamic incentive compatibility constraints of buyers and sellers who potentially form relationships. The model suggests that a price premium is paid by relational buyers in exchange for secured supply and hypothesizes how RC traders adjust the RC price as well as RC premium to sustain the relationship under supply shocks on the spot market. The empirical analysis provides supporting evidence for the hypotheses under various definitions of RC and shocks. Further, we show theoretically and empirically that RC is more likely to be formed in markets with more buyers relative to sellers or thicker markets, which the model also suggests. Taken together, we contribute novel evidence for the strategic complementarity between RC and spot markets