Contract Enforcement, Social Efficiency, and Distribution: Some Experimental Evidence

We use economic experiments to investigate how different contract enforcement regimes affect efficiency and the distribution of surplus in vertically coordinated markets where contractors have market power. We find that if a third party (e.g. government) provides full enforcement of contracts, social efficiency is enhanced. Surprisingly, we find when enforcement is completely absent, social efficiency will not necessarily decrease because trading partners find ways to self enforce contracts. However, opportunistic behavior by some traders widens the distribution of surplus generated and leaves some sellers (growers) with ex-post profits below reservation levels. Finally, partial or one-sided enforcement causes significant efficiency losses by constraining the ability of the regulated party to self enforce contracts.