Institutions and Contract Enforcement

Armin Falk, David Huffman, W. Bentley MacLeod

NBER Working Paper No. 13961
Issued in April 2008
NBER Program(s):Law and Economics, Labor Studies

We provide evidence on how two important types of institutions -- dismissal barriers, and bonus pay -- affect contract enforcement behavior in a market with incomplete contracts and repeated interactions. Dismissal barriers are shown to have a strong negative impact on worker performance, and market efficiency, by interfering with firms' use of firing threat as an incentive device. Dismissal barriers also distort the dynamics of worker effort levels over time, cause firms to rely more on the spot market for labor, and create a distribution of relationship lengths in the market that is more extreme, with more very short and more very long relationships. The introduction of a bonus pay option dramatically changes the market outcome. Firms are observed to substitute bonus pay for threat of firing as an incentive device, almost entirely offsetting the negative incentive and efficiency effects of dismissal barriers. Nevertheless, contract enforcement behavior remains fundamentally changed, because the option to pay bonuses causes firms to rely less on long-term relationships. Our results show that market outcomes are the result of a complex interplay between contract enforcement policies and the institutions in which they are embedded.

download in pdf format
   (458 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w13961

Published: Armin Falk & David Huffman & W. Bentley Macleod, 2015. "Institutions and Contract Enforcement," Journal of Labor Economics, University of Chicago Press, vol. 33(3), pages 571 - 590. citation courtesy of

Users who downloaded this paper also downloaded* these:
Anderson and Young w8847 Imperfect Contract Enforcement
Mohnen, Mairesse, and Dagenais w12280 Innovativity: A Comparison Across Seven European Countries
Spiller w14152 An Institutional Theory of Public Contracts: Regulatory Implications
Anderson w14045 Does Trade Foster Contract Enforcement?
Lemieux, MacLeod, and Parent w13128 Performance Pay and Wage Inequality
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us