Merage Research Colloquia - Information Design and Relational Contracting

Area: Accounting

Host: Assistant Professor Chenqi Zhu

Speaker: Jonathan Glover, James L. Dohr Professor of Accounting

University: Columbia University, Columbia Business School

Hold-up problems in buyer-supplier relationships can inhibit relation-specific investments, including supplier innovations aimed at cost reductions or quality improvements. One solution to such hold-up problems is to install an information system as a substitute for commitment, limiting the buyer's ability to extract rents from the supplier. Another solution is trust, i.e., a self-enforcing promise to let the supplier keep some of the rents created by innovation. The promise is made self-enforcing via a relational contract enforced by repeated play. On the surface, these two solutions appear to be substitutes for each other. We study a model in which both tools are available and find instead that trust and information system design are complements (holding innovation constant). The intuition is that the information system design solution is itself constrained by trust. Creating trust via a relational contract enables the buyer to use the information system more aggressively.