Relational Contracts and Product Quality: The Effect of Bargaining Power on Efficiency and Distribution

This paper studies how changes in bargaining power alter the surplus distribution and sustainability of incomplete agricultural contracts. When an enforceable payment exists, self enforcement is always sustainable, the highest quality is traded, and any surplus distribution is possible. However, there is a limit to how much bargaining power can be exercised when contracts are fully incomplete, as a seller cannot extract too much of the surplus without breaking down the trading relationship. The results provide insight into the limits of policies that attempt to redistribute bargaining power in markets having informal institutions or in which parties rely on implicit contracts.