"Long-Term Contracts and Repeated Interaction: Evidence from the Costa Rican Coffee Market"
We use contract - level data from the Costa Rican coffee industry to explore the relationship between formal and relational contracts — in particular, the relationship between long term contracting and repeated interaction. Long-term contracts may be useful in this industry for many reasons, including price hedging, assurance of supply, and — especially in the case of differentiated beans (those with a designation regarding sustainability or place of origin) — to protect against hold-up when an exporter makes specific investments in developing and marketing a blend of differentiated beans provided by a limited number of mills. However, long-term contracts in this setting may be costly and difficult to enforce.
As a result, long-term contracts may be more effective and more attractive on balance (given that they do come with costs of inflexibility) when employed between frequently contracting parties who can use the power of relational contracting to improve the enforceability of the long-term formal contract. The empirical analysis demonstrates that in fact more frequently contracting firms are more likely — other things equal — to employ long-term contracts than are infrequently contracting firms; this is especially so for differentiated beans. The result persists when we address identification problems such as unobservable heterogeneity and endogenous matching through fixed effects and instrumenting strategies. We interpret this as evidence that relational contracting acts as a complement to formal contracting by improving the enforceability of formal contracts.