How communication affects contract design: An experimental study of formal and informal contracting Jordi Brandts, Gary Charness, and Matthew Ellman April 13, 2012 Abstract: We study experimentally how the ability to communicate affects the frequency of using flexible and rigid contracts in a bilateral trade context where sellers can adjust trade quality after observing a post-contractual cost shock and a discretionary buyer transfer. In the absence of communication, we find that rigid contracts are more frequent and lead to higher quality levels. By contrast, in the presence of communication, flexible contracts are more frequent and productive. The first result generalizes previous theory and evidence to noncompetitive environments. The second result shows that communication can remove the cost of flexibility. We offer a theoretical explanation based on social norms. * Brandts: Universitat Autònoma de Barcelona, Institut d’Anàlisi Econòmica (CSIC) and Barcelona GSE. Charness: University of California, Santa Barbara. Ellman: Institut d’Anàlisi Econòmica (CSIC) and Barcelona GSE. The authors thank Christina Rott for excellent research assistance and Hector Solaz for running the experiments for us at the LINEEX lab of the University of Valencia. The authors benefited from comments received at the following conference and seminar presentations: IMEBE in Barcelona, ESA in Chicago, CESIfo in Munich, ASSA in Chicago, USC Law School and University of Amsterdam. Brandts acknowledges financial support from the Antoni Serra Ramoneda (UAB – Catalunya Caixa) Research Chair, the Spanish Ministry of Economics and Competitiveness (Grant: ECO2011-29847-C02-01) and the Generalitat de Catalunya (Grant: 2009 SGR 820) and Ellman gratefully acknowledges financial support from the Spanish Ministry of Science and Innovation, Grant number ECO2011- 25293 and the Generalitat de Catalunya (Grant: 2009 SGR 820).