Institutions and Contract Enforcement

We provide evidence on how two important types of institutions dismissal barriers, and bonus pay a ect contract enforcement behavior in a market with incomplete contracts and repeated interactions. Dismissal barriers are shown to have a strong negative e ect on worker performance, by interfering with rms' use of ring threat as an incentive device. Dismissal barriers also distort the dynamics of worker e ort levels: e ort levels are high initially and then drop sharply, if the rm activates dismissal barriers by choosing to extend the relationship beyond the institutionalized probation period. Firms shy away from long-term relationships, and rely more on the spot market for labor. The average rate of turnover is una ected, but the distribution of relationship lengths becomes more bi-model. The impact of dismissal barriers changes dramatically when the option for rms to pay bonuses is introduced. Firms are observed to substitute bonus pay for threat of ring as an incentive device, almost entirely o setting the negative incentive e ects of dismissal barriers, and eliminating probation period e ects. Contract enforcement behavior remains fundamentally changed, however, because the option to pay bonuses causes rms to rely less on relational incentives.