The value of relational contracts : evidence from a supply shock to Kenyan flower exporters

Contract enforcement between firms is an essential ingredient of economic development. Empirically, however, little is known about how enforcement is achieved in the absence of formal contracts and whether the associated inefficiencies are quantitatively relevant. This paper exploits transaction level data to provide a quantitative estimate of the value of relational contracts in the context of Kenyan flower exports, a setting in which formal contracts are not available and relational contracts coexist alongside a spot market. A lower bound estimate for the value of the relationship is derived from the incentive compatibility constraint of a stylized relational contract model. The value of the relational contract is at least 7% of the yearly turnover for the average relationship in the sample. Exploiting an exogenous shock to the cost function induced by an episode of ethnic violence, we find strong support for other assumptions and predictions of the model