Munich Personal RePEc Archive Promise, Trust and Betrayal: Costs of Breaching an Implicit Contract Levy, Daniel and Young, Andrew Bar-Ilan University, Emory University, and RCFEA, Texas Tech University 25 November 2020 Online at https://mpra.ub.uni-muenchen.de/104294/ MPRA Paper No. 104294, posted 03 Dec 2020 13:43 UTC Promise, Trust and Betrayal: Costs of Breaching an Implicit Contract* Daniel Levy Department of Economics, Bar-Ilan University Ramat-Gan 52900, ISRAEL, Department of Economics, Emory University Atlanta GA, 30322, USA, and Rimini Center for Economic Analysis, ITALY
[email protected] Andrew T. Young** College of Business Administration Texas Tech University Lubbock, TX 79409, USA
[email protected] Last Revision: November 25, 2020 Abstract: We study the cost of breaching an implicit contract in a goods market. Young and Levy (2014) document an implicit contract between the Coca-Cola Company and its consumers. This implicit contract included a promise of constant quality. We offer two types of evidence of the costs of breach. First, we document a case in 1930 when the Coca-Cola Company chose to avoid quality adjustment by incurring a permanently higher marginal cost of production, instead of a one-time increase in the fixed cost. Second, we explore the consequences of the company’s 1985 introduction of “New Coke” to replace the original beverage. Using the Hirschman’s (1970) model of Exit, Voice, and Loyalty, we argue that the public outcry that followed New Coke’s introduction was a response to the implicit contract breach. JEL Codes: E31, K10, L11, L16, L66, M20, M30, N80, N82 Keywords: Invisible Handshake, Implicit Contract, Customer Market, Long-Term Relationship, Cost of Breaching a Contract, Cost of Breaking a Contract, Coca-Cola, New Coke, Exit, Voice, Loyalty, Nickel Coke, Sticky/Rigid Prices, Cost of Price Adjustment, Cost of Quality Adjustment * We are grateful to two anonymous reviewers for constructive comments and suggestions which improved the paper significantly.