Intermediated Trade with Relational Contracts

Abstract

We study intermediation in markets for relational contracts. We show that centralized intermediaries that aggregate demand, monitor producers, and direct allocations can emerge to incentivize performance even when matching is frictionless. Such intermediaries, however, require an additional markup. This double marginalization leads bilateral and intermediated contracts to coexist in a unique steady-state equilibrium. A buyer’s optimal contractual choice depends on demand volatility, gains from specialization, market tightness, the extent of the market, and reputational effects. The model explains the growth of intermediaries despite falling communication costs. It also explains empirical findings regarding the drivers and effects of professional service outsourcing.