Contract Choice, Moral Hazard, and Performance Evaluation: Evidence from Online Labor Markets

Abstract

Due to the spatial and temporal separations between clients and freelancers, online labor markets (OLMs) are particularly susceptible to issues related to information asymmetry. Based on the economics of information, we hypothesize that the choice of contract type — i.e., between the fixed-priced (FP) contract and the time-and-materials (TM) contract — has important implications for curbing moral hazard during contract execution, and therefore will influence the client’s perceived contractual performance upon project completion. We test the predictions by assembling a dataset of data analytics projects completed by freelancers on Upwork, the largest online freelancing platform. We find that, consistent with our hypothesis, freelancers under a TM contract receive significantly lower performance ratings by their clients on average compared to those under an FP contract. Interestingly, we also find that the level of expertise required for a project moderates the effect of contract choice on client satisfaction; the negative impact of a TM contract is smaller (i.e., less negative) when a project requires intermediate-level or expert-level skills. Our study offers useful insights into an important institutional determinant of contractual performance evaluation, which has profound implications for f reelancers’ reputations in OLMs.