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

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 contract format choice—i.e., between the fixed-priced (FP) contract and the time-and-materials (TM) contract—has important implications for preventing 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 analytics projects completed by freelancers on Upwork, the largest online freelancing platform. We find that consistent with our hypothesis, freelancers under a TM contract on average receive significantly lower performance ratings by their clients compared to those under a FP contract. Interestingly, we also find that the expertise requirement of a project moderates the effect of contract choice on client satisfaction; specifically, the negative impact of TM contract is smaller (less negative) when a project requires expert-level skills. Our study offers useful insights into an important institutional determinant of contractual performance evaluation, which has profound implications for freelancers’ reputation in OLMs.