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Binding and Non-Binding Contracts: A Theoretical Appraisal

Author

Listed:
  • D’Agostino Elena

    (Department of Economics,University of Messina,Piazza Pugliatti 1, 98122,Messina,Italy)

  • Lisciandra Maurizio

    (Department of Economics,University of Messina,Piazza Pugliatti 1, 98122,Messina,Italy.)

Abstract

The article investigates the equilibrium conditions in the choice between legally binding contracts, which are costly to verify and enforce, and non-binding contracts, which simply rely on trust as an enforcement mechanism, in both one-shot and repeated interactions. The returns to effort appear to have an important effect on reputational behavior. The theoretical investigation is accompanied by numerical simulations of the welfare impact of the introduction of a legal system that allows for binding contracts. We find that contract-enforcing institutions mainly produce benefits when effort is particularly valuable, but turn out to be less effective otherwise and even detrimental for a subset of parameters. Finally, reputation unleashes its welfare-enhancing properties especially if non-binding agreements take place when the counterparty’s reliability is very unpredictable.

Suggested Citation

  • D’Agostino Elena & Lisciandra Maurizio, 2018. "Binding and Non-Binding Contracts: A Theoretical Appraisal," Review of Law & Economics, De Gruyter, vol. 14(2), pages 1-27, July.
    • Handle: RePEc:bpj:rlecon:v:14:y:2018:i:2:p:27:n:3
    DOI: 10.1515/rle-2016-0006
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    References listed on IDEAS

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    More about this item

    Keywords

    contract choice; trust; contract enforceability; strategic reputation; incomplete contracts;
    All these keywords.

    JEL classification:

    • C70 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - General
    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law

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