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Enforceable vs. non-enforceable contracts: a theoretical appraisal with fair players

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  • D'Agostino, Elena
  • Lisciandra, Maurizio

Abstract

In this paper we provide a simple model examining the choice between enforceable and non-enforceable contracts when, on the one hand, drafting an enforceable contract is costly and, on the other hand, fulfilling a non-enforceable contract is left to parties’ fairness. According to the previous literature we find that (1) the choice between the two contract settings in equilibrium depends on fairness and enforcement costs, and (2) whenever a non-enforceable contract is chosen in equilibrium it turns out welfare-improving. However, we are able to measure efficiency and make punctual predictions of how distant the decentralized solution is from first-best. Precisely, we find that efficiency is strongly conditioned by the stake of the transaction, so that both contracts allow for very high levels of efficiency in the presence of low-stake transactions, whereas efficiency always collapses to very low levels for high-stake transactions. It implies that a social planner should intervene only in the last case, even in the presence of high levels of fairness. Our results are robust and hold in a repeated game, proving that reputation is not welfare improving unless the number of interactions exceeds a given threshold.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 41261.

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Date of creation: 21 Aug 2012
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Handle: RePEc:pra:mprapa:41261

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Keywords: fairness; enforceability; contract choice; welfare analysis;

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  1. Matthew Rabin., 1992. "Incorporating Fairness into Game Theory and Economics," Economics Working Papers, University of California at Berkeley 92-199, University of California at Berkeley.
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  16. Cameron, Lisa A, 1999. "Raising the Stakes in the Ultimatum Game: Experimental Evidence from Indonesia," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 37(1), pages 47-59, January.
  17. Fudenberg, Drew & Maskin, Eric, 1986. "The Folk Theorem in Repeated Games with Discounting or with Incomplete Information," Econometrica, Econometric Society, Econometric Society, vol. 54(3), pages 533-54, May.
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