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

  • D'Agostino, Elena
  • Lisciandra, Maurizio

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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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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  1. Fehr, Ernst & Schmidt, Klaus M., 2004. "Fairness and incentives in a multi-task principal-agent model," Munich Reprints in Economics 20657, University of Munich, Department of Economics.
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  14. Berg Joyce & Dickhaut John & McCabe Kevin, 1995. "Trust, Reciprocity, and Social History," Games and Economic Behavior, Elsevier, vol. 10(1), pages 122-142, July.
  15. David K. Levine, 1998. "Modeling Altruism and Spitefulness in Experiment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 1(3), pages 593-622, July.
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  17. Hoffman, Elizabeth & McCabe, Kevin A & Smith, Vernon L, 1996. "On Expectations and the Monetary Stakes in Ultimatum Games," International Journal of Game Theory, Springer, vol. 25(3), pages 289-301.
  18. Akerlof, George A, 1982. "Labor Contracts as Partial Gift Exchange," The Quarterly Journal of Economics, MIT Press, vol. 97(4), pages 543-69, November.
  19. Georg Kirchsteiger & Ernst Fehr & Simon Gächter, 1997. "Reciprocity as a contract enforcement device: experimental evidence," ULB Institutional Repository 2013/5911, ULB -- Universite Libre de Bruxelles.
  20. Ofer H. Azar, 2007. "Do people tip strategically, to improve future service? Theory and evidence," Canadian Journal of Economics, Canadian Economics Association, vol. 40(2), pages 515-527, May.
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