Document Type

Article

Publication Date

2010

Center/Program

Center for Contract and Economic Organization

Abstract

This Article studies the relationship between formal and informal contract enforcement. The theoretical literature treats the two strategies as separate phenomena. By contrast, a rich experimental literature considers whether the introduction of formal contracting and state enforcement "crowds out" the operation of informal contracting. Both literatures focus too narrowly on how formal contracts create incentives for parties to perfom substantive actions, while assuming that informal enforcement depends on preexisting levels of trust. As a result, current scholarship misses the relationship between formal and informal contract mechanisms that characterizes contemporary contracting in practice. Parties respond to rising uncertainty by writing contracts that intertwine formal and informal mechanisms-what we call "braiding"-in a way that allows each to assess the disposition and capacity of the other to respond cooperatively and effectively to unforeseen circumstances. These parties agree on formal contracts for exchanging information about the progress and prospects of their joint activities, and it is this information sharing regime that "braids" the formal and informal elements of the contract and endogenizes trust. We argue that the low-powered enforcement associated with the formal governance structure in these braided contracts complements rather than crowds out the informal mechanisms that rely on increasing levels of trust. We examine the braiding phenomenon in a variety of contexts characterized by increasing uncertainty. In each instance, courts appear to have harnessed the braiding phenomenon by using low-powered sanctions to protect formal contractual "preliminaries."This technique allows potential collaborators to explore and develop their relations, but it does not impose mutually enforceable obligations to pursue a particular project. Despite the wisdom of temperate enforcement of braided contracts, however, courts that emphasize the contemporary duty to negotiate in good faith are often tempted to expand the legal sanction. We conclude by explaining how courts can best support the braiding strategies that are critical to the success of an integrated regime of formal and informal contracting.

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Contracts Commons

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