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Binding and Non-Binding Contracts: A Theoretical Appraisal

Review of Law & Economics, ahead of print, 2017, DOI: 10.1515/rle-2016-0006

Posted: 27 Sep 2012 Last revised: 30 Oct 2017

Elena D'Agostino

University of Messina

Maurizio Lisciandra

University of Messina - Department of Economics

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.

Keywords: contract choice; trust; contract enforceability; strategic reputation; incomplete contracts

JEL Classification: C70; D02; D03; D86; K12

Suggested Citation

D'Agostino, Elena and Lisciandra, Maurizio, Binding and Non-Binding Contracts: A Theoretical Appraisal. Review of Law & Economics, ahead of print, 2017, DOI: 10.1515/rle-2016-0006. Available at SSRN: https://ssrn.com/abstract=2153113 or http://dx.doi.org/10.2139/ssrn.2153113

Elena D'Agostino

University of Messina ( email )

Piazza Pugliatti, 1
Messina, 98122
Italy
+39090719202 (Fax)

Maurizio Lisciandra (Contact Author)

University of Messina - Department of Economics ( email )

Piazza Pugliatti 1
Messina, 98122
Italy
+39 (0)906764620 (Phone)

HOME PAGE: http://https://sites.google.com/site/mlisciandra/

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