Trust and Contracts: Empirical Evidence

Abstract

Trust between parties should shape contract design: if parties were suspicious about each others' reaction to unplanned events, they might pay higher negotiation costs to complete contracts ex-ante. Using a unique sample of U.S. consulting contracts, novel text-based-analysis measures of contract completeness, and a negative shock to trust between shareholders/managers (principals) and consultants (agents) staggered across space and over time, we find that lower trust increases contract completeness. Non-competes, details about equity compensation, indemnification, termination, and confidentiality clauses are added to contracts after trust drops.

Keywords: Empirical Contract Theory, Incomplete Contracts, Cultural Economics, Beliefs and Choice, Personnel Economics, Organizational Economics, FinTech and Textual Analysis, Consulting, Management, Non-Compete Agreements, Big Five, Fraud, Accounting, Disclosure

JEL Classification: D86, D91, J33, L14, Z10