Contracts Without Courts or Clans: How Business Networks Govern Exchange

Abstract

Legal scholars have long recognized the clan or close-knit community as alternative institutions for supporting trade when contract law and trusted courts are unavailable. But recent research finds that heterogeneous business networks engage in high-stakes transactions that are not fully susceptible to formal, judicially backed contracting. These networks lack features seen as undergirding clan- or community-supported trade. They lack preexisting noncommercial social ties that allow reliable and trusted information to spread at low cost, make exiting the network difficult, and enable coordinated sanctioning of cheaters. Consequently, some leading scholars doubt that these networks are doing the work of sustaining cooperation. Can business networks sustain cooperation? If so, how? This Article offers an answer by presenting and theorizing an original case study into a long-term, sophisticated, high-stakes trade network that relied on neither the court nor the clan. When the gains from trade are sufficiently large, parties can build mechanisms to produce and disseminate reliable information needed to support trade by starting with transactions that align incentives and commit to high transparency about behavior. Parties can then strengthen their commitments by investing in the bilateral relationship and by building a network in which each party is connected to multiple other parties, which facilitates the dissemination of information about behavior in trading relationships. The targeted cultivation of strong personal ties together with the construction of a trading network allow for bonding of higher-risk transactions and a greater variety of transactional terms than can be supported by incentive alignment alone. The reinsurance trade suggests that cultivated, freestanding business networks can support extralegal private ordering under a larger set of circumstances than legal scholars currently appreciate.

Keywords: contracts, private ordering, network governance, reinsurance, insurance

JEL Classification: k12, k41, l22, l23, l24, l14