Norms and Contracting

Norms and Contracting

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Article ID: iaor2012500
Volume: 58
Issue: 1
Start Page Number: 62
End Page Number: 77
Publication Date: Jan 2012
Journal: Management Science
Authors: ,
Keywords: game theory, experiment
Abstract:

We argue that contracts establish the norms of a relationship and that individuals incur disutility when deviating from these norms. In a laboratory experiment, we allow agents to make simple contracts before they play one of four games, and the most effective contract always includes an unenforceable ‘handshake’ agreement to take the first‐best action. In three games, a contract with only this handshake agreement is (at least weakly) optimal. The handshake is particularly effective in games with strategic complements. Our results highlight an explanation for contractual incompleteness: establishing a norm can effectively substitute for weak enforceable restrictions.

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