Enforceable vs. non-enforceable contracts: a theoretical appraisal with fair players

Elena D'Agostino and Maurizio Lisciandra ()

MPRA Paper from University Library of Munich, Germany

Abstract: In this paper we provide a simple model examining the choice between enforceable and non-enforceable contracts when, on the one hand, drafting an enforceable contract is costly and, on the other hand, fulfilling a non-enforceable contract is left to parties’ fairness. According to the previous literature we find that (1) the choice between the two contract settings in equilibrium depends on fairness and enforcement costs, and (2) whenever a non-enforceable contract is chosen in equilibrium it turns out welfare-improving. However, we are able to measure efficiency and make punctual predictions of how distant the decentralized solution is from first-best. Precisely, we find that efficiency is strongly conditioned by the stake of the transaction, so that both contracts allow for very high levels of efficiency in the presence of low-stake transactions, whereas efficiency always collapses to very low levels for high-stake transactions. It implies that a social planner should intervene only in the last case, even in the presence of high levels of fairness. Our results are robust and hold in a repeated game, proving that reputation is not welfare improving unless the number of interactions exceeds a given threshold.

Keywords: fairness; enforceability; contract choice; welfare analysis (search for similar items in EconPapers)
JEL-codes: D03 D86 (search for similar items in EconPapers)
Date: 2012-08-21
New Economics Papers: this item is included in nep-gth and nep-mic
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https://mpra.ub.uni-muenchen.de/53850/15/MPRA_paper_53850.pdf revised version (application/pdf)

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