Seminario 18/7: CANCELADO HASTA NUEVA ORDEN Juan José Ganuza (UPF and Barcelona GSE) and Fernando Gómez (UPF)- Formal Contracts Without Courts. Scoring Suppliers to Build Trust

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ABSTRACT

Relevant empirical findings point at the actual use of explicit (but imperfectly en- forceable) formal contracts by businesses alongside substantial informal dimensions in the relationship. In this paper we formally show the supporting role that formal contracts play for relational interactions.  We show that contractual documents, even in the extreme case when the parties know they are not meant to be enforced in real- ity, may have an important and positive influence on reputational or reciprocity-based sanctions firms may impose to sustain cooperation. We demonstrate that setting compliance with certain tasks in a formal document reduces the cost of reputational punishments that firms may need to inflict in order to ensure the right incentives. We also show that formal contracts impact the way in which reputational punishments will be structured: Formal contracts optimally induce a more eschewed pattern of sanctioning, compared to a benchmark case in which no formal document setting ob- servable tasks exists. Thus, when dealing with its counterparties a firm will be, when the relational contract comes together with a formal one, less forgiving with those counterparties who have not performed the tasks under the formal contract, and more forgiving with those other ones who have not infringed the provisions of the formal document. We extend the basic setting to imperfect-but positive-enforcement and explore optimal investment in setting explicit tasks in the contractual document.

JEL classification numbers: K13, K23, L51, H24.