Order With Some Law: Complementarity VS. Substitution of Formal and Informal Arrangements

While some argue that incomplete incentive contracts facilitate the self-enforcement of informal dealings, other authors submit that they substitute for or “crowd out” social norms supporting informal arrangements. We use experimental evidence to test these theories by manipulating the extent to which individuals transact repeatedly and the level of contract costs. We find that, by enforcing contractible exchange dimensions, contracts facilitate the self-enforcement of noncontractible dimensions. This complementarity effect is particularly important when repetition is unlikely and thus self-enforcement is difficult. Although our data suggest the existence of reciprocity as an alternative, informal enforcement mechanism, evidence that contracts substitute for this social norm is not robust.