Promises and conventions - An approach to pre-play agreements

I analyze how informal agreements can be sustained by moral emotions with regard to a large class of two-player games. Specifically, I assume that people feel guilty if they breach an agreement and that the guilt increases according to the degree of the harm inflicted on the other. A central insight is that it is easier to sustain efficient informal agreements if actions are strategic complements than if they are strategic substitutes. I complement this general insight by studying two specific cases where negotiators face uncertainty about the breach of the agreement. I show that while the optimal agreement in a game with strategic substitutes must compromise on surplus-maximization and efficiency, the optimal agreement in a game with sufficiently strong strategic complements tends to maximize both the surplus and the probability of compliance especially if the game is symmetric. JEL Classification: C72, C78, D03