Are Non-Binding Contracts Really not Worth the Paper?

This paper experimentally investigates behavior in sequential one-shot transactions which are governed by non-binding contracts. In a second, incomplete information treatment, contracts are binding for some players. While according to traditional game-theoretical analysis no trade is expected in the first treatment, full trade should result in the latter. However, we find that trade is even higher in the non-binding contract treatment. On the one hand, non-binding contracts – although they are cheap talk – do guide behavior, especially at the beginning of a business relationship, while reciprocal reactions prevail later on. On the other hand, in the treatment with binding contracts cooperative behavior appears to be crowded out.