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Contractual incompleteness as a signal of trust

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  • Herold, Florian

Abstract

This paper shows how the fear of signaling distrust can endogenously lead to incomplete contractual agreements. We consider a principal agent relationship where the agent may be trustworthy (dedicated to the project) or not. The principal may trust the agent (i.e. have a high belief of facing a trustworthy agent), or distrust him. The proposal of a complete contract, including fines and other explicit incentives, is shown to signal distrust. When trust is important in some non-contractible part of the relationship, a principal may prefer to leave the contract incomplete rather than to signal distrust by proposing a complete contract. Contractual incompleteness arises endogenously due to asymmetric information about how much one partner trusts the other side.

Suggested Citation

  • Herold, Florian, 2010. "Contractual incompleteness as a signal of trust," Games and Economic Behavior, Elsevier, vol. 68(1), pages 180-191, January.
    • Handle: RePEc:eee:gamebe:v:68:y:2010:i:1:p:180-191
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