Transaction cost economics and mutual legal uncertainty to build commitment

The central premise of transaction cost economics (TCE) is that parties select governance mechanisms to mitigate the hazards of opportunism (or “behavioral uncertainty”) while also economizing on the costs of more complex forms of governance. However, boundedly rational actors face meaningful limitations on their foresight which constrains their ability to negotiate complete contractual terms. TCE largely treats contractual incompleteness as a problem that parties eliminate whenever cost considerations allow. The theory developed here argues that under certain conditions, mutual legal uncertainty serves as a commitment strategy that enables contracting parties to ensure shared dependence and forbearance within their transactional relationship. Parties that employ this commitment strategy mutually accept the risk of an unfavorable outcome based upon an interpretation of the incomplete language imposed through the judicial enforcement mechanism. Thus, contractual incompleteness constitutes a shared commitment to both avoid judicial enforcement and adapt the relationship to unforeseen or unlikely future events.