Trust and Contracts: Empirical Evidence
Abstract:
Trust between parties should drive the design of contracts: if parties did not trust each others' reaction to unplanned events, they might agree to pay higher costs of negotiation to complete contracts. Using a unique sample of U.S. principal-agent consulting contracts and a negative shock to trust between parties staggered across space and over time, we find that lower trust increases contract completeness. Not only contract complexity but also the veriable states of the world contracts cover increase after a drop in trust. The results
hold for several text-analysis-based measures of completeness and do not arise when agents are also principals (shareholders) or in other falsification tests. Non-compete agreements,condentiality and indemnification clauses, and restrictions to agents' actions are more likely to be added to contracts signed in the same locations, same industries, and same years after a negative shock to trust.