The complementarity between trust and contract enforcement

Abstract

We show experimentally and theoretically that trust and contract enforcement can be complements, and identify the key mechanisms that drive this complementarity. In our experiments, the effect of improvements in contract enforcement is trust-dependent, and the effect of increases in trust is shaped by the strength of contract enforcement. We identify three key mechanisms underlying this complementarity: (1) heterogeneity in trustworthiness; (2) strength of contract enforcement affecting the ability to elicit reciprocal behavior from trustworthy types, and screen out untrustworthy types; (3) trust beliefs determining willingness to try such strategies.