The effects of contracts on interpersonal trust

Administrative Science Quarterly,  Sept, 2002  by Deepak Malhotra,  J. Keith Murnighan

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Hypothesis 3 (H3): Choosing not to offer a binding contract after having offered binding contracts previously will inhibit the development of trust.

Hypothesis 4 (H4): Choosing not to offer a binding contract will inhibit the development of trust more so than will an exogenous removal of contracts.

Non-binding contracts. While the use of binding contracts is quite common, especially in business relationships, non-binding, informal agreements form the basis for many mutually beneficial interactions between individuals and between organizations (e.g., Powell, Koput, and Smith-Doerr, 1996). Non-binding contracts are often characterized by mutual agreement and may be explicit, but due to the legal or normative context, they may not be strictly enforceable. Although such agreements can be efficient substitutes for binding contracts, either party can more easily renege on a non-binding agreement than a binding one because the cost of doing so is relatively low. To some degree, the choice between binding and non-binding contracts may depend on an analysis of the costs of binding contracts and the risks associated with informal, non-binding contracts.

An additional benefit of non-binding contracts is the possibility that they may not inhibit the development of interpersonal trust. In contrast to the effects of binding contracts, promises and assurances that are not binding may actually facilitate trust development by increasing the likelihood of attributions of trustworthiness: when one party promises to cooperate and then fulfills his or her promise, positive attributions are likely. Subsequent positive interactions can then increase trust. Here we investigate whether assurances of benevolence or reciprocity, which are characteristics of non-binding contracts, will elicit cooperation without the clear control or monitoring mechanisms that are provided by binding contracts. If they do not, then people must choose between building trust (by foregoing binding contracts) versus using binding contracts that mandate cooperation. If non-binding contracts enhance cooperation but do not inhibit the development of trust, then they can solve the potential problems o f binding contracts (hypotheses 2-4).

Formal models of rational economic behavior (e.g., Farrell and Gibbons, 1989) suggest that, in many economic interactions, talk is "cheap," that is, the claims of potentially self-interested parties are unverifiable and essentially costless and so should not be presumed to be trustworthy (e.g., Pillutla and Murnighan, 1995; Croson, Boles, and Murnighan, 2002). Cheap-talk models suggest that because people will be dubious, neither party has anything to gain by communicating an intent to behave in a trustworthy manner unless a proposal is binding or one party can impose costs on the other for violating the proposal. Cheap-talk experiments, however, have consistently shown that mere words can facilitate mutual cooperation (e.g., Farrell and Rabin, 1996; Bottom, et al., 2002). Talk is particularly beneficial in coordination tasks, in which the parties' interests may differ but are not opposed (e.g., Crawford, 1998). Thus, two negotiators who have compatible interests will gain from communicating their interests t o each other. Models of procedural and interactional justice (e.g., Bies and Moag, 1986) also suggest that words have potent effects on individuals' feelings of satisfaction as well as on their behavior (e.g., Shapiro, 1991; Elsbach, 1994). In addition, the recent literature on psychological contracts (e.g., McLean Parks and Kidder, 1994; Robinson and Rousseau, 1994; Rousseau, 1995; Robinson, 1996) indicates that talk provides the basis for both expectations and substantive action. Similarly, Shapiro, Sheppard, and Cheraskin (1992) suggested that regular communication can lay the foundation for trust. Finally, research on deception suggests that verbal assurances are often perceived to be credible. McCornack and Parks (1986) noted that people exhibit a "truth bias," or a tendency to judge others, even strangers, as truthful even without supporting evidence (e.g., Comadena, 1982; Miller, Mongeau, and Sleight, 1986). All of these perspectives suggest that non-binding contracts will enhance cooperation, but not necessarily as much as binding contracts. Thus,