Reputations, Relationships and the Enforcement of Incomplete Contracts Incomplete∗- Comments welcome

This paper discusses the literature on the enforcement of incomplete contracts. It compares legal enforcement to enforcement via relationships and reputations. A number of mechanisms, such as the repeat purchase mechanism (Klein and Leffler (1981)) and efficiency wages (Shapiro and Stiglitz (1984)), have been offered as solutions to the problem of enforcing an incomplete contract. It is shown that the efficiency of these solutions are very sensitive to the characteristics of the good or service that is exchanged. In general neither the repeat purchase mechanism nor efficiency wages are the most efficient in the set of possible relational contracts. In many situations total output may be increased through the use of performance pay and increasing the quality of law. ∗I would like to thank Kyle Bagwell, Avner Grief and Ali Hortaçsu for helpful discussions. I also appreciate the comments from seminar participants at Stanford, MIT, the Conference in Honour of J.J. Laffont, Toulouse, University of Washington and USC.