This paper examines the role governance institutions play in the adoption of contracts. We develop a simple model of the contracting relationship in a setting where unverifiable outcomes exist and use it to interpret data on groundwater irrigation contracts in Bangladesh. A distinguishing feature of this market is the variety of village-level institutions which impose different degrees of punishment for contract violation. Consistent with the model, we find households adopt contracts that rely on unverifiable outcomes, which are not formally contractible, when punishment for contract violation is weak. Conversely, households adopt contracts that rely on formally contractible and verifiable outcomes when punishment is severe. This evidence is consistent with contract terms being chosen optimally given what is or is not formally contractible.
- Contract enforcement
- Formal and relational contracting
- Verifiability problem
ASJC Scopus subject areas
- Economics and Econometrics
- Organizational Behavior and Human Resource Management