Contractual Incompleteness as a Signal of Trust

This paper shows how the fear of signaling distrust can endogenously lead to incomplete contractual agreements. We consider a principal agent relationship where the agent may be trustworthy (dedicated to the project) or not. The principal may trust the agent (i.e. have a high belief of facing a trustworthy agent), or distrust him. The proposal of a complete contract, including fines and other explicit incentives, is shown to signal distrust. When trust is important in some non-contractible part of the relationship, a principal may prefer to leave the contract incomplete rather than to signal distrust by proposing a complete contract. Contractual incompleteness arises endogenously due to asymmetric information about how much one partner trusts the other side.

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