Reputation or court: Individualism, collectivism, and the choice of enforcement mechanism in exchange

Abstract

Courts and reputation-based enforcement mechanisms are often employed to mitigate the problem of cheating in trade relationships. The choice between these two enforcement mechanisms is closely associated with individualistic/collectivistic cultural dispositions. Nevertheless, the selection of enforcement mechanism and how it relates to the reliability of third-party enforcement remains understudied. I designed a laboratory experiment in which the options for a safe local trade and a risky yet more profitable long-distance trade are available. When conducting Long-distance trade, subjects could employ a formal or an informal enforcement mechanism to oversee the trade relationships. I examined the subjects' choice of enforcement mechanism while controlling for their cultural disposition. Results suggest that those subjects with an individualistic disposition employ the court system (i.e., formal enforcement) more often than their collectivist counterparts when the court system is reliable. A belief elicitation task revealed that those with individualistic cultural orientation perceive new trade partners as more cooperative than their collectivist counterparts when trades are registered in a strong court.