What do contracts do to facilitate relationships?

Abstract

I demonstrate that transacting parties may expend resources on ex ante contracting, which may not be legally enforceable, to help build and maintain their long-term relationships. I first introduce three legal concepts, namely scaffolding, managerial provisions, and formal relational contracts, which highlight the recent trend towards more detailed contracts. These concepts indicate that the role of detailed contracts is not to improve judicial contract enforcement, but to enhance clarity and alignment of interests and to reduce renegotiation costs, which ultimately support the parties’ relationships. I then proceed to present and analyze a simple reduced-form model, which demonstrates that the parties’ efforts for ex ante contracting are not necessarily monotonic with the level of alignment of their interests. Furthermore, I discuss recent contracting practices in Japan and attempt to provide an explanation for the lack of change observed in these practices.