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Stronger Contracts, Less Trust

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AgreementBusiness agreements are usually secured by written agreements that define the obligations of the parties and state what happens under various conditions. Having been party to a few business deals launched based mostly on enthusiasm and trust, I can certainly vouch for the importance of such agreements. Not everyone relies entirely on extensive documentation, though – oilman T. Boone Pickens famously collected $3 billion when courts upheld his handshake deal to acquire a piece of Getty Oil. And, we find, there’s actually scientific evidence that stronger contracts can reduce trust.

In a paper titled More Order with Less Law: On Contract Enforcement, Trust, and Crowding, researchers Iris Bohnet, Bruno S. Frey and Steffen Huck describe simulates contractual environments in which subjects formed agreements under two conditions: strong enforcement and weaker enforcement. Surprisingly, stronger enforcement didn’t always result in higher levels of successful performance per the agreement. According to the authors, weaker performance “crowds in” trust. In other words, when an agreement is made in an environment of limited contract enforcement, the parties depend on trust to a greater degree and performance can actually increase.

This may sound counter-intuitive, but there are real-world examples of this. Think about the “honor codes” at some schools – rather than trying to build sophisticated monitoring systems to prevent cheating, they do the reverse: they reduce monitoring, and trust the students to adhere to the honor code. Despite the occasional cheating scandal, this approach has been largely effective. On the other hand, contracts in the Soviet era in Russia were extremely specific and tightly enforced; this environment caused both sides to precisely follow the letter of the contract, sometimes to the exclusion of common sense. Meaningless deviations from the exact provisions of the contract became major negotiation points, causing delays and cost overruns with no improvement in the delivered product or service.

The message from this isn’t that businesses and consumers don’t need agreements or contracts – clearly, these documents are a good way to specify what each party will do and they help avoid costly misunderstandings and errors. But, rather than relying on contracts to cover all possible eventualities, in some cases it may be better to avoid haggling over endless paragraphs of legalese it may be better to work on building trust. (At least in the U.S., members of the legal profession are great at coming up with “but what if…?” scenarios, each of which requires lengthening the contract.)

In fact, most people and businesses DO want to hold up their end of the agreements they make. Relying on trust won’t give one party to the bargain a “license to cheat” if they find they can get away with something but remain in compliance with the letter of the contract. And, as we saw in “Trust Your Customer,” offering trust is a way to build mutual trust.

By |August 4th, 2011|

About the Author:

Roger Dooley is the author of Brainfluence: 100 Ways to Persuade and Convince Consumers with Neuromarketing (Wiley). He is the primary author at Neuromarketing, and writes at Entrepreneur and Forbes. Learn more at RogerDooley.com, and follow him on Twitter at @rogerdooley.

9 Comments

  1. Jina Man August 5, 2011 at 8:30 am - Reply

    I think that in the world of business there is no place for “trust” – everything should be previously agreed and signed in written – that way there is no place for misunderstanding!

    • Roger Dooley
      Twitter: rogerdooley
      August 5, 2011 at 10:11 am - Reply

      Jina, I’d never advise business people to work without an agreement, simply because even when both parties mean well there is the possibility of misunderstanding, errors in performance, etc. Rather, the point of the research was that if you try and work to a highly detailed agreement with very strict enforcement of these details, you lose trust between the parties and performance may suffer. Imagine, for example that an agreement specified 2mm thick steel for a machine housing but the vendor was now making the part out of 3mm steel for greater durability. In a loose enforcement situation, the buyer would say, “No problem, we appreciate the improvement.” In a very tight enforcement environment (as actually happened at times in Soviet Russia), the buyer would demand that the specification be met or that the seller make a financial concession. The seller might choose to furnish the inferior part to avoid conflict, and the ultimate performance under the contract would be reduced.

      Roger

  2. Ben Miller
    Twitter: buyvssell
    August 5, 2011 at 8:43 am - Reply

    Great point, Roger. I really like this post. (Where are the links to retweet?) I’m in the middle of negotiating a three year exclusive contract myself right now, and I have been taking the less is more approach. I just sent them over a paragraph with three bullet points describing the deal.

    In sales you have to have happy customers. If your customer wants out of the deal, there is a reason they are not happy. There is no amount of legalese that will fix the problem. Forcing them to comply because of a contract a) might not work (they can get out of a lot nowadays) and b) will tick them off and cause them to get out as soon as possible and not look back. You’re much better off to work with them to fix the problem.

    • Roger Dooley
      Twitter: rogerdooley
      August 5, 2011 at 10:15 am - Reply

      Working on the sharing links problem, Ben!

      I think the potential for problems you mention is real, and goes to the “revenge” factor described in Apologies Really Do Work. If one party feels they have been abused by the other party, they are far more likely to behave in an unethical manner.

      Roger

  3. Robin Jennings
    Twitter: explainafide
    August 9, 2011 at 3:35 am - Reply

    Great article and rather timely for myself.

    I do web design and marketing and I always write up a terms of agreement outlining what I promise to do for the agreed amount. I normally don’t bother to get the client to sign it ,we just shake hands and its done.

    However, I did get a new client from a large firm to sign a contract and low-and-behold I did 20 hours of work and then he refused to pay and basically said “Come and get me”. He knows I didn’t have the money to progress the issue further so back to handshakes for me!!!

  4. Roger Dooley
    Twitter: rogerdooley
    August 9, 2011 at 7:37 am - Reply

    Sorry to hear about your bad experience, Robin. It does illustrate the limited power of contracts between parties with unequal resources, or when one party simply doesn’t plan to honor it. Having said that, web design is a tricky area where getting agreement on the scope and details of the project is essential. Without clear limits, a small project can morph into a never-ending nightmare. For that and similar marketing projects, I like a very simple agreement that may not anticipate every possibility but which ensures the client and provider share a common understanding of the project.

    Roger

  5. Dr.Zachar August 14, 2011 at 7:48 pm - Reply

    I’ll have to agree with said poster about the level of “trust” in today’s market. It’s ALWAYS better to have a written document between two parties. You really have nothing to lose.

  6. Rebecca Staton-Reinstein
    Twitter: doctorrebeccasr
    August 24, 2011 at 8:28 am - Reply

    For most of my business dealings I have a contract. However, there are some key exceptions. I have 4 strategic partners whom I work with on a regular basis. I’ve known them all at least 20 years. We have no contracts. We’ve never had an issue that wasn’t settled in a 3-minute conversation. If we can’t trust one another, then why work together. I came through colleges with strong honor systems that worked. On the other hand, as a small business doing business with very large companies where we had huge detailed contracts, I’ve had 4 occasions in 17 years where they broke the contract and there was no way I could go up against their giant legal departments. So although I always have a contract with clients I don’t put much trust in contracts. Instead, I try to build a trusting relationship, deliver more than expected, and let go of things that don’t work out.

    • Roger Dooley
      Twitter: rogerdooley
      August 24, 2011 at 10:15 am - Reply

      That all makes a lot of sense, Rebecca. Even tightly written contracts aren’t much good if the other party is determined to behave in an unethical manner. Often, the cost of making the other party perform is just too high compared to the potential benefit.

      Roger

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