Legal scholars have long recognized the close-knit community as an alternative means of supporting trade when contract law and trusted courts cannot. But recent research suggests that another option may be available: heterogeneous business networks. What is interesting is that these networks lack features traditionally seen as essential to community-supported trade. In particular, they lack preexisting social ties that allow reliable information to spread at low cost, make exiting the trade difficult, and enable the coordinated sanctioning of cheaters. As a result, some leading scholars have come to doubt that these networks are capable of sustaining cooperation.
This Article offers compelling evidence that heterogenous business networks can indeed sustain high-stakes trade. Through an original case study of the reinsurance industry, it shows that when the gains from trade are sufficiently robust, parties can build mechanisms to spread the reliable information needed to support trade by starting with transactions that align incentives and require high transparency. Parties can then strengthen their commitments by both investing in the bilateral relationship and building a network that connects each party to the other’s contacts. This strategy helpfully allows information about behavior in trading relationships to spread at low cost. Once constructed, the network enables reputation-based bonding of higher-risk transactions and a greater variety of transactional terms than can be supported by incentive alignment alone. In short, this study of the reinsurance trade suggests that cultivated, freestanding business networks can support extralegal private ordering under a broader set of circumstances than legal scholars currently appreciate.
"Contracts Without Courts or Clans: How Business Networks Govern Exchange,"
Georgia Law Review: Vol. 57:
1, Article 5.
Available at: https://digitalcommons.law.uga.edu/glr/vol57/iss1/5