The Limits of Reputation: Lies, Opportunism, and the Evolution of Contract Enforcing Institutions

Abstract: This paper uses an analytic narrative approach to demonstrate that lending contracts create dual-sided problems of opportunism and that familiar institutional arrangements provide protection to both borrowers and lenders. This insight allows a reinterpretation of key elements of the historical evolution of the English common law, as well as an exploration of the ways that politics and status influence dispute resolution in a variety of institutional arrangements. It also suggests that reputation is a less reliable way of managing these types of disputes—even in small communities—than much of the existing political economy literature has tended to suggest. These conclusions have implications for our understanding of the history of institutional development, for common policy prescriptions for institutional reform in contemporary emerging markets, and for our interpretation of current trends in dispute resolution, including firms’ increasing preference for addressing disputes with international arbitration rather than in domestic courts of law.