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III. Moral Norms as Default Rules

One way to think about the behavioral role of fault in contracts is that fault matters because contracts are incomplete. No contract can specify, for example, every possible contingency for breach. This means that some eventualities are not spelled out in the text of the agreement. When rights or obligations are not specified within the contract, behavioral research suggests that parties look to social and moral norms to fill in the blanks. Where a contract is incomplete, the economic assumption is that parties will either rely on the default rule or behave strategically and negotiate for optimal terms. There is another possibility, one that a number of behavioral researchers have begun to address: When parties omit terms from the contract, they may assume that the relevant framework for their obligations is trust.11 Th at is, the parties trust that they are both bound by the same set of social norms, including promise keeping and reciprocity. In the final section of this chapter, I argue that the best way to think about the role of moral intuitions regarding fault in contract law is that the moral intuitions act as default rules when contracts are incomplete.

At least three pathways exist for moral norms to affect legal decision making. First, when a strong moral norm is in conflict with a legal rule, people may mistakenly assume that the legal rule mirrors the moral rule. Second, people may fear that violating a shared moral or social norm will lead to social sanctions, no matter what the legal rule provides. Third, moral beliefs may directly affect behavior: if I think a certain behavior is immoral, I may decide not to do it even when it is f inancially advantageous and perfectly legal. Behavioral research supports the existence of each of these phenomena, though it is sometimes difficult to distinguish the explanatory mechanisms in the context of a given decision.

Th ere is evidence that moral norms affect parties’ understanding of contractual obligations – both moral and legal obligations – irrespective of the background rule. In particular, researchers have found that people believe contracts are enforceable as written, even when some of the clauses are unenforceable. Dennis Stolle and Andrew Slain studied the effects of exculpatory clauses in contracts on consumer behavior.12 Th ey found that exculpatory language in a standard form contract had a deterrent effect on subjects’ likelihood to seek compensation, even when the clause would be unenforceable. Perhaps more

11Deepak Malhotra & J. Keith Murnighan. The Effects of Contracts on Interpersonal Trust. 47 Adminis. Sci. Quar. 534–59 (2002).

12Dennis Stolle & Andrew J. Slain. Standard Form Contracts and Contract Schemas: A Preliminary Investigation of the Effects of Exculpatory Clauses on Consumers’ Propensity to Sue. 15 Behav. Sci. & Law 83–94 (1997).

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important, the researchers found that subjects did not think that a contract with an exculpatory clause was less fair than a contract without an exculpatory clause – even though such provisions are usually unenforceable as a matter of public policy. Even more telling is that subjects did not make a moral distinction between two contracts, one of which limited the rights of the consumer much more sharply than the other. As long as the term was specified in the contract such that both parties were aware of it, they believed that all was fair.

As a follow-up question to the willingness-to-breach study reported above, I asked participants to answer questions about their understanding of the legal ramifications of breach of contract. They were asked to predict how a judge would deal with a series of breach of contract cases. Subjects could choose between damages and specific performance, and if they chose damages, they wrote in the amount the judge would impose. Over half the subjects thought that in at least one of the six presented cases, the judge would require specific performance. Legally, there is no reason to think that any of the straightforward cases presented would require specific performance, since money damages were adequate and easy to assess. This means that half the subjects were mistaken about the state of the law, and their mistakes about the law tended to reflect their moral intuitions.

Th is evidence does not necessarily indicate, of course, that parties’ behavior would not change if they were fully informed about their legal rights and obligations – these studies suggest that there are cases in which parties may make assumptions about the law that depend on perceived moral norms. In the contracts context, erroneous assumptions about the law may never be corrected. A party’s decision not to pursue damages for breach, or not to breach, is not one that courts or lawyers will have a chance to review. And, in the case that parties think their course of action is supported by their moral beliefs, they will presumably be less likely to seek better information about the legal rule.

Th e behavioral implications of a moral norm are more complicated in the case of informal agreements. In this context, parties may adhere to informal norms either because they fear informal sanctions or because they have internalized the norm and believe that breaking a deal is intrinsically wrong. One of the most important empirical findings about contractual relationships is the vitality of contractual norms in the absence of formal contracts. In 1963, Stewart Macaulay documented the informal means by which businesses could reach agreement on an exchange, and the ways that they would seek to enforce their deal.13 Interviewees in Macaulay’s study reported that,

13Stewart Macaulay. Non-Contractual Relations in Business: A Preliminary Study. 28 Amer. Soc. Rev. 55–67 (1963).

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even in cases in which a formal contract existed, the important contractual obligations were defined by the parties’ informal mutual understanding. Furthermore, breach of that understanding was remediated with renegotiation at best, and blacklisting or termination of the relationship at worst. Legal remedies were more or less ignored. Other studies have found, similarly, that when contracts are incomplete, the penalty for breach is termination of the contract.14 In other words, when contracts are incomplete, the parties do not turn to the court to enforce money damages or renegotiate the terms; they end the business relationship.

Sandra Robinson and Denise Rousseau have also addressed the nature of commonsense understandings of contract in their work on the “psychological contract.”15 Th e psychological contract is defined by a person’s belief about the terms and conditions of her participation in a reciprocal exchange. Studies have shown that violations of the psychological contract are distinct from unmet expectations – that is, though people respond negatively to disappointment when the reality does not meet their expectations, the emotional and attitudinal response to breach of contract is more intense. The core of this difference is in “the individual’s belief that an agreement is mutual, that is, a common understanding exists that binds the parties involved.”16 Th is is particularly apt in the employment context, their primary focus, because even when a written employment contract exists, it is unlikely to iterate the various contributions, obligations, and inducements that characterize an employer/ employee relationship over time. The psychological schema, or mental model, of the contract includes professional norms, information gathered during recruitment, societal beliefs, and formal mechanisms for the exchange of promises within the employment contract. Robinson and Rousseau found that perceived violations of the psychological contract have real effects for employers, including higher turnover and lower employee satisfaction.

Behavioral economists have recently redescribed this phenomenon in terms of trust: When the parties trust that they can rely on a certain level of reciprocal cooperation and good faith, informal agreements may actually provide a greater social surplus than a completely specified contract.17 Th e norm, and utility, of reciprocity in incomplete contracts have been demonstrated

14Martin Brown, Armin Falk, & Ernst Fehr. Relational Contracts and the Nature of Market Interactions. 72 Econometrica 747–80 (2002).

15Sandra Robinson & Denise M. Rousseau. Violating the Psychological Contract: Not the Exception but the Norm. 15 J. Org. Behav. 245–59 (1994).

16Denise Rousseau. Schema, Promise and Mutuality: The Building Blocks of the Psychological Contract. 74 J. Occup. & Org. Psychol. 511–41 (2001).

17Yongmin Chen. Promises, Trust, and Contracts. 16 J. Law, Econ., & Org. 209–32 (2000).

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experimentally. In one example, researchers used a game in which players interacted with each other under conditions of incomplete contract in a context modeled on an employer/employee relationship.18 One player was the employer and the other was the worker. The employer offered some amount to the worker, ranging from a minimum wage to a generous wage, and the worker then offered some amount of effort in return. Effort was costly to the worker but profitable to the employer. In the main treatment, players did not meet one another, so all choices were anonymous. The economic prediction was that the worker would return the minimum amount (minimal effort) to the employer. The employer, expecting this selfishness, would offer the minimum wage in the first case. In fact, the experimenters found that the dominant pattern was reciprocal behavior, and that the reciprocity was intrinsic rather than driven by any particular experimental manipulation (including social approval incentives or more iterations of the game). This means that employers offered an amount signif icantly above the minimum wage and workers returned an effort significantly greater than the lowest possible effort. Although the contract was incomplete – that is, it did not specify how much the employer had to pay or how much effort the employee had to contribute – the parties behaved as though the social norm of reciprocity were built into their contract, and high wages led to high effort.

Th e role of the norm of reciprocity has been documented in part by showing how explicit sanctions can actually serve to “crowd out” the relevant social or moral norms. In other words, people may be less likely to conform to the dictates of moral norms when the contingency and penalty for breach are specified. Experimental economics games have repeatedly found that players in a game that requires cooperation or reciprocity for the best overall results are more cooperative when there is no penalty for defection and less cooperative when there is a small penalty for defection.19 In fact, some research suggests that, when a game is fully described in terms of rewards and penalties, parties attribute one another’s behavior to self-interest rather than cooperation. The theory proposes that, when a transaction is described in terms of monetary rewards and penalties, the parties to the transaction stop depending on social or moral norms to make their decisions or judgments.20 The explicit rules crowd out the implicit norms – much as explicit terms in a contract replace default rules.

18Armin Falk, Simon Gachter, & Judit Kovacs. Intrinsic Motivation and Extrinsic Incentives in a Repeated Game with Incomplete Contracts. 20 J. Econ. Psychol. 251–84 (1999).

19Daniel Houser, Erte Xiao, Kevin McCabe, & Vernon Smith. When Punishment Fails: Research on Sanctions, Intentions and Non-Cooperation. 62 Games & Econ. Behav. 509–32 (2008).

20Uri Gneezy & Aldo Rustichini. A Fine is a Price. 29 J. Legal Stud. 1–17 (2000).

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In a particularly relevant example, experimenters used a game modeled on contractual relationships to show that moderate sanctions can crowd out the norm of reciprocity.21 In this game, the first player could offer a small sum to the second player. If the second player chose to perform, both players would get a reward. If the second player breached, one of two possible outcomes occurred. One outcome, which the authors describe as an unenforced contract, was that the second player would receive a large reward and the first player a nominal amount. The other possible outcome was that the players would receive the same payouts that they would have received had the second player performed. In this game, the enforceability of the contract varied. This means that subjects understood that in the event of breach, there was a 10, 50, or 90 percent chance that the experimenters would enforce the contract. The authors found that individuals performed when the enforcement was strong or when it was very weak, but not when it was moderate – that is, strong enough to be a salient element of the game but weak enough that defection was still the dominant strategy. The authors concluded that when the enforceability was so low as to be almost negligible, players understood that the rules of the game would conform to the moral norm of reciprocity. When the enforcement was so high as to be almost absolute, there was no point in breaching. But when the enforcement was in the middle, it crowded out the moral norm without introducing a penalty heavy enough to deter selfish behavior.

I have suggested that one mechanism for moral norms to act on legal decision making is that people may simply believe breach of contract is morally wrong, and therefore choose to punish breach even when punishment is costly or to avoid breach even when breach would be lucrative. The worker effort experiment makes an important point about the norm of reciprocity. Players did not just behave according to the norm in order to further their own self-interest. They behaved as though bound by the norm even when the game was limited to a single round, and whether or not they were playing anonymously or face-to-face. Experiments have repeatedly shown that many people engage in positive reciprocity that cannot be entirely explained by self-interest.22 Friendly waitresses get more tips, even from customers who do not plan to return.23 Various one-shot experimental games have also

21Iris Bohnet, Bruno Frey, & Steffen Huck. More Order with Less Law: On Contract Enforcement, Trust, and Crowding. 95 Amer. Pol. Sci. Rev. 131–44 (2001).

22Ernst Fehr & Simon Gachter. Fairness and Retaliation: The Economics of Reciprocity. 14 J. Econ. Perspectives 159–81 (2000).

23Kathi Tidd & Joan Lochard. Monetary Significance of the Affiliative Smile: A Case for Reciprocal Altruism. 11 Bull. Psycho. Soc. 344–6 (1978).