The Handshake

The plates before this one have shown the contract as the law sees it: a promise the sword enforces, its gaps filled by the law's defaults, its incentives designed against the agent's hidden ease. But there is a discovery, made not in the law library but in the field, that unsettles all of it: that in the ordinary commerce of the world, the formal contract is hardly used at all, and the court almost never. Businessmen do deals on a handshake, write loose agreements they never consult, and settle their disputes by negotiation and goodwill — and the promise that binds them is kept not for fear of the law but for the worth of the relationship. This is the relational contract, and it is, by far, the most of what contracting actually is.

Stewart Macaulay went and asked them — the businessmen, the lawyers, the purchasing agents — how they actually used contracts, and the answer surprised the legal mind. They used them remarkably little. Deals were struck on a handshake or a brief note, the details left vague and the contingencies unaddressed; the formal contract, if one was drawn at all, was filed and forgotten, never consulted as the deal unfolded. And when something went wrong — a late delivery, a flawed batch, a changed circumstance — the parties did not reach for the contract and threaten suit; they picked up the telephone, explained the trouble, and worked it out, each giving a little, because each valued the relationship and the future business more than the point in dispute. To sue, or even to insist too rigidly on one's contractual rights, was thought bad form, a sign one did not understand how business was done — for it would poison the relationship that was the real asset, far more valuable than any single deal. The formal contract, Macaulay found, was at most a frame; the relationship was the substance, and the relationship, not the law, was what made the promises hold.¹

What enforces these relational promises, if not the court? The answer is the shadow of the future — the same logic the volumes on the commons and on the cartel met in the repeated game. When two parties deal not once but again and again, expecting to go on dealing, neither can profitably cheat: the gain from breaking a promise today is a one-time thing, but the cost — the loss of the relationship, the future dealings forfeited, the reputation destroyed — is paid over and over, for as long as the relationship would have lasted. So long as the future is valued enough — so long as the relationship is expected to continue and its worth exceeds the one-time gain from cheating — each party keeps faith not from honor alone but from interest, for keeping the promise is worth more than breaking it. The relational contract is thus self-enforcing: it needs no external sword, because the relationship itself supplies the enforcement, the value of its continuance held hostage against each party's good behavior. And reputation extends the discipline beyond the single relationship: the party who cheats one partner is found out by others, and loses not one relationship but his standing in the whole community of those who might have dealt with him.²

Here the relational contract answers the question the volume has been circling: what fills the gaps that the law's defaults and the cleverest incentives cannot? The relationship fills them. When the unforeseen arrives — the contingency no clause addressed, the circumstance no incentive anticipated — the parties to a relational contract do not consult the silent document, which says nothing, nor run to a court, which would end the relationship; they fall back on the relationship itself, adjusting by negotiation and good faith, each trusting the other to be reasonable because each means to go on dealing. The gap that would baffle a court, or trigger a ruinous dispute between strangers, is filled between relational partners by a telephone call and a fair adjustment, governed by the understanding that whatever is not written will be handled in the spirit of the deal. So the relational contract is not merely a substitute for the formal one but a superior way of governing the unforeseeable: where the formal contract must specify in advance and falls silent on what it failed to foresee, the relational contract leaves the future open and fills it as it comes, by the living judgment of parties who trust each other. The gaps the written contract cannot close, the relationship closes — not in advance, by a clause, but as they arise, by good faith.³

The advantages run deeper than gap-filling, and explain why so much contracting is relational by choice, not merely by laziness. The relational contract is cheaper: it spares the cost of drafting elaborate terms, retaining lawyers, and litigating disputes, replacing all of it with a relationship that polices itself. It is more adaptable: where a formal contract, once signed, binds the parties to terms that events may overtake, a relational contract bends with circumstance, the parties adjusting by agreement as the world changes. And it governs the unmeasurable: the quality, the care, the goodwill that no contract can specify or court enforce are precisely what a valued relationship elicits, for the party who means to keep his partner gives more than any clause could compel. Against all this, the formal contract and its law stand as the expensive backstop of last resort — invoked not in the ordinary course but when the relationship breaks down entirely, when one party means to walk away and no future restrains him, and the disappointed other turns at last to the court. The law is what the parties fall back on when the relationship fails; but while the relationship holds, it does the work the law cannot, and does it better.⁴

Yet the relational contract has limits as sharp as its strengths, and they mark exactly where the formal contract and its law become indispensable. The relationship enforces only where there is a future to value: it fails in the one-shot deal, where the parties will not meet again and the shadow of the future does not fall; it fails among strangers, who have no relationship to lose and no shared reputation to forfeit; it fails across distance and difference, where reputation cannot travel and conduct cannot be observed. In all these cases — the very cases the impersonal modern economy most requires, the dealing with the distant and the unknown — the self-enforcing relationship offers no enforcement at all, and there the formal contract, backed by the law's sword, must serve. And the relational contract has a darker limit too: the relationships and reputations that enforce it can entrench and exclude, binding the insiders who have them and shutting out the newcomer who has none, so that a world governed by relationship can be a closed world, where one cannot deal at all without the connections one was not born to. The relational contract governs the world of the known; the formal contract opens the world of the stranger.⁵

The handshake, then, is the contract that needs no court: the promise kept not for fear of the sword but for the worth of the relationship, enforced by the shadow of the future and the value of a name. Macaulay found it to be the most of what contracting actually is — the formal contract a frame, the relationship the substance, the law a backstop rarely reached. And it answers, in its domain, the volume's central question: what fills the gaps the written contract cannot close is the relationship itself, the trust between parties who deal again tomorrow, filling the unforeseen as it comes by good faith rather than by clause. But the relationship reaches only as far as the future is valued and reputation travels — to the edge of the known, and no further — and beyond it the formal contract must serve the world of strangers. We have now seen all the gap-fillers: the law's defaults, the designed incentive, the self-enforcing relationship. It remains to ask what they have in common, and what their common dependence reveals about the contract itself. The next plate is the flagship. The next plate is the promise.