Reputation Effect on Contract Choice and Self-Enforcement: A Case Study of Farmland Transfer in China

Abstract

The prevailing informal contracts of farmland transfer in China are facing frequent disputes and defaults, which call for effective self-enforcement mechanisms operating through transactors’ reputations and social networks. However, the effects of reputation on contract choice and self-enforcement have not been thoroughly considered and examined by existing research in the case of farmland transfer. This study explores the reputation’s ex-ante signaling effect on farmers’ contract choices and the ex-post penalty effect on farmers’ performance in informal contracts. Based on 403 transfer contracts obtained from a field survey conducted in the Hebei province of China, we apply the multinomial logit model and Heckman probit model to perform empirical analysis. The results show that, affected by the penalty effect, farmers with good reputations are more likely to fulfill informal contracts to avoid reputation damage and the resulting loss of future trading opportunities. However, in the ex-ante stage of contract choice, a farmer’s reputation has no significant signaling effect on the formation of informal contracts. The informal contracts are chosen due to farmers’ trust in the close social network and the demand for reduced transaction costs. These findings highlight the importance of personal reputation serving as a form of relational governance in the self-enforcement of informal contracts, which provides a means of enhancing the informal contract’s effectiveness in terms of farmland transfer in the rural acquaintance society. It also provides insights into the necessity of creating a supportive environment for informal rules. Policies should encourage the building of personal reputation and establishment of good social norms to form a long-term, stable and reasonable contractual relationship for farmland transfer.