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Combining formal and informal contract enforcement in a developed legal system: a latent class approach

Published online by Cambridge University Press:  15 November 2018

Károly Mike*
Faculty of Economics, Corvinus University of Budapest and HETFA Research Institute, Budapest, Hungary
Gábor Kiss
HETFA Research Institute, Budapest Hungary (at the time of researching this article)
*Corresponding author. Email:


How do firms combine a broad range of contract enforcement mechanisms into coherent governance structures? How often are distinct structures used in an economy? We develop a new empirical approach, based on latent class analysis, to answer these questions. Economy-level data from Hungary are used to derive a data-driven typology of contractual governance between firms. The joint use of law, morality, self-enforcing contracts, reputation and community norms is examined. They are shown to be combined into bilateral, third-party or comprehensive governance structures. The crucial governance choice is whether to move beyond bilateralism and, if yes, whether to use a mixture of (formal and informal) third-party mechanisms as a substitute or a complement. Complementarity is much more common. We find no instances of ‘impersonal exchange’; the law never stands alone. By implication, economic development may be best understood as a process from a narrower towards a broader set of enforcement mechanisms.

Research Article
Copyright © Millennium Economics Ltd 2018 

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