In today’s globalized economy, trust is a cornerstone of successful business relationships, particularly in contracts that span industries, regions, and countries. The enforcement of business contracts is critical, but the means by which this trust is established often extend beyond formal legal institutions. This article draws on a study titled “How Do Business Associations Support Contract Enforcement? Evidence from Hungary” to explore how business associations (BAs) play a vital role in contract enforcement mechanisms, especially in developed economies with well-functioning legal systems, such as Hungary. Through mechanisms such as member selection, norm enforcement, dispute resolution, and information sharing, BAs act as private-order institutions that enhance the credibility of business relationships.
The Role of Business Associations in Contract Enforcement
Business associations, as private-order institutions, fill a crucial gap between informal trust-building mechanisms and the formal legal system. Economic theory suggests that BAs have the potential to extend the scope of sanctions beyond personal or local ties, providing contract enforcement at a lower cost than through courts. While previous research has primarily focused on their role in countries with weak or dysfunctional legal systems, this study investigates how BAs operate in a developed context.
Using a large-scale survey of small and medium-sized enterprises (SMEs) in Hungary, the study finds that BAs are effective in building contractual trust among members, as well as between members and non-members. Specifically, mechanisms such as information sharing and member selection were shown to be the most influential, suggesting that the roles of BAs in contract enforcement extend beyond dispute resolution.
Mechanisms of Contractual Trust: How BAs Operate
The study identifies four main mechanisms through which business associations support contract enforcement:
Member Selection: BAs enforce ethical and professional standards when selecting members, ensuring that firms joining the association have a strong willingness and capability to fulfill their contractual commitments. This form of selection serves as a signal of trustworthiness, which increases the confidence that both members and non-members have in the association’s members. The study finds that BAs with robust member selection processes are more likely to foster trust between members and also from outsiders, who rely on these signals to gauge the reliability of firms.
Norm Enforcement: Many BAs establish formal codes of conduct or professional standards, which members are required to follow. These norms are often enforced through formal mechanisms, such as accreditation and regular audits, as well as informal social pressure. This enforcement supports a culture of compliance within the association and acts as a deterrent against contractual breaches. However, the study notes that formal norm enforcement is particularly important for establishing trust with non-members who need to be reassured that association members adhere to certain standards.
Dispute Resolution: Another important function of BAs is providing a platform for resolving business disputes among members. These services are usually quicker and less costly than pursuing legal action through the courts. While this mechanism is primarily beneficial for maintaining trust between association members, it can also have a positive spillover effect on relationships with non-members, particularly if the BA offers dispute resolution services to them as well.
Information Sharing: Perhaps the most significant contribution BAs make to contract enforcement is through facilitating the flow of reliable information about the performance and reliability of businesses. By sharing records and reputation-related information about their members, BAs strengthen the reputational incentives that encourage businesses to honor their contracts. This information-sharing function is vital for fostering trust both within the association and with external business partners.
Trust in Distant and Unknown Business Partners
One of the key findings of the study is the impact of BAs on fostering trust in business relationships with geographically distant or initially unknown partners. In theory, trust is harder to build with partners who are outside one’s immediate network, as informal enforcement mechanisms are weaker in such cases. The study shows that BAs, particularly those that engage in ethical selection and information sharing, play an essential role in bridging this gap. By providing a platform for businesses to learn about the reputation and performance of potential partners, BAs help firms to engage in new business relationships with confidence, thereby facilitating market expansion and diversification.
This aspect of the study aligns with broader theories about the role of business associations in market economies. While interest-group theory often characterizes BAs as self-serving entities that pursue the narrow interests of their members (Olson, 1982), this study adds to a growing body of evidence that BAs also contribute to broader economic welfare by facilitating trust and cooperation in the marketplace. In this sense, they align more closely with Putnam’s (1993) view of civic associations as value-creating institutions that enhance social capital and cooperation.
The Hungarian Context: A Developed Legal System
The study’s focus on Hungary is particularly relevant because it provides a glimpse into how BAs function in a developed legal context. Hungary, with its well-established legal system and strong tradition of private law, offers a case study of how BAs continue to play an essential role in contract enforcement even when courts are effective. The findings suggest that BAs are not just a substitute for weak legal institutions but serve as complementary mechanisms that enhance the credibility of business commitments.
Hungary’s strong showing in global rankings of contract enforcement (23rd in the World Bank’s Doing Business report in 2016) highlights the country’s robust legal framework. However, the study finds that even in this context, BAs play an important role in supporting business trust and contractual enforcement, particularly through information sharing and member selection. This suggests that the role of BAs is not diminished as legal systems improve, but rather that they continue to provide valuable services that enhance the functioning of markets.
Policy Implications and Future Research
The findings of this study have important implications for policymakers and business leaders. For policymakers, the study highlights the importance of supporting and promoting business associations as essential institutions that contribute to the health of the economy. By fostering trust, facilitating contract enforcement, and helping businesses to navigate the complexities of the marketplace, BAs play a vital role in promoting economic growth and stability.
For business leaders, the study underscores the value of participating in BAs, particularly those that engage in active member selection, norm enforcement, and information sharing. By joining associations that offer these services, businesses can enhance their credibility and build stronger relationships with both their peers and potential partners.
Future research could build on these findings by examining the role of BAs in other developed economies and by exploring how digital platforms and technologies are reshaping the ways in which business associations support contract enforcement.
Conclusion
Business associations are often overlooked in discussions about contract enforcement, but this study sheds light on their critical role in fostering trust and ensuring the credibility of business relationships. In Hungary, BAs play an essential role in supporting contractual trust through mechanisms like member selection, norm enforcement, dispute resolution, and information sharing. These institutions are particularly valuable in building trust between distant or initially unknown business partners, making them an indispensable part of the modern market economy.
As businesses navigate an increasingly complex and globalized world, the role of BAs in supporting contract enforcement will only become more important. Their ability to enhance trust, provide dispute resolution services, and facilitate information sharing makes them key players in the smooth functioning of markets, both in Hungary and beyond.
This blog post is based on the research paper: How do business associations support contract enforcement? Evidence from Hungary – published in Annals of Public and Cooperative Economics.
