ABSTRACT
Contract law facilitates exchange in the sense that it makes the gain from trade more predictable. Effi cient exchange, however, requires the existence of clear property rights. North claims that ‘the inability of societies to develop effective, low-cost enforcement of contracts is the most important source of both historical stagnation and contemporary underdevelopment in the Third World’.1 Some evidence in China and elsewhere is consistent with North’s claim.2 Enforcement of contracts, however, can be carried out by informal or formal means.3 The economic theory of self-enforcing contracts suggests that a contract is self-enforcing if the expected future gains from adhering to the contract exceed the current gain from a violation of the contract.4 It is obvious that self-enforcing agreements are not feasible if the sequence of occasions for transactions has a defi nite known last period.5 In addition, highly uncertain conditions are not conducive to self-enforcing agreements.6 In the modern world, however, unexpected things occur very frequently. The Asian fi nancial crisis, the recent US fi nancial crisis and signifi cant change of cost conditions resulting from commodity price fl uctuation are some of the unexpected events which are likely to affect the payoff of contractual parties. To support exchanges, contractual parties may take hostage from the other contractual party.7 If hostage is used, non-performance by a contractual party will result in the loss of or harm to the hostage.
