The Crunchpad, a tablet PC project spearheaded by Michael Arrington, based on the feedback of the TechCrunch user community and engineered by FusionGarage, has spectacularly imploded over the last couple weeks.

I’ve been interested to read about how seemingly ‘underpapered’ this deal was:  FusionGarage claims there simply was no contract between them and TechCrunch.  The general reaction from observers seems to be somewhere between confusion and horror.  Why would such an important project be run on the trust between the partners?  Why wouldn’t this undertaking be wrapped up in ironclad legalese and staffed on both sides by razor-toothed lawyers?

The notion that contracting must underlie every deal to avoid TechCrunch style nightmares is pervasive.  In a 2002 study, Manigart, Korsgaard, Folger, Sapienza and Baeyens presented investors with hypothetical investment opportunites.  When responding to these paper vignettes, investors claimed to want bulletproof contracting even in the presence of trust.  In theory, people want to have their cake and eat it, too:  They want relationships based on mutual trust but underpinned with contracting, incentives, monitoring and punishment.  The pervasive view in business seems to echo Reagan:  ”Trust, but verify.”

The problem is, verification isn’t free.

Not only does contracting cost time and money, but trust researchers Davis, Schoorman and Donaldson (1997) warn that contracting may also have the effect of diminishing trust.  ”Control,” they wrote, “can be potentially counterproductive, because it undermines pro-organizational behaviour.”  Swiss economist Bruno Frey has made a similar point, suggesting that in some situations contracting can ‘crowd out’ trust in relationships by cheapening longstanding, “personalized” relationships.

In some ways, parties in business partnerships suffer much the same dilemma faced by fiancés considering a prenuptial agreement:  Contracting is useful and helps avoid the risk of opportunism, but it communicates considerable skepticism and distrust to the other party.

There’s a lot to be said, in other words, about wild, precipitous acts of trust.  But as TechCrunch has learned, there is also much to be lost.  Here are four ways of distinguishing the constructive from the calamitous when it comes to using trust instead of contracting:

  1. Clarify the details. One of the things contracts are useful for is making expectations perfectly clear.  If you don’t have a contract, make sure that you are still clearly talking through each side’s assumptions and expectations.  These are difficult conversations, but important ones.
  2. Build a shared identity.  The psychology of identity can be really powerful.  If both sides in a partnership see themselves as attached to a common project, and invest their self of self into a shared group, they tend to behave more cooperatively.  They don’t draw as sharp a distinction between their own outcomes and the group’s outcome.  They think of the group’s successes as their own, and are less prone to act out of raw self-interest.  Being part of a group that trusts one another and acts in the service of the collective can also provide a motivational and emotional boost that can be an end in itself (and serve to further discourage opportunism).  This argument, for those interested, is far better articulated in Rod Kramer and colleagues’ 2001 chapter in Groups at Work:  Theory and Research.
  3. Depend on each other. In the Crunchpad partnership, TechCrunch was entirely reliant on FusionGarage, while FusionGarage seems capable of going it alone without TechCrunch’s ongoing involvement.  ’Undercontracted’ partnerships are more successful when there is mutual and symmetric dependence — where each player brings something unique and hard-to-replace to the table.  (A caveat here:  The only time this doesn’t work is when both parties are the monopoly providers of their piece of the partnership; see that Nobel-winnin’ Williamson fella on the risks of bilateral monopoly).  But the overall message remains:  If you want to depend on trust rather than contracts, don’t set up a situation where one side risks everything and the other risks nothing.
  4. Let the future cast a shadow on the present. Okay, I’m stealing Robert Axelrod’s phrase, but it’s a good one:  People tend to cooperate more when it’s not a one-shot game.  If you plan to work on more than one project together, and if there are ways for each party’s reputation to travel, it helps keep people honest.  Contracting can be a (costly) substitute for some of these things, but it’s ideal to create a situation where the short-term gains of opportunism are outweighed by long-lasting reputations and relationships.