Enforceability and risk-sharing in financial contracts : from the sea loan to the commenda in late medieval Venice

Abstract

Long lasting sea loan and commenda contracts can be seen as optimal contracts in economies with enforcement and verifiability constraints. These contracts allowed the financing of ’large commercial enterprises' for more them 15 centuries. While the sea loan (a simple debt contract) was the dominant contract until the beginning of the Commercial Revolution, the more refined (state-contingent) commenda (a simple equity contract) replaced it when, and where, the verifiability constraints ceased to be binding. A simple contracting model that captures these features is developed. Then, using data from Venice commerce in the period 1021-12611 advance that in late medieval Venice institutions for contract enforcement were based on the authority of the "state”. By the state I mean a third-party enforcer with coercive power. However, this state-based mechanism cannot be identified with the legal system, at least as traditionally described by economic historians and economists. It went far beyond securing property rights, ensuring freedom of contracts, and providing impartial justice. The peculiarity of this state-based mechanism for contract enforcement is that it also generated verifiable information, coercive power, and incentives for merchants to submit themselves to the coercive power of the state. To these ends, the Venetians implemented a whole set of institutional arrangements that reflected and reinforced the entire organization of the society, both political- and economically. These institutional arrangements rendered effective the expectation of being punished by the state for embezzling part of all of the funds entrusted by financiers. In doing so, they enabled a fairly developed system of contracts, including the commenda. Moreover, the development of better ’’legal institutions and judicial enforcement" also enabled the transition from the sea loan to the commenda. This, empirically supported, explanation for the development of alternative financial contracts differs from a simple 'reputation mechanism' where financing is done through networks (families. etc.).