Working Paper: CEPR ID: DP8195
Authors: Elisabetta Iossa; Giancarlo Spagnolo
Abstract: Contracts often reward inefficient tasks and are not enforced ex post. We provide a new explanation based on the relationship between explicit contracts and implicit agreements, distinguishing the ex-ante decision to sign a contract from the ex-post decision whether to apply it. We show that it is often optimal to have overcontracting - contractual clauses requiring costly, inefficient, verifiable tasks (A) - not enforced in equilibrium. Overcontracting facilitates relational contracting on efficient non-contractible tasks (B) by anticipating and strengthening punishments following defections. With adverse selection, it is optimal to choose tasks A analogous to B in terms of required skills. The model also explains why stipulated damages must be moderate in size. These results apply independently of whether B is a `productive' task or a 'bribe'.
Keywords: governance; incomplete contracts; multitasking; relational contracts
JEL Codes: C73; D86; L14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Overcontracting (task A) (D86) | Improved performance on noncontractible tasks (task B) (D29) |
| Choice of inefficient tasks (A) (D61) | Enhanced enforcement of relational contracts on efficient tasks (B) (D86) |
| Inefficient contractual clauses (D86) | Encouragement of compliance on noncontractible tasks (task B) (C78) |
| Presence of inefficient tasks (D24) | Increased likelihood of cooperation on efficient tasks (task B) (C71) |
| Moderate penalties for contract infringement (K12) | Maintenance of cooperation dynamics (D70) |
| Choice of tasks A should require skills analogous to those needed for task B (Y80) | Optimization of relational contract's effectiveness (L14) |