Working Paper: NBER ID: w19001
Authors: Maija Halonen-Akatwijuka; Oliver D. Hart
Abstract: Why are contracts incomplete? Transaction costs and bounded rationality cannot be a total explanation since states of the world are often describable, foreseeable, and yet are not mentioned in a contract. Asymmetric information theories also have limitations. We offer an explanation based on "contracts as reference points". Including a contingency of the form, "The buyer will require a good in event E", has a benefit and a cost. The benefit is that if E occurs there is less to argue about; the cost is that the additional reference point provided by the outcome in E can hinder (re)negotiation in states outside E. We show that if parties agree about a reasonable division of surplus, an incomplete contract can be strictly superior to a contingent contract.
Keywords: No keywords provided
JEL Codes: D23; D86; K12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| contractual incompleteness (D86) | costs associated with anticipating contingencies (D84) |
| costs associated with anticipating contingencies (D84) | inclusion of contingencies in contracts (D86) |
| inclusion of contingencies in contracts (D86) | hindered renegotiation (L15) |
| hindered renegotiation (L15) | deadweight losses from shading (H21) |
| similar views about division of surplus (D46) | exclusion of verifiable contingencies from contracts (D86) |