Working Paper: NBER ID: w26245
Authors: David Frydlinger; Oliver D. Hart
Abstract: We consider a buyer and seller who contract over a service. The contract encourages investment and provides a reference point for the transaction. In normal times the contract works well. But with some probability an abnormal state occurs and the service must be modified. The parties expect each other to behave “reasonably”, but given self-serving biases their views of reasonableness may not coincide, leading to aggrievement and deadweight losses. The adoption by the parties of guiding principles such as loyalty and equity in their contract can help. We provide supporting evidence in the form of case studies and interviews.
Keywords: contractual incompleteness; guiding principles; loyalty; equity; deadweight losses
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 |
|---|---|
| guiding principles (I00) | reduction of deadweight losses (H21) |
| aggrievement (J52) | deadweight losses (H21) |
| contractual incompleteness (D86) | aggrievement (J52) |
| guiding principles (I00) | improvement of contractual relationships (L14) |
| communication processes (L96) | activation of guiding principles (G38) |
| contract incorporating guiding principles (K12) | better performance than standard contract (D86) |