More is Less: Why Parties May Deliberately Write Incomplete Contracts

Maija Halonen-Akatwijuka*, Oliver Hart

*Corresponding author for this work

Research output: Book/ReportAuthored book

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 is strictly superior to a contingent contract. If parties have different views about the division of surplus, an incomplete contract can be superior if including a contingency would lead to divergent reference points.
Original languageEnglish
Place of PublicationUnited Kingdom
PublisherCambridge University Press
Number of pages34
ISBN (Electronic)9781009396059
ISBN (Print)9781009396073, 9781009396059
DOIs
Publication statusE-pub ahead of print - 24 Apr 2024

Publication series

NameElements in Law, Economics and Politics
PublisherCambridge University Press

Structured keywords

  • ECON Microeconomic Theory

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