More is Less
Why Parties May Deliberately Write Incomplete Contracts

A verifiable contingency provides additional reference points for parties writing incomplete contracts, potentially hindering renegotiation.

Maija Halonen-Akatwijuka (Author), Oliver Hart (Author)

9781009396073, Cambridge University Press

Paperback / softback, published 23 May 2024

34 pages
22.8 x 15.1 x 0.3 cm, 0.07 kg

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.

1. Introduction
2. The model
3. Is more less?
4. Large gains in event
5. Summary and conclusions
Appendix
References.

Subject Areas: Economics [KC]