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Endogenous Verifiability and Relational Contracting

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  • Ola Kvaløy
  • Trond E. Olsen

Abstract

Principal-agent models usually invoke the strong assumption that the parties know for sure ex ante whether a variable is verifiable or not. This paper assumes that only the probability of verification is known, and that this probability is endogenously determined. We analyze a principal-agent relationship where the verifiability of the agent's output is determined by the principal's investment in drafting an explicit contract. The model is well suited for analyzing the relationship between explicit contracting, legal courts, trust, and relational contracting. In particular, we show how trust -- established through repeated interaction -- and legal courts may induce contractual incompleteness. (JEL D82, D86)

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.99.5.2193
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Bibliographic Info

Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 99 (2009)
Issue (Month): 5 (December)
Pages: 2193-2208

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Handle: RePEc:aea:aecrev:v:99:y:2009:i:5:p:2193-2208

Note: DOI: 10.1257/aer.99.5.2193
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Citations

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Cited by:
  1. Manuel Willington & Roy Costilla, 2007. "Endogenous Verifiability and Optimality in Agency: A non-contingent approach," ILADES-Georgetown University Working Papers inv189, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines.
  2. Kvaløy, Ola & Olsen, Trond, 2012. "Incentive provision when contracting is costly," UiS Working Papers in Economics and Finance 2012/16, University of Stavanger.
  3. Chen, Bo, 2012. "All-or-nothing payments," Journal of Mathematical Economics, Elsevier, vol. 48(3), pages 133-142.
  4. Michael D. Ryall & Rachelle C. Sampson, 2009. "Formal Contracts in the Presence of Relational Enforcement Mechanisms: Evidence from Technology Development Projects," Management Science, INFORMS, vol. 55(6), pages 906-925, June.
  5. Randolph Sloof & Joep Sonnemans, 2009. "The Interaction between Explicit and Relational Incentives: An Experiment," Tinbergen Institute Discussion Papers 09-030/1, Tinbergen Institute.
  6. James Malcomson, 2010. "Relational Incentive Contracts," Economics Series Working Papers 508, University of Oxford, Department of Economics.
  7. Tore Ellingsen & Eirik Gaard Kristiansen, 2011. "Financial Contracting Under Imperfect Enforcement," The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 323-371.
  8. Bohdan Kukharskyy & Michael Pflüger, 2011. "Relational Contracts and the Economic Well-Being of Nations," Working Papers 095, Bavarian Graduate Program in Economics (BGPE).
  9. Matthias Lang, 2012. "Contracting with Subjective Evaluations and Communication," Working Paper Series of the Max Planck Institute for Research on Collective Goods 2012_14, Max Planck Institute for Research on Collective Goods, revised Feb 2013.
  10. Lumineau, Fabrice & Quelin, Bertrand, 2012. "An Empirical Investigation of Interorganizational Opportunism and Contracting Mechanisms," MPRA Paper 38362, University Library of Munich, Germany.
  11. Hyytinen, Ari & Steen, Frode & Toivanen, Otto, 2012. "Anatomy of Cartel Contracts," Discussion Paper Series in Economics 25/2012, Department of Economics, Norwegian School of Economics.
  12. Hideshi Itoh & Hodaka Morita, 2011. "Formal Contracts, Relational Contracts, and the Threat-Point Effect," CESifo Working Paper Series 3533, CESifo Group Munich.

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