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Exit options in incomplete contracts with asymmetric information

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Author Info

  • Bester, Helmut
  • Krähmer, Daniel

Abstract

This paper analyzes bilateral contracting in an environment with contractual incompleteness and asymmetric information. One party (the seller) makes an unverifiable quality choice and the other party (the buyer) has private information about its valuation. A simple deterministic exit option contract, which allows the buyer to refuse trade, achieves the first-best in the benchmark cases where either quality is verifiable or the buyerʼs valuation is public information. But, when unverifiable and asymmetric information are combined, deterministic contracts are necessarily inefficient. The first-best can be achieved, however, through simple message games with stochastic terms of trade as off-equilibrium outcomes.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 147 (2012)
Issue (Month): 5 ()
Pages: 1947-1968

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Handle: RePEc:eee:jetheo:v:147:y:2012:i:5:p:1947-1968

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Web page: http://www.elsevier.com/locate/inca/622869

Related research

Keywords: Incomplete contracts; Asymmetric information; Option contracts;

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Citations

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Cited by:
  1. Bester, Helmut & Krähmer, Daniel, 2013. "Exit options and the allocation of authority," Discussion Papers 2013/5, Free University Berlin, School of Business & Economics.
  2. Philippe Aghion & Drew Fudenberg & Richard Holden & Takashi Kunimoto & Olivier Tercieux, 2012. "Subgame-Perfect Implementation Under Information Perturbations," The Quarterly Journal of Economics, Oxford University Press, vol. 127(4), pages 1843-1881.
  3. Bester, Helmut & Münster, Johannes, 2013. "Subjective evaluation versus public information," Discussion Papers 2013/6, Free University Berlin, School of Business & Economics.
  4. Gilberto SERAVALLI, 2011. "Conflict, Contract, Leadership and Innovation: An Interdisciplinary View," Journal of Knowledge Management, Economics and Information Technology, ScientificPapers.org, vol. 1(6), pages 48, October.

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