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Exit options in incomplete contracts with asymmetric information

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  • 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

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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 Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 401, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  2. Tercieux, Olivier & Aghion, Philippe & Fudenberg, Drew & Holden, Richard & Kunimoto, Takashi, 2012. "Subgame-Perfect Implementation Under Information Perturbations," Scholarly Articles 11224965, Harvard University Department of Economics.
  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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