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Incomplete Contracts and Complexity Costs

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  • Luca Anderlini
  • Leonardo Felli

Abstract

This paper investigates, in a simple risk-sharing framework, the extent to which the incompleteness of contracts could be attributed to the complexity costs associated with the writing and the implementation of contracts. We show that, given any measure of complexity in a very general class, it is possible to find simple contracting problems such that, when complexity costs are explicitly taken into account, the contracting parties optimally choose an incomplete contract which coincides with the ‘default’ division of surplus. Optimal contracts with complexity costs are constrained efficient in our model. We therefore interpret our results as saying that, in the absence of a strategic role for complexity costs, their effect is entirely determined by their size relative to the size of payoffs.

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File URL: http://hdl.handle.net/10.1023/A:1004917722235
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Bibliographic Info

Article provided by Springer in its journal Theory and Decision.

Volume (Year): 46 (1999)
Issue (Month): 1 (February)
Pages: 23-50

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Handle: RePEc:kap:theord:v:46:y:1999:i:1:p:23-50

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Web page: http://www.springerlink.com/link.asp?id=100341

Related research

Keywords: Incomplete contracts; Complexity measures; Computability;

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  1. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
  2. Luca Anderlini & Leonardo Felli, 1998. "Costly coasian contracts," LSE Research Online Documents on Economics 3583, London School of Economics and Political Science, LSE Library.
  3. Aghion, Philippe & Tirole, Jean, 1997. "Formal and Real Authority in Organizations," Scholarly Articles 4554125, Harvard University Department of Economics.
  4. Chung, Tai-Yeong, 1991. "Incomplete Contracts, Specific Investments, and Risk Sharing," Review of Economic Studies, Wiley Blackwell, vol. 58(5), pages 1031-42, October.
  5. Hart, Oliver D. & Moore, John, 1990. "Property Rights and the Nature of the Firm," Scholarly Articles 3448675, Harvard University Department of Economics.
  6. Piccione Michele & Rubinstein Ariel, 1993. "Finite Automata Play a Repeated Extensive Game," Journal of Economic Theory, Elsevier, vol. 61(1), pages 160-168, October.
  7. Georg Noldeke & Klaus M. Schmidt, 1995. "Option Contracts and Renegotiation: A Solution to the Hold-Up Problem," RAND Journal of Economics, The RAND Corporation, vol. 26(2), pages 163-179, Summer.
  8. Anderlini, Luca & Felli, Leonardo, 1994. "Incomplete Written Contracts: Undescribable States of Nature," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 1085-1124, November.
  9. Rubinstein, Ariel, 1986. "Finite automata play the repeated prisoner's dilemma," Journal of Economic Theory, Elsevier, vol. 39(1), pages 83-96, June.
  10. Piccione, Michele, 1992. "Finite automata equilibria with discounting," Journal of Economic Theory, Elsevier, vol. 56(1), pages 180-193, February.
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