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Contracts as Threats: on a Rationale For Rewarding A while Hoping For B

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  • Elisabetta Iossa

    (Brunel University; University of Rome 'Tor Vergata', CMPO, CEDI, EIEF)

  • Giancarlo Spagnolo

    (University of Rome 'Tor Vergata', SITE, EIEF, and CEPR)

Abstract

Contracts often reward inefficient tasks and are not enforced ex post. We provide an explanation based on the relationship between explicit contracts and implicit agreements. We show that signing but then ignoring contractual clauses requiring costly, inefficient, verifiable tasks (A) may facilitate relational contracting on efficient noncontractible tasks (B) by anticipating and strengthening punishments following defections. With adverse selection, it is optimal to choose tasks A analogous to B in terms of required skills. We also explain why stipulated damages must be moderate in size. These results apply independently of whether B is a 'productive' task or a 'bribe'.

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Bibliographic Info

Paper provided by Einaudi Institute for Economics and Finance (EIEF) in its series EIEF Working Papers Series with number 1022.

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Length: 31 pages
Date of creation: 2008
Date of revision: Dec 2010
Handle: RePEc:eie:wpaper:1022

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Cited by:
  1. Butler, Jeffrey & Carbone, Enrica & Conzo, Pierluigi & Spagnolo, Giancarlo, 2012. "Reputation and Entry," SITE Working Paper Series 21, Stockholm Institute of Transition Economics, Stockholm School of Economics.
  2. James Malcomson, 2010. "Relational Incentive Contracts," Economics Series Working Papers 508, University of Oxford, Department of Economics.
  3. Anita Kopanyi-Peuker & Theo Offerman & Randolph Sloof, 2012. "Fostering Cooperation through the Enhancement of Own Vulnerability," Tinbergen Institute Discussion Papers 12-132/I, Tinbergen Institute.
  4. Martimort, David & Semenov, Aggey & Stole, Lars, 2014. "A Theory of Contracts With Limited Enforcement," MPRA Paper 53504, University Library of Munich, Germany.
  5. Chiara D'Alpaos & Michele Moretto & Paola Valbonesi & Sergio Vergalli, 2009. "It is never too late: Optimal penalty for investment delay in public procurement contracts," Working Papers, University of Brescia, Department of Economics 0907, University of Brescia, Department of Economics.

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