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Costly Contracting in a Long-Term Relationship

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  • Pierpaolo Battigalli
  • Giovanni Maggi

Abstract

We examine a model of contracting where parties interact repeatedly and can contract at any point in time, but writing enforceable contracts is costly. A contract can describe contingencies and actions at a more or less detailed level, and the cost of writing a contract is proportional to the amount of detail. We consider both formal (externally enforced) and informal (self-enforcing) contracts. The presence of writing costs has important implications both for the optimal structure of formal contracts, particularly the tradeoff between contingent and spot contracts, and for the interaction between formal and informal contracting. Our model sheds light on these implications and generates a rich set of predictions about the determinants of the optimal mode of contracting.

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Bibliographic Info

Paper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 249.

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Date of creation: 2003
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Handle: RePEc:igi:igierp:249

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References

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  1. Nabil J Al-Najjar & Luca Anderlini & Leonardo Felli, 2002. "Unforeseen Contingencies," STICERD - Theoretical Economics Paper Series 431, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  2. Bull, Clive, 1987. "The Existence of Self-Enforcing Implicit Contracts," The Quarterly Journal of Economics, MIT Press, vol. 102(1), pages 147-59, February.
  3. Pearce, David G. & Stacchetti, Ennio, 1998. "The Interaction of Implicit and Explicit Contracts in Repeated Agency," Games and Economic Behavior, Elsevier, vol. 23(1), pages 75-96, April.
  4. 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.
  5. Maskin, Eric & Tirole, Jean, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 83-114, January.
  6. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
  7. MacLeod, W Bentley & Malcomson, James M, 1989. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment," Econometrica, Econometric Society, vol. 57(2), pages 447-80, March.
  8. George Baker & Robert Gibbons & Kevin J. Murphy, 1993. "Subjective Performance Measures in Optimal Incentive Contracts," NBER Working Papers 4480, National Bureau of Economic Research, Inc.
  9. Oliver Hart & Bengt Holmstrom, 1986. "The Theory of Contracts," Working papers 418, Massachusetts Institute of Technology (MIT), Department of Economics.
  10. Anderlini, Luca & Felli, Leonardo, 1998. "Incomplete Contracts and Complexity Costs," MPRA Paper 28483, University Library of Munich, Germany.
  11. Gray, Jo Anna, 1978. "On Indexation and Contract Length," Journal of Political Economy, University of Chicago Press, vol. 86(1), pages 1-18, February.
  12. Pierpaolo Battigalli & Giovanni Maggi, 2002. "Rigidity, Discretion, and the Costs of Writing Contracts," American Economic Review, American Economic Association, vol. 92(4), pages 798-817, September.
  13. Dye, Ronald A, 1985. "Costly Contract Contingencies," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(1), pages 233-50, February.
  14. W. Bentley Macleod, 2000. "Complexity and Contract," Revue d'Économie Industrielle, Programme National Persée, vol. 92(1), pages 149-178.
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Citations

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Cited by:
  1. Mehand Fares, 2009. "Specific performance, separability condition and the hold-up problem," Working Papers 34611, Institut National de la Recherche Agronomique, France.
  2. Dhillon, Amrita & Rigolini, Jamele, 2011. "Development and the interaction of enforcement institutions," Journal of Public Economics, Elsevier, vol. 95(1-2), pages 79-87, February.
  3. Claudine Desrieux & Jean Beuve, 2011. "Relational contracts as a foundation for contractual incompleteness," Economics Bulletin, AccessEcon, vol. 31(3), pages 2030-2040.
  4. Hermalin, Benjamin E. & Li, Larry & Naughton, Tony, 2013. "The relational underpinnings of formal contracting and the welfare consequences of legal system improvement," Economics Letters, Elsevier, vol. 119(1), pages 72-76.
  5. 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.
  6. Kvaløy, Ola & Olsen, Trond E., 2012. "The Tenuous Relationship between Effort and Performance Pay," Discussion Papers 2012/8, Department of Business and Management Science, Norwegian School of Economics.
  7. Kvaløy, Ola & Olsen, Trond E., 2004. "Endogenous Verifiability in Relational Contracting," Discussion Papers 2004/20, Department of Business and Management Science, Norwegian School of Economics.
  8. M'hand Fares, 2009. "Specific Performance, Separability Condition and the Hold-Up Problem," Economics Bulletin, AccessEcon, vol. 29(3), pages 2055-2062.
  9. Wu, Steven Y., 2013. "Adapting Contract Theory to Fit Contract Farming," 2014 Allied Social Science Association (ASSA) Annual Meeting, January 3-5, 2014, Philadelphia, PA 161894, Agricultural and Applied Economics Association.
  10. López-Bayón, Susana & González-Díaz, Manuel, 2010. "Indefinite contract duration: Evidence from electronics subcontracting," International Review of Law and Economics, Elsevier, vol. 30(2), pages 145-159, June.
  11. James Malcomson, 2010. "Relational Incentive Contracts," Economics Series Working Papers 508, University of Oxford, Department of Economics.
  12. Hu, Yifan & Qiu, Larry D., 2010. "An empirical analysis of contracting by Chinese firms," China Economic Review, Elsevier, vol. 21(3), pages 423-431, September.
  13. Aurélien Portuese, 2012. "Law and economics of the European multilingualism," European Journal of Law and Economics, Springer, vol. 34(2), pages 279-325, October.
  14. Kvaløy, Ola & Olsen, Trond, 2012. "Incentive provision when contracting is costly," UiS Working Papers in Economics and Finance 2012/16, University of Stavanger.

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