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Rigidity, Discretion, and the Costs of Writing Contracts

Author

Listed:
  • Pierpaolo Battigalli
  • Giovanni Maggi

Abstract

In this paper we model contract incompleteness "from the ground up," as arising endogenously from the costs of describing the environment and the parties' behavior. Optimal contracts may exhibit two forms of incompleteness: discretion, meaning that the contract does not specify the parties' behavior with sufficient detail; and rigidity, meaning that the parties' obligations are not sufficiently contingent on the external state. The model sheds light on the determinants of rigidity and discretion in contracts, and yields rich predictions regarding the impact of changes in the exogenous parameters on the degree and form of contract incompleteness. (JEL D23, D8, L14)

Suggested Citation

  • 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.
  • Handle: RePEc:aea:aecrev:v:92:y:2002:i:4:p:798-817
    Note: DOI: 10.1257/00028280260344470
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    References listed on IDEAS

    as
    1. Al-Najjar, Nabil & Anderlini, Luca & Felli, Leonardo, 2002. "Unforeseen contingencies," LSE Research Online Documents on Economics 3578, London School of Economics and Political Science, LSE Library.
    2. Allen, Franklin & Gale, Douglas, 1992. "Measurement Distortion and Missing Contingencies in Optimal Contracts," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 2(1), pages 1-26, January.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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