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Costly contracting in a long-term relationship

  • Pierpaolo Battigalli
  • Giovanni Maggi

We examine a model of contracting where parties interact repeatedly and can contract at any point in time, but writing formal contracts is costly. A contract can describe the external environment and the parties' behavior in a more or less detailed way, 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 contracting, 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. Copyright (c) 2008, RAND.

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Article provided by RAND Corporation in its journal The RAND Journal of Economics.

Volume (Year): 39 (2008)
Issue (Month): 2 ()
Pages: 352-377

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Handle: RePEc:bla:randje:v:39:y:2008:i:2:p:352-377
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  1. Nabil Al-Najjar & Luca Anderlini & Leonardo Felli, 2002. "Unforeseen contingencies," LSE Research Online Documents on Economics 3578, London School of Economics and Political Science, LSE Library.
  2. Maskin, Eric & Tirole, Jean, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 83-114, January.
  3. Anderlini, L. & Felli, L., 1993. "Incomplete Written Contracts: Undescribable States of Nature," Papers 183, Cambridge - Risk, Information & Quantity Signals.
  4. Gray, Jo Anna, 1978. "On Indexation and Contract Length," Journal of Political Economy, University of Chicago Press, vol. 86(1), pages 1-18, February.
  5. Gray, Jo Anna, 1976. "Wage indexation: A macroeconomic approach," Journal of Monetary Economics, Elsevier, vol. 2(2), pages 221-235, April.
  6. Bull, Clive, 1987. "The Existence of Self-Enforcing Implicit Contracts," The Quarterly Journal of Economics, MIT Press, vol. 102(1), pages 147-59, February.
  7. Luca Anderlini & Leonardo Felli, 1999. "Incomplete Contracts and Complexity Costs," Theory and Decision, Springer, vol. 46(1), pages 23-50, February.
  8. Baker, George & Gibbons, Robert & Murphy, Kevin J, 1994. "Subjective Performance Measures in Optimal Incentive Contracts," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 1125-56, November.
  9. W. Bentley MacLeod & James M. Malcomson, 1986. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment," Working Papers 585, Queen's University, Department of Economics.
  10. 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.
  11. W. Bentley Macleod, 2000. "Complexity and Contract," Revue d'Économie Industrielle, Programme National Persée, vol. 92(1), pages 149-178.
  12. 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.
  13. 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.
  14. Oliver Hart & Bengt Holmstrom, 1986. "The Theory of Contracts," Working papers 418, Massachusetts Institute of Technology (MIT), Department of Economics.
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