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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 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.

Suggested Citation

  • Pierpaolo Battigalli & Giovanni Maggi, 2008. "Costly contracting in a long-term relationship," RAND Journal of Economics, RAND Corporation, vol. 39(2), pages 352-377.
  • Handle: RePEc:bla:randje:v:39:y:2008:i:2:p:352-377
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    References listed on IDEAS

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    Cited by:

    1. Ola Kvaløy & Trond E. Olsen, 2009. "Endogenous Verifiability and Relational Contracting," American Economic Review, American Economic Association, pages 2193-2208.
    2. Aurélien Portuese, 2012. "Law and economics of the European multilingualism," European Journal of Law and Economics, Springer, vol. 34(2), pages 279-325, October.
    3. Dhillon, Amrita & Rigolini, Jamele, 2011. "Development and the interaction of enforcement institutions," Journal of Public Economics, Elsevier, pages 79-87.
    4. Claudine Desrieux & Jean Beuve, 2011. "Relational contracts as a foundation for contractual incompleteness," Economics Bulletin, AccessEcon, vol. 31(3), pages 2030-2040.
    5. Battigalli, Pierpaolo & Fumagalli, Chiara & Polo, Michele, 2007. "Buyer power and quality improvements," Research in Economics, Elsevier, pages 45-61.
    6. Antoine Faure-Grimaud & Eloïc Peyrache & Lucía Quesada, 2009. "The ownership of ratings," RAND Journal of Economics, RAND Corporation, pages 234-257.
    7. Kvaløy, Ola & Olsen, Trond E., 2015. "The tenuous relationship between effort and performance pay," Journal of Public Economics, Elsevier, pages 32-39.
    8. 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.
    9. Jean Beuve & Claudine Desrieux, 2011. "Relational contracts as a foundation for contractual incompleteness," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-01463000, HAL.
    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. 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.
    12. Ola Kvaløy & Trond E. Olsen, 2016. "Incentive Provision when Contracting is Costly," Economica, London School of Economics and Political Science, vol. 83(332), pages 741-767, October.
    13. 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.
    14. 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.
    15. Matthias Fahn & Valeria Merlo & Georg Wamser, 2017. "Relational Contracts, the Cost of Enforcing Formal Contracts, and Capital Structure Choice - Theory and Evidence," Economics working papers 2017-11, Department of Economics, Johannes Kepler University Linz, Austria.
    16. Anthony J. Venables, 2011. "Productivity in cities: self-selection and sorting," Journal of Economic Geography, Oxford University Press, pages 241-251.
    17. Erkal, Nisvan & Wu, Steven Y. & Roe, Brian E., 2014. "Strategic Incomplete Contracts: Theory and Experiments," IZA Discussion Papers 8704, Institute for the Study of Labor (IZA).
    18. Sharon Novak & Scott Stern, 2008. "How Does Outsourcing Affect Performance Dynamics? Evidence from the Automobile Industry," Management Science, INFORMS, pages 1963-1979.
    19. Kukharskyy, Bohdan, 2016. "Relational contracts and global sourcing," Journal of International Economics, Elsevier, pages 123-147.
    20. M'hand Fares, 2009. "Specific Performance, Separability Condition and the Hold-Up Problem," Economics Bulletin, AccessEcon, vol. 29(3), pages 2055-2062.
    21. James M. Malcomson, 2012. "Relational Incentive Contracts," Introductory Chapters,in: Robert Gibbons & John Roberts (ed.), The Handbook of Organizational Economics Princeton University Press.

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