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Exit options in incomplete contracts with asymmetric information

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  • Bester, Helmut
  • Krähmer, Daniel

Abstract

This paper analyzes bilateral contracting in an environment with contractual incompleteness and asymmetric information. One party (the seller) makes an unverifiable quality choice and the other party (the buyer) has private information about its valuation. A simple deterministic exit option contract, which allows the buyer to refuse trade, achieves the first-best in the benchmark cases where either quality is verifiable or the buyerʼs valuation is public information. But, when unverifiable and asymmetric information are combined, deterministic contracts are necessarily inefficient. The first-best can be achieved, however, through simple message games with stochastic terms of trade as off-equilibrium outcomes.

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  • Bester, Helmut & Krähmer, Daniel, 2012. "Exit options in incomplete contracts with asymmetric information," Journal of Economic Theory, Elsevier, vol. 147(5), pages 1947-1968.
    • Handle: RePEc:eee:jetheo:v:147:y:2012:i:5:p:1947-1968
    DOI: 10.1016/j.jet.2012.05.008
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    Cited by:

    1. Matthias Lang, 2023. "Stochastic contracts and subjective evaluations," RAND Journal of Economics, RAND Corporation, vol. 54(1), pages 104-134, March.
    2. Gilberto SERAVALLI, 2011. "Conflict, Contract, Leadership and Innovation: An Interdisciplinary View," Journal of Knowledge Management, Economics and Information Technology, ScientificPapers.org, vol. 1(6), pages 1-48, October.
    3. Philippe Aghion & Drew Fudenberg & Richard Holden & Takashi Kunimoto & Olivier Tercieux, 2012. "Subgame-Perfect Implementation Under Information Perturbations," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 127(4), pages 1843-1881.
    4. Helmut Bester & Johannes Münster, 2016. "Subjective evaluation versus public information," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 61(4), pages 723-753, April.
    5. Takashi Shimizu, 2017. "Cheap talk with an exit option: a model of exit and voice," International Journal of Game Theory, Springer;Game Theory Society, vol. 46(4), pages 1071-1088, November.
    6. Bester, Helmut & Krähmer, Daniel, 2013. "Exit Options and the Allocation of Authority," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 401, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    7. Eccles, Peter & Wegner, Nora, 2016. "Robustness of subgame perfect implementation," Bank of England working papers 601, Bank of England.
    8. Ram Singh, 2018. "Public–private partnerships vs. traditional contracts for highways," Indian Economic Review, Springer, vol. 53(1), pages 29-63, December.

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    More about this item

    Keywords

    Incomplete contracts; Asymmetric information; Option contracts;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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