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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.

Suggested Citation

  • 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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    References listed on IDEAS

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    Citations

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    Cited by:

    1. 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.
    2. Eccles, Peter & Wegner, Nora, 2016. "Robustness of subgame perfect implementation," Bank of England working papers 601, Bank of England.
    3. 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.
    4. Bester, Helmut & Krähmer, Daniel, 2013. "Exit options and the allocation of authority," Discussion Papers 2013/5, Free University Berlin, School of Business & Economics.
    5. Philippe Aghion & Drew Fudenberg & Richard Holden & Takashi Kunimoto & Olivier Tercieux, 2012. "Subgame-Perfect Implementation Under Information Perturbations," The Quarterly Journal of Economics, Oxford University Press, vol. 127(4), pages 1843-1881.
    6. Takashi Shimizu, 2016. "Cheap Talk with an Exit Option: A Model of Exit and Voice," Discussion Papers 1607, Graduate School of Economics, Kobe University.

    More about this item

    Keywords

    Incomplete contracts; Asymmetric information; Option contracts;

    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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