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Bounded rationality and incomplete contracts

  • Anderlini, Luca
  • Felli, Leonardo

This paper explores the link between boundedly rational behaviour and incomplete contracts. The bounded rationality of the agents in our world is embodied in a constraint that the contracts they write must be algorithmic in nature. We start with a definition of contract incompleteness that seems both appealing and widely applicable. Our first task is then to show that, by itself, the algorithmic nature of contracts is not enough to generate genuinely incomplete contracts in equilibrium. As in Anderlini and Felli (1994), we call this the Approximation Result. We then consider contractual situations in which the complexity costs of a contract are explicitly taken into accoaunt. We consider a broad (axiomatically defined) class of complexity measures and in this framework we show that incomplete contracts obtain in equilibrium. We also extensively discuss some recent literature directly related to the results reported here

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Article provided by Elsevier in its journal Research in Economics.

Volume (Year): 58 (2004)
Issue (Month): 1 (March)
Pages: 3-30

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Handle: RePEc:eee:reecon:v:58:y:2004:i:1:p:3-30
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  1. 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.
  2. Hart, Oliver D. & Moore, John, 1990. "Property Rights and the Nature of the Firm," Scholarly Articles 3448675, Harvard University Department of Economics.
  3. Luca Anderlini & Leonardo Felli, 1994. "Incomplete Written Contracts: Undescribable States of Nature," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 1085-1124.
  4. Philippe Aghion & Jean Tirole, 1994. "Formal and Real Authority in Organizations," Working papers 95-8, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. Oliver Hart & John Moore, 1999. "Foundations of Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 115-138.
  6. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, vol. 67(4), pages 741-782, July.
  7. Ilya Segal, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 57-82.
  8. Hardman Moore, John & Hart, Oliver, 1985. "Incomplete Contracts and Renegotiation," CEPR Discussion Papers 60, C.E.P.R. Discussion Papers.
  9. P. Battigalli & G. Maggi, 2000. "Imperfect Contracting," Princeton Economic Theory Papers 00s11, Economics Department, Princeton University.
  10. Grossman, Sanford J & Hart, Oliver D, 1986. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Journal of Political Economy, University of Chicago Press, vol. 94(4), pages 691-719, August.
  11. Raghuram G. Rajan & Luigi Zingales, 1997. "Power in a Theory of the Firm," NBER Working Papers 6274, National Bureau of Economic Research, Inc.
  12. Nabil I. Al-Najjar & Luca Anderlini & Leonardo Felli, 2006. "Undescribable Events," Review of Economic Studies, Oxford University Press, vol. 73(4), pages 849-868.
  13. Anderlini, Luca & Felli, Leonardo, 1998. "Describability and agency problems," European Economic Review, Elsevier, vol. 42(1), pages 35-59, January.
  14. Luca Anderlini & Leonardo Felli, 1999. "Incomplete Contracts and Complexity Costs," Theory and Decision, Springer, vol. 46(1), pages 23-50, February.
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