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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
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622941

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  1. Luca Anderlini & Leonardo Felli, 1995. "Describability and Agency Problems," Game Theory and Information 9511001, EconWPA, revised 20 Sep 1996.
  2. Hardman Moore, John & Hart, Oliver, 1985. "Incomplete Contracts and Renegotiation," CEPR Discussion Papers 60, C.E.P.R. Discussion Papers.
  3. Grossman, Sanford J & Hart, Oliver, 1985. "The Cost and Benefits of Ownership: A Theory of Vertical and Lateral Integration," CEPR Discussion Papers 70, C.E.P.R. Discussion Papers.
  4. Anderlini, Luca & Felli, Leonardo, 1998. "Incomplete Contracts and Complexity Costs," MPRA Paper 28483, University Library of Munich, Germany.
  5. Rajan, Raghuram G & Zingales, Luigi, 1998. "Power in a Theory of the Firm," CEPR Discussion Papers 1777, C.E.P.R. Discussion Papers.
  6. Hart, Oliver & Moore, John, 1999. "Foundations of Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 115-38, January.
  7. Aghion, Philippe & Tirole, Jean, 1997. "Formal and Real Authority in Organizations," Scholarly Articles 4554125, Harvard University Department of Economics.
  8. 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.
  9. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, vol. 67(4), pages 741-782, July.
  10. Segal, Ilya, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 57-82, January.
  11. Nabil I. Al-Najjar & Luca Anderlini & Leonardo Felli, 2006. "Undescribable Events," Review of Economic Studies, Oxford University Press, vol. 73(4), pages 849-868.
  12. P. Battigalli & G. Maggi, 2000. "Imperfect Contracting," Princeton Economic Theory Papers 00s11, Economics Department, Princeton University.
  13. Hart, Oliver D. & Moore, John, 1990. "Property Rights and the Nature of the Firm," Scholarly Articles 3448675, Harvard University Department of Economics.
  14. Anderlini, Luca & Felli, Leonardo, 1994. "Incomplete Written Contracts: Undescribable States of Nature," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 1085-1124, November.
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