Procedural vs. Substantive Approaches in Non-Comprehensive Contracts

In this study, we examine two adjudication methods designed to resolve disputes between principals and agents concerning bonus payments in relationships characterized by moral hazard and where the parties have been forced to use soft, imprecise, and subjective information to align incentives. The first method is a procedural approach where the court applies preponderance-of-the-evidence to determine whether the agent acted in accordance with the contract. In the second method, the court adopts a substantive approach, treating the original contract as incomplete, thus rendering a decision based on what it believes the parties would have agreed upon had they been able to complete the contract ahead of time. From an efficiency standpoint, we find that neither method consistently outperforms the other, although the procedural approach becomes more advantageous as the effort to be implemented becomes sufficiently large.