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Contentious Contracts

  • Hege, Ulrich
  • Viala, Pascale

This paper offers an explanation of rationally incomplete contracts, where incompleteness refers to unforeseen contingencies. Agents enter a two-sided moral hazard relationship, in which a commitment to discard parts of the joint resources may be ex-ante efficient. This happens through costly legal dispute which arises when contract terms are missing for undesirable outcomes. We show that an optimal contract needs only to specify the obligation for the more litigious party to assure a certain output level – the threshold between foreseen and unforeseen contingencies – and a linear sharing rule for the foreseen contingencies. If litigation reveals some information about the effort levels of the agents, less costly dispute is typically needed and the allocation will improve.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1910.

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Date of creation: Jun 1998
Date of revision:
Handle: RePEc:cpr:ceprdp:1910
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  1. Alchian, Armen A & Demsetz, Harold, 1972. "Production , Information Costs, and Economic Organization," American Economic Review, American Economic Association, vol. 62(5), pages 777-95, December.
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  8. Kennan, John & Wilson, Robert, 1993. "Bargaining with Private Information," Journal of Economic Literature, American Economic Association, vol. 31(1), pages 45-104, March.
  9. Sugato Bhattacharyya & Francine Lafontaine, 1995. "Double-Sided Moral Hazard and the Nature of Share Contracts," RAND Journal of Economics, The RAND Corporation, vol. 26(4), pages 761-781, Winter.
  10. Luca Anderlini & Leonardo Felli, 1996. "Costly Contingent Contracts," STICERD - Theoretical Economics Paper Series 313, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  11. Schweizer, Urs, 1989. "Litigation and Settlement under Two-Sided Incomplete Information," Review of Economic Studies, Wiley Blackwell, vol. 56(2), pages 163-77, April.
  12. Shavell, Steven, 1984. "The Design of Contracts and Remedies for Breach," The Quarterly Journal of Economics, MIT Press, vol. 99(1), pages 121-48, February.
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  15. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-90, September.
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