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Contracts as Threats: on a Rationale For Rewarding A while Hoping For B

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  • Iossa, Elisabetta
  • Spagnolo, Giancarlo

Abstract

Contracts often reward inefficient tasks and are not enforced ex post. We provide a new explanation based on the relationship between explicit contracts and implicit agreements, distinguishing the ex-ante decision to sign a contract from the ex-post decision whether to apply it. We show that it is often optimal to have overcontracting - contractual clauses requiring costly, inefficient, verifiable tasks (A) - not enforced in equilibrium. Overcontracting facilitates relational contracting on efficient non-contractible tasks (B) by anticipating and strengthening punishments following defections. With adverse selection, it is optimal to choose tasks A analogous to B in terms of required skills. The model also explains why stipulated damages must be moderate in size. These results apply independently of whether B is a `productive' task or a 'bribe'.

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  • Iossa, Elisabetta & Spagnolo, Giancarlo, 2011. "Contracts as Threats: on a Rationale For Rewarding A while Hoping For B," CEPR Discussion Papers 8195, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:8195
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    Cited by:

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    2. David Martimort & Aggey Semenov & Lars Stole, 2017. "A Theory of Contracts with Limited Enforcement," Review of Economic Studies, Oxford University Press, vol. 84(2), pages 816-852.
    3. Butler, Jeffrey V. & Carbone, Enrica & Conzo, Pierluigi & Spagnolo, Giancarlo, 2020. "Past performance and entry in procurement: An experimental investigation," Journal of Economic Behavior & Organization, Elsevier, vol. 173(C), pages 179-195.
    4. Decio Coviello & Luigi Moretti & Giancarlo Spagnolo & Paola Valbonesi, 2018. "Court Efficiency and Procurement Performance," Scandinavian Journal of Economics, Wiley Blackwell, vol. 120(3), pages 826-858, July.
    5. Kopányi-Peuker, Anita & Offerman, Theo & Sloof, Randolph, 2017. "Fostering cooperation through the enhancement of own vulnerability," Games and Economic Behavior, Elsevier, vol. 101(C), pages 273-290.
    6. James M. Malcomson, 2012. "Relational Incentive Contracts," Introductory Chapters, in: Robert Gibbons & John Roberts (ed.),The Handbook of Organizational Economics, Princeton University Press.
    7. Sergio Vergalli & Chiara D’Alpaos & Michele Moretto & Paola Valbonesi, 2009. ""It Is Never too late": Optimal Penalty for Investment Delay in Public Procurement Contracts," Working Papers 2009.78, Fondazione Eni Enrico Mattei.
    8. Spagnolo, Giancarlo, 2012. "Reputation, competition, and entry in procurement," International Journal of Industrial Organization, Elsevier, vol. 30(3), pages 291-296.
    9. Giuseppe Gori & Patrizia Lattarulo & Marco Mariani, 2014. "The effect of Regional Law 35/2011 on strategic public works," Studi e approfondimenti 521, Istituto Regionale per la Programmazione Economica della Toscana.

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    More about this item

    Keywords

    Governance; incomplete contracts; multi-tasking; relational contracts;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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