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Incentive provision when contracting is costly

  • Kvaløy, Ola

    (Dept. of Economics and Business Administration, University of Stavanger)

  • Olsen, Trond E.

    ()

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

We analyze optimal incentive contracts in a model where the probability of court enforcement is determined by the costs spent on contracting. We show that contract costs matter for incentive provision, both in static spot contracts and repeated game relational contracts. We find that social surplus may be higher under costly relational contracting than under costless verifiable contracting, and show that there is not a monotonic relationship between contracting costs and incentive intensity. In particular we show that an increase in contracting costs may lead to higher-powered incentives. Moreover we formulate hypotheses about the relationship between legal systems and incentive provision, specifically the model predicts higher-powered incentives in common law than in civil law systems.

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File URL: http://hdl.handle.net/11250/164144
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Paper provided by Department of Business and Management Science, Norwegian School of Economics in its series Discussion Papers with number 2010/10.

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Length: 34 pages
Date of creation: 31 Aug 2010
Date of revision:
Handle: RePEc:hhs:nhhfms:2010_010
Contact details of provider: Postal:
NHH, Department of Business and Management Science, Helleveien 30, N-5045 Bergen, Norway

Phone: +47 55 95 92 93
Fax: +47 55 95 96 50
Web page: http://www.nhh.no/en/research-faculty/department-of-business-and-management-science.aspx
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  1. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
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  9. Alan Schwartz, 2004. "The Law and Economics of Costly Contracting," Journal of Law, Economics and Organization, Oxford University Press, vol. 20(1), pages 2-31, April.
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  11. Bull, Jesse & Watson, Joel, 2002. "Evidence Disclosure and Verfiability," University of California at San Diego, Economics Working Paper Series qt19p7z2gm, Department of Economics, UC San Diego.
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  13. Dye, Ronald A, 1985. "Costly Contract Contingencies," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(1), pages 233-50, February.
  14. Erling Barth & Bernt Bratsberg & Torbjørn Hægeland & Oddbjørn Raaum, 2008. "Who pays for performance?," International Journal of Manpower, Emerald Group Publishing, vol. 29(1), pages 8-29, May.
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  18. Pierpaolo Battigalli & Giovanni Maggi, 2008. "Costly contracting in a long-term relationship," RAND Journal of Economics, RAND Corporation, vol. 39(2), pages 352-377.
  19. Ola Kvaløy & Trond E. Olsen, 2009. "Endogenous Verifiability and Relational Contracting," American Economic Review, American Economic Association, vol. 99(5), pages 2193-2208, December.
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  24. Pearce, David G. & Stacchetti, Ennio, 1998. "The Interaction of Implicit and Explicit Contracts in Repeated Agency," Games and Economic Behavior, Elsevier, vol. 23(1), pages 75-96, April.
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