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Incentive provision when contracting is costly

  • Kvaløy, Ola

    ()

    (UiS)

  • Olsen, Trond

    (NHH)

We analyze optimal incentive contracts in a model where the probability of court enforcement is determined by the costs spent on contracting. The analysis shows that contract costs matter for incentive provision, both in static spot contracts and repeated game relational contracts. We show that there is not a monotonic relationship between contracting costs and incentive intensity, and 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://dl.dropbox.com/u/8078351/uis_wps_econ_fin/uis_wps_2012_16_kvaloy_olsen.pdf
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Paper provided by University of Stavanger in its series UiS Working Papers in Economics and Finance with number 2012/16.

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Length: 47 pages
Date of creation: 19 Sep 2012
Date of revision:
Handle: RePEc:hhs:stavef:2012_016
Contact details of provider: Postal:
University of Stavanger, NO-4036 Stavanger, Norway

Web page: http://www.uis.no/research/economics_and_finance

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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.
  2. Bull, Jesse & Watson, Joel, 2004. "Evidence disclosure and verifiability," Journal of Economic Theory, Elsevier, vol. 118(1), pages 1-31, September.
  3. 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.
  4. Kvaløy, Ola & Olsen, Trond E., 2004. "Endogenous Verifiability in Relational Contracting," Discussion Papers 2004/20, Department of Business and Management Science, Norwegian School of Economics.
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  8. 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.
  9. George Baker & Robert Gibbons & Kevin J. Murphy, 1994. "Subjective Performance Measures in Optimal Incentive Contracts," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 1125-1156.
  10. Steven Shavell, 1980. "Damage Measures for Breach of Contract," Bell Journal of Economics, The RAND Corporation, vol. 11(2), pages 466-490, Autumn.
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  12. Demougin, Dominique & Fluet, Claude, 2001. "Monitoring versus incentives," European Economic Review, Elsevier, vol. 45(9), pages 1741-1764, October.
  13. Katherine Doornik, 2010. "Incentive Contracts with Enforcement Costs," Journal of Law, Economics and Organization, Oxford University Press, vol. 26(1), pages 115-143, April.
  14. Schmidt, Klaus M. & Schnitzer, Monika, 1995. "The interaction of explicit and implicit contracts," Economics Letters, Elsevier, vol. 48(2), pages 193-199, May.
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  18. Steven Shavell, 2006. "On the Writing and the Interpretation of Contracts," Journal of Law, Economics and Organization, Oxford University Press, vol. 22(2), pages 289-314, October.
  19. Dirk Sliwka, 2007. "Trust as a Signal of a Social Norm and the Hidden Costs of Incentive Schemes," American Economic Review, American Economic Association, vol. 97(3), pages 999-1012, June.
  20. Pierpaolo Battigalli & Giovanni Maggi, 2004. "Costly Contracting in a Long-Term Relationship," Working Papers 04-33, New York University, Leonard N. Stern School of Business, Department of Economics.
  21. Schwartz, Alan & Watson, Joel, 2001. "The Law and Economics of Costly Contracting," University of California at San Diego, Economics Working Paper Series qt2wh8m7bv, Department of Economics, UC San Diego.
  22. W. Bentley MacLeod, 2007. "Reputations, Relationships, and Contract Enforcement," Journal of Economic Literature, American Economic Association, vol. 45(3), pages 595-628, September.
  23. Patrick Bajari & Steven Tadelis, 1999. "Incentives versus Transaction Costs: A Theory of Procurement Contracts," Working Papers 99029, Stanford University, Department of Economics.
  24. Ishiguro, Shingo, 2002. "Endogenous Verifiability and Optimality in Agency," Journal of Economic Theory, Elsevier, vol. 105(2), pages 518-530, August.
  25. Louis Kaplow & Steven Shavell, 1992. "Accuracy in the Determination of Liability," NBER Working Papers 4203, National Bureau of Economic Research, Inc.
  26. 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.
  27. Garey Ramey & Joel Watson, 1997. "Contractual Fragility, Job Destruction, and Business Cycles," The Quarterly Journal of Economics, Oxford University Press, vol. 112(3), pages 873-911.
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