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Incomplete contracts and corporate ethics: a game theoretical model under fuzzy information

Corporations allocate to they corporate governance structures authority over a large part of the transactions they carry out, both regulated by (incomplete) labour contracts or by (incomplete) arm's length contract. These contracts, as the eventuality of unforeseen contingencies is anticipated, are completed by residual rights of control allocating discretion upon ex ante non-contractible decisions to one party in the contract. Ownership and control structures respond to a need of minimising some transaction costs, but also admit the risk of abuse of authority. Both empirical investigation and theoretical deduction from the theory of firm suggest that corporations need systems of self-regulatory norms of behaviour like codes of ethics exactly because of the 'abuse of authority' problem. One requirement that a code of ethics must satisfy is to answer the question how who holds authority in the firm may undertake commitments over events and situations that cannot be ex ante contractible nor describable. This paper suggests a first modelling of unforeseen contingencies in terms of fuzzy sets theory. Incomplete knowledge about unforeseen contingencies is captured by defining some events as fuzzy sub-sets of the set of unforeseen states of the world. Such events correspond to terms of the ex ante language used to define the domain of general abstract principles. The cost of their all-encompassing nature is vagueness. This opens the route to define domains of abstract principles as fuzzy sets of unforeseen states of the world. Then a model is suggested of the reasoning the players perform, given this incomplete (vague) base of knowledge, in order to jump from vague premises to what it has to be done in any unforeseen contingency. Players' inferences are understood according to the logic of default reasoning. The intuition is that, given our limited knowledge, we extend our belief that the "normal course" does in fact hold also to the unforeseen situations. As a consequence are defined commitments that a player conforming to the code is expected to carry out. This allows replicating within the new context some well-known results in the theory of reputation games.

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Paper provided by Cattaneo University (LIUC) in its series LIUC Papers in Ethics, Law and Economics with number 91.

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Length: 30 pages
Date of creation: Oct 2001
Date of revision:
Publication status: Published in LIUC papers, no.91, 2001 - Etica, diritto ed economia 1
Handle: RePEc:liu:liuced:91
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  1. Fudenberg, Drew & Levine, David K, 1989. "Reputation and Equilibrium Selection in Games with a Patient Player," Econometrica, Econometric Society, vol. 57(4), pages 759-78, July.
  2. Oliver Hart & Sanford Grossman, 1985. "The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration," Working papers 372, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Fudenberg, Drew & Levine, David K, 1992. "Maintaining a Reputation When Strategies Are Imperfectly Observed," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 561-79, July.
  4. Luca Anderlini & Leonardo Felli, 2000. "Bounded Rationality and Incomplete Contracts," STICERD - Theoretical Economics Paper Series 407, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  5. Hart, Oliver & Moore, John, 1999. "Foundations of Incomplete Contracts," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 115-38, January.
  6. Harsanyi,John C., 1986. "Rational Behaviour and Bargaining Equilibrium in Games and Social Situations," Cambridge Books, Cambridge University Press, number 9780521311830.
  7. Anderlini, Luca & Felli, Leonardo, 1998. "Incomplete Contracts and Complexity Costs," MPRA Paper 28483, University Library of Munich, Germany.
  8. Hart, Oliver D. & Moore, John, 1990. "Property Rights and the Nature of the Firm," Scholarly Articles 3448675, Harvard University Department of Economics.
  9. Lorenzo Sacconi & Stefano Moretti, 2002. "Fuzzy norms, default reasoning and equilibrium selection in games under unforeseen contingencies and incomplete knowledge," LIUC Papers in Ethics, Law and Economics 104, Cattaneo University (LIUC).
  10. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, vol. 67(4), pages 741-782, July.
  11. Nash, John, 1950. "The Bargaining Problem," Econometrica, Econometric Society, vol. 18(2), pages 155-162, April.
  12. Drew Fudenberg & Jean Tirole, 1991. "Game Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061414, June.
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