IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

A Theory of Contracts With Limited Enforcement

Listed author(s):
  • Martimort, David
  • Semenov, Aggey
  • Stole, Lars

We present a Theory of Contracts under costly enforcement in the context of a dynamic relationship between an uninformed buyer and a seller who is privately informed on his persistent cost at the outset. Public enforcement relies on remedies for breach. Private enforcement comes from severing relationships. We first characterize aggregate enforcement constraints ensuring that trading partners do not breach contracts unduly. Whether a long-term contract is enforceable does not depend on the distribution of penalties for breach between the buyer and the seller. While under complete information, the optimal contract would remain stationary, non-stationarity might arise under asymmetric information. Enforcement constraints are time-dependent and easier to satisfy as time passes. Indeed, a high-cost seller may be tempted to trade high volumes at high prices at the beginning of the relationship before breaching the contract later on. Yet, such take-the-money-and-run strategy becomes less attractive as time passes and can be prevented with backloaded payments. The optimal contract thus goes through two different phases. First, quantities and prices increase at the inception of the relationship. Later on, the contract looks more stationary. The public and private sides of enforcement plays different roles in determining the length of the earlier phase of contracting. Long-run screening distortions encapsulate the quality of enforcement, offering de facto a link between the quality of the legal system and contractual performances.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: https://mpra.ub.uni-muenchen.de/53504/1/MPRA_paper_53504.pdf
File Function: original version
Download Restriction: no

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 53504.

as
in new window

Length:
Date of creation: 07 Feb 2014
Handle: RePEc:pra:mprapa:53504
Contact details of provider: Postal:
Ludwigstraße 33, D-80539 Munich, Germany

Phone: +49-(0)89-2180-2459
Fax: +49-(0)89-2180-992459
Web page: https://mpra.ub.uni-muenchen.de

More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as
in new window


  1. Andrei Shleifer & Robert W. Vishny, 1996. "A Survey of Corporate Governance," NBER Working Papers 5554, National Bureau of Economic Research, Inc.
  2. Watson, Joel, 1999. "Starting Small and Renegotiation," Journal of Economic Theory, Elsevier, vol. 85(1), pages 52-90, March.
  3. Narayana Kocherlakota, 2010. "Implications of Efficient Risk Sharing Without Commitment," Levine's Working Paper Archive 2053, David K. Levine.
  4. Bernheim, B Douglas & Whinston, Michael D, 1998. "Incomplete Contracts and Strategic Ambiguity," American Economic Review, American Economic Association, vol. 88(4), pages 902-932, September.
  5. Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, "undated". "Law and Finance," Working Paper 19451, Harvard University OpenScholar.
  6. Rey, Patrick & Salanie, Bernard, 1996. "On the Value of Commitment with Asymmetric Information," Econometrica, Econometric Society, vol. 64(6), pages 1395-1414, November.
  7. Joskow, Paul L, 1988. "Asset Specificity and the Structure of Vertical Relationships: Empirical Evidence," Journal of Law, Economics and Organization, Oxford University Press, vol. 4(1), pages 95-117, Spring.
  8. Paul Beaudry & Michel Poitevin, 1994. "The Commitment Value of Contracts under Dynamic Renegotiation," RAND Journal of Economics, The RAND Corporation, vol. 25(4), pages 501-517, Winter.
  9. Keith J. Crocker & Scott E. Masten, 1988. "Mitigating Contractual Hazards: Unilateral Options and Contract Length," RAND Journal of Economics, The RAND Corporation, vol. 19(3), pages 327-343, Autumn.
  10. Edlin, Aaron S, 1996. "Cadillac Contracts and Up-Front Payments: Efficient Investment under Expectation Damages," Journal of Law, Economics and Organization, Oxford University Press, vol. 12(1), pages 98-118, April.
  11. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-641, August.
  12. Albert Marcet & Ramon Marimon, 2011. "Recursive Contracts," CEP Discussion Papers dp1055, Centre for Economic Performance, LSE.
  13. W. Bentley MacLeod & James Malcomson, 1997. "Motivation and Markets," Boston College Working Papers in Economics 339., Boston College Department of Economics.
  14. Robert Gibbons, 2005. "Incentives Between Firms (and Within)," Management Science, INFORMS, vol. 51(1), pages 2-17, January.
  15. Matthias Messner & Nicola Pavoni & Christopher Sleet, 2011. "On the Dual Approach to Recursive Optimization," Working Papers 423, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  16. Oliver D. Hart & Jean Tirole, 1988. "Contract Renegotiation and Coasian Dynamics," Review of Economic Studies, Oxford University Press, vol. 55(4), pages 509-540.
  17. Joel Watson, 1999. "Starting Small and Commitment," Cowles Foundation Discussion Papers 1217, Cowles Foundation for Research in Economics, Yale University.
  18. Daron Acemoglu & Davide Ticchi & Andrea Vindigni, 2006. "Emergence and Persistence of Inefficient States," Carlo Alberto Notebooks 34, Collegio Carlo Alberto.
  19. Hart, Oliver, 1995. "Firms, Contracts, and Financial Structure," OUP Catalogue, Oxford University Press, number 9780198288817.
  20. Steven A. Matthews & Andrew Postlewaite, 1987. "Pre-Play Communication in Two-Person Sealed-Bid Double Auctions," Discussion Papers 744R, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  21. Crocker, Keith J & Masten, Scott E, 1996. "Regulation and Administered Contracts Revisited: Lessons from Transaction-Cost Economics for Public Utility Regulation," Journal of Regulatory Economics, Springer, vol. 9(1), pages 5-39, January.
  22. 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.
  23. Olivier Compte & Philippe Jehiel, 2006. "Veto Constraint in Mechanism Design: Inefficiency with Correlated Types," Levine's Bibliography 321307000000000085, UCLA Department of Economics.
  24. Paul Milgrom & Ilya Segal, 2002. "Envelope Theorems for Arbitrary Choice Sets," Econometrica, Econometric Society, vol. 70(2), pages 583-601, March.
  25. Guesnerie, Roger & Laffont, Jean-Jacques, 1984. "A complete solution to a class of principal-agent problems with an application to the control of a self-managed firm," Journal of Public Economics, Elsevier, vol. 25(3), pages 329-369, December.
  26. Wolitzky, Alexander, 2010. "Dynamic monopoly with relational incentives," Theoretical Economics, Econometric Society, vol. 5(3), September.
  27. Marina Halac, 2012. "Relational Contracts and the Value of Relationships," American Economic Review, American Economic Association, vol. 102(2), pages 750-779, April.
  28. Joel Sobel, 1985. "A Theory of Credibility," Review of Economic Studies, Oxford University Press, vol. 52(4), pages 557-573.
  29. Myerson, Roger B. & Satterthwaite, Mark A., 1983. "Efficient mechanisms for bilateral trading," Journal of Economic Theory, Elsevier, vol. 29(2), pages 265-281, April.
  30. Macho-Stadler, Ines & Perez-Castrillo, J. David, 2001. "An Introduction to the Economics of Information: Incentives and Contracts," OUP Catalogue, Oxford University Press, edition 2, number 9780199243273.
  31. Watson, Joel, 2002. "Contract, Mechanism Design, and Technological Detail," University of California at San Diego, Economics Working Paper Series qt18x0r2nn, Department of Economics, UC San Diego.
  32. Rustichini, A., 1998. "Lagrange multipliers in incentive-constrained problems," Journal of Mathematical Economics, Elsevier, vol. 29(4), pages 365-380, May.
  33. Elisabetta Iossa & Giancarlo Spagnolo, 2009. "Contracts as Threats: on a Rationale For Rewarding A while Hoping For B," CEIS Research Paper 147, Tor Vergata University, CEIS, revised 30 Sep 2009.
  34. J-J. Laffont & J. Tirole, 1994. "Pollution Permits and Compliance Strategies," Working papers 95-9, Massachusetts Institute of Technology (MIT), Department of Economics.
  35. 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.
  36. Joskow, Paul L, 1987. "Contract Duration and Relationship-Specific Investments: Empirical Evidence from Coal Markets," American Economic Review, American Economic Association, vol. 77(1), pages 168-185, March.
  37. Steven Shavell, 1980. "Damage Measures for Breach of Contract," Bell Journal of Economics, The RAND Corporation, vol. 11(2), pages 466-490, Autumn.
  38. Laffont,Jean-Jacques, 2005. "Regulation and Development," Cambridge Books, Cambridge University Press, number 9780521549486, December.
  39. Carl Shapiro, 1983. "Premiums for High Quality Products as Returns to Reputations," The Quarterly Journal of Economics, Oxford University Press, vol. 98(4), pages 659-679.
  40. Schmidt, Klaus M. & Schnitzer, Monika, 1995. "The interaction of explicit and implicit contracts," Munich Reprints in Economics 19763, University of Munich, Department of Economics.
  41. Ola Kvaløy & Trond E. Olsen, 2009. "Endogenous Verifiability and Relational Contracting," American Economic Review, American Economic Association, vol. 99(5), pages 2193-2208, December.
  42. George J. Mailath & Andrew Postlewaite, 1990. "Asymmetric Information Bargaining Problems with Many Agents," Review of Economic Studies, Oxford University Press, vol. 57(3), pages 351-367.
  43. Georg Nöldeke & Larry Samuelson, 2006. "Optimal Bunching without Optimal Control," Working papers 2006/12, Faculty of Business and Economics - University of Basel.
  44. Olivier Compte & Philippe Jehiel, 2007. "On Quitting Rights in Mechanism Design," Post-Print halshs-00754659, HAL.
  45. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
  46. Rochet, Jean-Charles, 1985. "Bilateral monopoly with imperfect information," Journal of Economic Theory, Elsevier, vol. 36(2), pages 214-236, August.
  47. Paul Beaudry & Michel Poitevin, 1995. "Contract Renegotiation: A Simple Framework and Implications for Organization Theory," Canadian Journal of Economics, Canadian Economics Association, vol. 28(2), pages 302-335, May.
  48. MacLeod, W Bentley & Malcomson, James M, 1989. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment," Econometrica, Econometric Society, vol. 57(2), pages 447-480, March.
  49. Abreu, Dilip, 1988. "On the Theory of Infinitely Repeated Games with Discounting," Econometrica, Econometric Society, vol. 56(2), pages 383-396, March.
  50. Steven Shavell, 1984. "The Design of Contracts and Remedies for Breach," The Quarterly Journal of Economics, Oxford University Press, vol. 99(1), pages 121-148.
  51. Johannes Hörner, 2002. "Reputation and Competition," American Economic Review, American Economic Association, vol. 92(3), pages 644-663, June.
  52. Parikshit Ghosh & Debraj Ray, 1995. "Cooperation in Community Interaction Without Information Flows," Boston University - Institute for Economic Development 64, Boston University, Institute for Economic Development.
  53. Mathias Dewatripont, 1989. "Renegotiation and Information Revelation Over Time: The Case of Optimal Labor Contracts," The Quarterly Journal of Economics, Oxford University Press, vol. 104(3), pages 589-619.
  54. 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.
  55. Stefan Krasa & Anne P. Villamil, 2003. "Optimal Contracts when Enforcement is a Decision Variable: A Reply," Econometrica, Econometric Society, vol. 71(1), pages 391-393, January.
  56. Myerson, Roger B., 1982. "Optimal coordination mechanisms in generalized principal-agent problems," Journal of Mathematical Economics, Elsevier, vol. 10(1), pages 67-81, June.
  57. Jonathan Levin, 2003. "Relational Incentive Contracts," American Economic Review, American Economic Association, vol. 93(3), pages 835-857, June.
  58. Marco Battaglini, 2005. "Long-Term Contracting with Markovian Consumers," American Economic Review, American Economic Association, vol. 95(3), pages 637-658, June.
  59. James M. Malcomson, 2016. "Relational Incentive Contracts With Persistent Private Information," Econometrica, Econometric Society, vol. 84, pages 317-346, 01.
  60. Seungjin Whang, 1992. "Contracting for Software Development," Management Science, INFORMS, vol. 38(3), pages 307-324, March.
  61. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, September.
  62. Thomas, Lionel, 2002. "Non-linear pricing with budget constraint," Economics Letters, Elsevier, vol. 75(2), pages 257-263, April.
  63. Lewis, Tracy R. & Sappington, David E. M., 1989. "Countervailing incentives in agency problems," Journal of Economic Theory, Elsevier, vol. 49(2), pages 294-313, December.
  64. Stefan Krasa & Anne P. Villamil, 2000. "Optimal Contracts when Enforcement Is a Decision Variable," Econometrica, Econometric Society, vol. 68(1), pages 119-134, January.
  65. J. Luis Guasch & Jean-Jacques Laffont & Stephane Straub, 2003. "Renegotiation of Concession Contracts in Latin America," ESE Discussion Papers 103, Edinburgh School of Economics, University of Edinburgh.
  66. Gibbons, Robert, 2005. "Four forma(lizable) theories of the firm?," Journal of Economic Behavior & Organization, Elsevier, vol. 58(2), pages 200-245, October.
  67. Anja Schöttner, 2008. "Relational Contracts, Multitasking, and Job Design," Journal of Law, Economics and Organization, Oxford University Press, vol. 24(1), pages 138-162, May.
  68. Baron, David P. & Besanko, David, 1984. "Regulation and information in a continuing relationship," Information Economics and Policy, Elsevier, vol. 1(3), pages 267-302.
  69. Katherine Doornik, 2010. "Incentive Contracts with Enforcement Costs," Journal of Law, Economics and Organization, Oxford University Press, vol. 26(1), pages 115-143, April.
  70. 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.
  71. Clive Bull, 1987. "The Existence of Self-Enforcing Implicit Contracts," The Quarterly Journal of Economics, Oxford University Press, vol. 102(1), pages 147-159.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:53504. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Joachim Winter)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.