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Exit options in incomplete contracts with asymmetric information

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  • Bester, Helmut
  • Krähmer, Daniel

Abstract

This paper analyzes bilateral contracting in an environment with contractual incompleteness and asymmetric information. One party (the seller) makes an unverifiable quality choice and the other party (the buyer) has private information about its valuation. A simple exit option contract, which allows the buyer to refuse trade, achieves the firstbest in the benchmark cases where either quality is verifiable or the buyer's valuation is public information. But, when unverifiable and asymmetric information are combined, exit options induce inefficient pooling and lead to a particularly simple contract. Inefficient pooling is unavoidable also under the most general form of contracts, which make trade conditional on the exchange of messages between the parties. Indeed, simple exit option contracts are optimal if random mechanisms are ruled out.

Suggested Citation

  • Bester, Helmut & Krähmer, Daniel, 2008. "Exit options in incomplete contracts with asymmetric information," Discussion Papers 2008/23, Free University Berlin, School of Business & Economics.
  • Handle: RePEc:zbw:fubsbe:200823
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Gilberto SERAVALLI, 2011. "Conflict, Contract, Leadership and Innovation: An Interdisciplinary View," Journal of Knowledge Management, Economics and Information Technology, ScientificPapers.org, vol. 1(6), pages 1-48, October.
    2. Philippe Aghion & Drew Fudenberg & Richard Holden & Takashi Kunimoto & Olivier Tercieux, 2012. "Subgame-Perfect Implementation Under Information Perturbations," The Quarterly Journal of Economics, Oxford University Press, vol. 127(4), pages 1843-1881.
    3. Helmut Bester & Johannes Münster, 2016. "Subjective evaluation versus public information," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 61(4), pages 723-753, April.
    4. Bester, Helmut & Krähmer, Daniel, 2013. "Exit Options and the Allocation of Authority," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 401, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    5. Eccles, Peter & Wegner, Nora, 2016. "Robustness of subgame perfect implementation," Bank of England working papers 601, Bank of England.
    6. Takashi Shimizu, 2016. "Cheap Talk with an Exit Option: A Model of Exit and Voice," Discussion Papers 1607, Graduate School of Economics, Kobe University.

    More about this item

    Keywords

    Incomplete contracts; asymmetric information; exit options;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality

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