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Opportunism and the Dynamics of Incomplete Contracts

Mehmet Bac

International Economic Review, 1993, vol. 34, issue 3, 663-83

Abstract: This paper studies a buyer-seller relationship where "quality" is not contractible but is affected by effort and the seller's privately known innate value. The seller's cost of effort is also private knowledge. Assuming constant outside opportunities, we show that more than two contracts is redundant, the sequence of contracts exhibits increasing prices and durations, and commitments for prices beyond the actual contract invite opportunism, not effort. The seller uses effort during the screening process, which improves noncontractible quality. As a result, type-related information may have negative value when contracts are incomplete. Copyright 1993 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Date: 1993
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