Overconfidence and Endogenous Contract Incompleteness

Te Bao, Yun Dai and Yongqin Wang

Journal of Institutional and Theoretical Economics (JITE), 2024, vol. 180, issue 3, 463-484

Abstract: We set up a model on the hold-up problem with uncertain bargaining power and find that, when two agents are overconfident about their bargaining power ex ante, both of them may endogenously choose incomplete contract over complete contract even when complete contracting is feasible. The intuition behind the result is that ceteris paribus, overconfidence leads to a higher expected return to relationspecific investment and a higher investment level. Our model provides an additional behavioral explanation for the prevalence of contract incompleteness in addition to those existing in the literature.

Keywords: endogenous contract incompleteness; overconfidence; control right; bargaining power (search for similar items in EconPapers)
JEL-codes: D03 D23 D86 (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1628/jite-2024-0025

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