Incomplete Contracts: An Empirical Approach

Sarath Sanga

The Journal of Law, Economics, and Organization, 2018, vol. 34, issue 4, 650-679

Abstract: The strategic ambiguity hypothesis posits that when some aspects of performance are observable but not verifiable, the optimal contract is deliberately incomplete. I test this result for the first time. Because a direct test is infeasible, I derive an equivalent result: incompleteness is optimal when some terms are legally void. I test this using executive contracts from S&P 500 firms. I find that firms pay severance in discretionary installments to induce their executives to comply with noncompete agreements—but only in California, where noncompetes are void. Outside California, noncompetes are valid and these same firms pay non-discretionary severance upfront. I conclude that firms use strategic ambiguity to circumvent legal constraints.

JEL-codes: D86 J41 K12 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (3)

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