Contracts as Threats: on a Rationale For Rewarding A while Hoping For B

Giancarlo Spagnolo and Elisabetta Iossa

No 8195, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Contracts often reward inefficient tasks and are not enforced ex post. We provide a new explanation based on the relationship between explicit contracts and implicit agreements, distinguishing the ex-ante decision to sign a contract from the ex-post decision whether to apply it. We show that it is often optimal to have overcontracting - contractual clauses requiring costly, inefficient, verifiable tasks (A) - not enforced in equilibrium. Overcontracting facilitates relational contracting on efficient non-contractible tasks (B) by anticipating and strengthening punishments following defections. With adverse selection, it is optimal to choose tasks A analogous to B in terms of required skills. The model also explains why stipulated damages must be moderate in size. These results apply independently of whether B is a `productive' task or a 'bribe'.

Keywords: Governance; Incomplete contracts; Multi-tasking; Relational contracts (search for similar items in EconPapers)
JEL-codes: C73 D86 L14 (search for similar items in EconPapers)
Date: 2011-01
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Citations: View citations in EconPapers (13)

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Related works:
Working Paper: Contracts as Threats: on a Rationale For Rewarding A while Hoping For B (2010)
Working Paper: Contracts as Threats: on a Rationale For Rewarding A while Hoping For B (2009)
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