Strategic Incomplete Contracts: Theory and Experiments

Nisvan Erkal, Steven Y. Wu (sywu@purdue.edu) and Brian Roe
Additional contact information
Steven Y. Wu: Purdue University

No 8704, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: We develop a model of strategic contractual incompleteness that identifies conditions under which principals might omit even costlessly verifiable terms. We then use experiments to test comparative statics predictions of the model. While it is well known that verifiability imperfections can limit complete contracting, researchers know less about how the degree of imperfection affects endogenous incompleteness, particularly with repeat trading. In our baseline treatment with perfect verifiability, subjects overwhelmingly used complete contracts to conduct trades, achieving nearly first best outcomes. In our partial verifiability treatment with a reduced set of verifiable performance levels, the results reversed and parties relied heavily on incomplete contracts that omitted even costlessly verifiable terms. However, the efficacy of incomplete contracts in outperforming available complete contracts depends critically on the continuation probability of repeat trading. With a small continuation probability, incomplete contracts did no better than complete contracts while exposing parties to considerable strategic uncertainty.

Keywords: incomplete contract; relational contract; endogenous incompleteness; informal incentives; experimental economics (search for similar items in EconPapers)
JEL-codes: C73 C91 D86 J41 L14 L24 M52 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2014-12
New Economics Papers: this item is included in nep-cta, nep-exp and nep-hrm
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://docs.iza.org/dp8704.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:iza:izadps:dp8704

Ordering information: This working paper can be ordered from
IZA, Margard Ody, P.O. Box 7240, D-53072 Bonn, Germany
library@iza.org

Access Statistics for this paper

More papers in IZA Discussion Papers from Institute of Labor Economics (IZA) IZA, P.O. Box 7240, D-53072 Bonn, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Holger Hinte (hinte@iza.org).