A Theory of Contracts with Limited Enforcement

David Martimort, Aggey Semenov and Lars Stole

No E1304E, Working Papers from University of Ottawa, Department of Economics

Abstract: We present a Theory of Contracts under costly enforcement in the context of a dynamic relationship between an uninformed buyer and a seller who is privately informed on his persistent cost at the outset. Public enforcement relies on remedies for breach. Private enforcement comes from severing relationships. We first characterize aggregate enforcement constraints ensuring that trading partners do not breach contracts unduly. Whether a long-term contract is enforceable does not depend on the distribution of penalties for breach between the buyer and the seller. While under complete information, the optimal contract would remain stationary, non-stationarity might arise under asymmetric information. Enforcement constraints are time-dependent and easier to satisfy as time passes. Indeed, a high-cost seller may be tempted to trade high volumes at high prices at the beginning of the relationship before breaching the contract later on. Yet, such take-the-money-and-run strategy becomes less attractive as time passes and can be prevented with back loaded payments. The optimal contract thus goes through two different phases. First, quantities and prices increase at the inception of the relationship. Later on, the contract looks more stationary. Long-run screening distortions encapsulate the quality of enforcement, offering de facto a link between the quality of the legal system and contractual performances.

Keywords: Asymmetric information; enforcement; breach of contracts; dynamic contracts (search for similar items in EconPapers)
JEL-codes: D82 D86 K2 (search for similar items in EconPapers)
Pages: 56 pages
Date: 2013
New Economics Papers: this item is included in nep-cta and nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

Downloads: (external link)
http://sciencessociales.uottawa.ca/economics/sites ... mics/files/1304e.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 502 Bad Gateway (http://sciencessociales.uottawa.ca/economics/sites/socialsciences.uottawa.ca.economics/files/1304e.pdf [301 Moved Permanently]--> https://sciencessociales.uottawa.ca/economics/sites/socialsciences.uottawa.ca.economics/files/1304e.pdf)

Related works:
Journal Article: A Theory of Contracts with Limited Enforcement (2017)
Working Paper: A Theory of Contracts with Limited Enforcement (2017)
Working Paper: A Theory of Contracts with Limited Enforcement (2017)
Working Paper: A Theory of Contracts With Limited Enforcement (2014)
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:ott:wpaper:e1304e

Access Statistics for this paper

More papers in Working Papers from University of Ottawa, Department of Economics Contact information at EDIRC.
Bibliographic data for series maintained by Aggey Semenov ().