Ulrich Hege () and
No 1997-109, Discussion Paper from Tilburg University, Center for Economic Research
This paper offers an explanation of rationally incomplete contracts where incompleteness refers to unforeseen contingencies. Agents enter a relationship with two-sided moral hazard in which a commitment to discard parts of the joint resources may be ex ante efficient. This happens through costly legal dispute which arises when contract terms are missing for the undesirable outcomes. We show that an optimal contract needs only to specify the obligation for the more litigious party to assure a certain output level - the threshold between foreseen and unforeseen contingencies - and a linear sharing rule for the foreseen contingencies. If litigation reveals some information about the e¤ort levels of the agents, less costly dispute is typically needed and the allocation will improve.
Keywords: incomplete contracts; unforeseen contingencies; burning money; team production; contract law (search for similar items in EconPapers)
JEL-codes: D82 K12 (search for similar items in EconPapers)
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Working Paper: Contentious Contracts (2012)
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