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Theory and Decision

01.03.2024

Incomplete contracts with disparity, uncertainty, information and incentives

verfasst von: Susheng Wang

Erschienen in: Theory and Decision

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Abstract

Cooperation among firms is governed by contracts. An interesting phenomenon is that some contracts are comprehensive while some are limited. This study tries to explain different levels of the incompleteness of contracts that firms choose to govern their cooperation with. We find that a limited contract is more efficient than a comprehensive contract if partners are highly disparate or product quality is largely uncertain, and vice versa. In contrast, if there are private information and incentives to invest in quality, a comprehensive contract is likely to be more efficient. These findings offer an understanding as to why incomplete contracts are so popular in practice.

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The firms’ knowledge about quality θ differ in Model 2, and they can take action to improve quality θ in Model 3. We use one parameter θ for convenience; extending to many parameters is straightforward.

For convenience, we use f(·) to denote all density functions; the same treatment for revenue function R(·).

Although contractual items such as s_i(x) cannot be dependent on θ, non-contractual items can still be dependent on θ if θ is known at the time.

There are two theoretical approaches to contracting: the principal-agent setting, and the bargaining setting. We use the bargaining setting. These two settings are equivalent to a large extent; see Wang (2012, p. 30) for an explanation.

For example, for a Cobb–Douglas production function \(y={x}_{1}^{\alpha }{x}_{2}^{1-\alpha }\), there is a parameter α representing some inherent characteristics, and x₁ and x₂ are action variables. However, with endogenous growth, α can be dependent on actions.

An easy way to understand this derivative is to assume that the density function is discrete.

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Titel: Incomplete contracts with disparity, uncertainty, information and incentives
verfasst von: Susheng Wang
Publikationsdatum: 01.03.2024
Verlag: Springer US
Erschienen in: Theory and Decision
Print ISSN: 0040-5833
Elektronische ISSN: 1573-7187
DOI: https://doi.org/10.1007/s11238-024-09976-w

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