Complexity and Contract

Abstract:     
It is well known that contract incompleteness can arise from the impossibility of planning for all future contingencies in a relationship (e.g. Williamson (1975)). In this paper it is shown that whether or not such imcompleteness constrains the efficiency of the contract is very sensitive to assumptions concerning the timing of the resolution of uncertainty. It is shown that when agents must respond to an unforeseen contingency before being able to renegotiate the contract, then contract complexity is a binding constraint, a case that is called ex post hold-up. Secondly, it is suggested that the amount of multi-tasking can provide a measure of contract complexity. When complexity is low, contingent contracting is efficient, while subjective performance evaluation is more efficient when complexity is high. In this case the optimal contract for ex post hold-up is based upon the ability of humans to make subject judgements that are in some cases more informative than explicit performance measures. Moreover, the efficiency of the contract is not sensitive to human error per se, but is an increasing function of the correlation in judgements between the contracting parties.

JEL Classifications: D81, D82

Working Paper Series