Agreeing Now to Agree Later: Contracts that Rule Out But Do Not Rule in
47 Pages Posted: 16 Jul 2008
Date Written: March 2004
We view a contract as a list of outcomes. Ex ante, the parties commit not to consider outcomes not on the list, i.e., these are "ruled out". Ex post, they freely bargain over outcomes on the list, i.e., the contract specifies no mechanism to structure their choice; in this sense outcomes on the list are not "ruled out". A "loose" contract (long list) maximizes flexibility but may interfere with ex ante investment incentives. When these incentives are important enough, the parties may write a "tight" contract (short list), even though this leads to ex post inefficiency.
JEL Classification: D23, O32, O34
Suggested Citation: Suggested Citation