Contract, Uncertainty and Innovation
35 Pages Posted: 20 Nov 2010
Date Written: November 18, 2010
Contract today increasingly links entrepreneurial innovations to the efforts and finance necessary to transform ideas into value. In this Chapter, we describe the match between a form of contract that "braids" formal and informal contractual elements in novel ways and the process by which innovation is pursued. It is hardly surprising that these innovative forms of contract have emerged first in markets, and that the common law, and the theory of contract, then play catch-up. Between the time contracting practice adapts to the demands of innovation and the time contract doctrine adapts to the demands of practice, law acts as a friction on the innovation process rather than a lubricant to it. Our goal here is to reduce that lag by providing a theory that can guide courts in developing case law that addresses current forms of innovation This chapter provides an overview of our ongoing work. The starting point is the Knightian distinction between risk and uncertainty. In our view, traditional contracting techniques and traditional contract law address problems of risk. Braiding, or contracting for innovation, addresses conditions of uncertainty. We illustrate the relevance of this distinction by describing the shift in the organizational location of innovation - in particular a fundamental shift from vertical integration to contract as the organizing mechanism for cutting-edge innovation. We then describe the braiding of formal and informal contracting that has developed to organize collaboration across organizational boundaries where the desired outcome can, at best, be anticipated only very approximately. Next, we re-examine the interaction between formal and informal contracting to understand why braiding was not envisaged as a theoretical possibility before it became a salient reality, and to make theoretical sense of braiding now that it has. Finally, we look to recent case law, especially that considering preliminary agreements, to argue that the domain of braiding now includes contexts where uncertainty is not generated by technological development, and we examine the failure of courts to recognize the difference between and consequences of low-powered and high-powered enforcement in addressing braided contracts.
Keywords: contract, innovation, informal contracting, contract theory, uncertainty, preliminary agreements, letters of intent
JEL Classification: D80, K12, L14, L22, D23
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