Endogenous Outside Options, Incomplete Contracts and the Theory of the Firm

University of Siena, Economics Working Paper No. 250

28 Pages Posted: 29 Nov 1999

See all articles by Antonio Nicita

Antonio Nicita

University of Siena - Department of Economics

Date Written: April 1999

Abstract

The paper asserts that introducing endogenous outside options in the standard incomplete contract framework might reverse some of the main conclusions on incomplete contracts enforcement and on the nature of the firm drawn by the New Institutional Economists. In particular, the explanations of the firm provided by the New Property Rights school (the GHM model) are based on the assumption that agents outside options are not affected by human capital investments. When outside options are endogenous, in order to maximise contractual power in a transactional exchange and/or to increase market share, agents will then be induced to invest a greater amount of economic resources than the neo-classical ideal-type requires. Bilateral enforcement mechanisms are thus affected by the actions selected by agents in order to deter a competitor's entry, and viceversa, competition strategies are affected by the economic incentives promoted by parties for the enforcement of contractual obligations. We label such a complex institutional context cross competition. Such a framework provides an alternative explanation of the firm which helps to understand the diversity of institutional arrangements observed in different economic systems, and suggests that the co-existence of alternative governance structures of the firm could represent a second best response to the market failures which arise in a "cross competition" context.

JEL Classification: K00, J41, L21, L22, L23

Suggested Citation

Nicita, Antonio, Endogenous Outside Options, Incomplete Contracts and the Theory of the Firm (April 1999). University of Siena, Economics Working Paper No. 250. Available at SSRN: https://ssrn.com/abstract=189993 or http://dx.doi.org/10.2139/ssrn.189993

Antonio Nicita (Contact Author)

University of Siena - Department of Economics ( email )

Piazza S. Francesco, 7
Siena, I-53100
Italy

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