Long Term Contracting with Private Information
37 Pages Posted: 6 Mar 2012 Last revised: 20 Apr 2012
Date Written: February 27, 2012
This paper explores the possibility for efficient long term contracts among traders with changing and privately known incentives for exchange. We analyze a negotiation process that enables parties to adapt the default rules of exchange to changes in their preferences for trade. The selection of control rights and default options is delegated to the traders themselves, who collectively are best informed as to which investments and exchanges are efficient. The paper demonstrates how contracts with flexible and endogenous default options are tailored to maximize the gains from exchange. Applications of our findings for contract theory, the design of commercial contracts, and the need for legal support are discussed.
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