More is Less: Why Parties May Deliberately Write Incomplete Contracts

28 Pages Posted: 28 Apr 2013

See all articles by Maija Halonen-Akatwijuka

Maija Halonen-Akatwijuka

University of Bristol - Leverhulme Centre for Market and Public Organisation (CMPO)

Oliver Hart

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Date Written: April 2013

Abstract

Why are contracts incomplete? Transaction costs and bounded rationality cannot be a total explanation since states of the world are often describable, foreseeable, and yet are not mentioned in a contract. Asymmetric information theories also have limitations. We offer an explanation based on "contracts as reference points". Including a contingency of the form, "The buyer will require a good in event E", has a benefit and a cost. The benefit is that if E occurs there is less to argue about; the cost is that the additional reference point provided by the outcome in E can hinder (re)negotiation in states outside E. We show that if parties agree about a reasonable division of surplus, an incomplete contract can be strictly superior to a contingent contract.

Suggested Citation

Halonen-Akatwijuka, Maija and Hart, Oliver D., More is Less: Why Parties May Deliberately Write Incomplete Contracts (April 2013). NBER Working Paper No. w19001, Available at SSRN: https://ssrn.com/abstract=2257191

Maija Halonen-Akatwijuka (Contact Author)

University of Bristol - Leverhulme Centre for Market and Public Organisation (CMPO) ( email )

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Oliver D. Hart

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER) ( email )

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European Corporate Governance Institute (ECGI) ( email )

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