Short-Term, Long-Term, and Continuing Contracts

32 Pages Posted: 9 Mar 2015

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: March 2015

Abstract

Parties often regulate their relationships through “continuing” contracts that are neither long-term nor short-term but usually roll over. We study the trade-off between long-term, short-term, and continuing contracts in a two period model where gains from trade exist in the first period, and may or may not exist in the second period. A long-term contract that mandates trade in both periods is disadvantageous since renegotiation is required if there are no gains from trade in the second period. A short-term contract is disadvantageous since a new contract must be negotiated if gains from trade exist in the second period. A continuing contract can be better. In a continuing contract there is no obligation to trade in the second period but if there are gains from trade the parties will bargain “in good faith” using the first period contract as a reference point. This can reduce the cost of negotiating the next contract. Continuing contracts are not a panacea, however, since good faith bargaining may preclude the use of outside options in the bargaining process and as a result parties will sometimes fail to trade when this is efficient.

Suggested Citation

Halonen-Akatwijuka, Maija and Hart, Oliver D., Short-Term, Long-Term, and Continuing Contracts (March 2015). NBER Working Paper No. w21005, Available at SSRN: https://ssrn.com/abstract=2575490

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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