32 Pages Posted: 3 Sep 2016
Date Written: August 25, 2016
Parties often regulate their relationships through “continuing” contracts that are neither long‐term nor short‐term but usually roll over: a leading example is a standard employment contract. We argue that what distinguishes a continuing contract from a short‐term (or fixed‐term) contract is that parties apply notions of fairness, fair dealing, and good faith as they revise the terms of the contract: specifically, they use the previous contract as a reference point. We show that a continuing contract can reduce (re)negotiation costs relative to a short‐term or long‐term contract when there is uncertainty about future gains from trade. However, fair dealing may limit the use of outside options in bargaining and as a result parties will sometimes fail to trade when this is efficient. For‐cause contracts, where termination can occur only for a good reason, can reduce this inefficiency.
Keywords: short‐term, long‐term, continuing contracts, fairness, good faith bargaining, for‐cause, at-will
JEL Classification: D23, D86, K12
Suggested Citation: Suggested Citation