Incentives for Contract Designers and Contractual Design

Abstract

This paper examines the optimal provision of incentives for contract designers and the implications for contractual design. A buyer hires an agent to draft a contract for a seller. The buyer-seller contract is incomplete because the ex-ante specified design might not be appropriate ex-post. The degree of contract incompleteness is endogenously determined by the effort exerted by the agent, who can manipulate the buyer’s beliefs because his effort is not observable (moral hazard), and because he is better informed at the outset (adverse selection). We discuss how the asymmetric information generated during the contract drafting stage explains some empirical observations and contracting phenomena.

Keywords: Adverse Selection, Incomplete Contracts, Information Acquisition, Moral Hazard, Pricing, Principal-Agent.

JEL Classification: D23, D82, D83, D86, L22