Renegotiation Facilitates Contractual Incompleteness

Posted: 8 Dec 2006

See all articles by Birger Wernerfelt

Birger Wernerfelt

Massachusetts Institute of Technology (MIT) - Sloan School of Management

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Abstract

Attempts to economize on bargaining costs imply that two parties may write a contract which is incomplete in the sense that each party tacitly cedes some decision rights to the other. If decision-makers can be disciplined by the threat of ex post renegotiation of decisions initially delegated to them, contracts may be even more incomplete. In the limit, the parties may leave all non-price decisions out of the contract. By thus arguing that the threat of renegotiation facilitates contractual incompleteness, the paper reverses the direction of causality stressed by the literature.

Keywords: Incomplete contracts, theory of the firm

JEL Classification: D23, L22

Suggested Citation

Wernerfelt, Birger, Renegotiation Facilitates Contractual Incompleteness. Journal of Economics and Management Strategy, Vol. 16. Available at SSRN: https://ssrn.com/abstract=950469

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