Imperfect Contracting
by
Pierpaolo Battigalli
European University Institute
Coauthors: Giovanni Maggi (Princeton University)

In this paper we model imperfect contracting `from the ground up, ' as arising endogenously from the costs of writing contracts. We model these costs by making explicit the language used to describe the environment and the parties' behavior. The optimal contract may exhibit two forms of incompleteness: excessive discretion left to the parties and/or excessive rule rigidity. By imposing more structure on the framework, we are able to fully characterize the optimal contract, and examine under what conditions it displays rigidity or discretion. We then argue that endogenizing contract incompleteness, and in particular the of incompleteness, is important to understand its economic consequences, for example the distortion of incentives to undertake relationship-specific investments. Finally, the model offers a theoretical explanation for the existence of legal default rules (as in the U.S. Uniform Commercial Code) that are meant to ``fill the gaps'' of private contracts.

http://www.iue.it/Personal/Battigalli/Welcome.html

Date received: June 8, 2000

Copyright © 2000 by the author(s). The author(s) of this document and the organizers of the conference have granted their consent to include this abstract in Atlas Conferences Inc. Document # cafi-22.