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Series:   Elements in Law, Economics and Politics

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Why Parties May Deliberately Write Incomplete Contracts

Published online by Cambridge University Press:  24 April 2024

Maija Halonen-Akatwijuka  and
Oliver Hart
Maija Halonen-Akatwijuka
Affiliation:
University of Bristol
Oliver Hart
Affiliation:
Harvard University

Summary

Why are contracts incomplete? Transaction costs and bounded rationality cannot be a total explanation since states of the world are often describable, foreseeable, and yet are not mentioned in a contract. Asymmetric information theories also have limitations. We offer an explanation based on 'contracts as reference points'. Including a contingency of the form, 'The buyer will require a good in event E', has a benefit and a cost. The benefit is that if E occurs there is less to argue about; the cost is that the additional reference point provided by the outcome in E can hinder (re)negotiation in states outside E. We show that if parties agree about a reasonable division of surplus, an incomplete contract is strictly superior to a contingent contract. If parties have different views about the division of surplus, an incomplete contract can be superior if including a contingency would lead to divergent reference points.
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Keywords

incomplete contractscontracts as reference pointsrenegotiationshared viewsambiguity
Type
Element
Information
Series: Elements in Law, Economics and Politics
Online ISBN: 9781009396059
Publisher: Cambridge University Press
Print publication: 23 May 2024

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