DP8195 Contracts as Threats: on a Rationale For Rewarding A while Hoping For B
|Author(s):||Elisabetta Iossa, Giancarlo Spagnolo|
|Publication Date:||January 2011|
|Keyword(s):||Governance, incomplete contracts, multi-tasking, relational contracts|
|JEL(s):||C73, D86, L14|
|Programme Areas:||Industrial Organization|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=8195|
Contracts often reward inefficient tasks and are not enforced ex post. We provide a new explanation based on the relationship between explicit contracts and implicit agreements, distinguishing the ex-ante decision to sign a contract from the ex-post decision whether to apply it. We show that it is often optimal to have overcontracting - contractual clauses requiring costly, inefficient, verifiable tasks (A) - not enforced in equilibrium. Overcontracting facilitates relational contracting on efficient non-contractible tasks (B) by anticipating and strengthening punishments following defections. With adverse selection, it is optimal to choose tasks A analogous to B in terms of required skills. The model also explains why stipulated damages must be moderate in size. These results apply independently of whether B is a `productive' task or a 'bribe'.