Patrick W. Schmitz
Abstract. Contract theory is one of the most active fields of research in contemporary microeconomics. One of the reasons for its popularity in recent years may be the fact that many economists think that the incomplete contracts approach as pioneered by Grossman and Hart (1986) and Hart and Moore (1990) can help to answer important questions regarding the boundaries of the firm, which have first been raised by Coase (1937). However, several economic theorists still feel uncomfortable about the foundations of the incomplete contracts approach. Why should one only compare the consequences of writing 'simple' contracts that result in inefficient outcomes, if there are more sophisticated contracts which might even implement the first best? Such concerns have lead some researchers to a renewed interest in the more traditional theory of complete contracts, which is closely related to the theory of implementation or mechanism design.
The first chapter of the book provides a non-technical survey on recent topics in the theory of contracts, emphasizing Williamson's famous hold-up problem. Existing surveys are of a quite technical nature and therefore difficult to access for readers who are not already specialists in the field. In contrast, while trying to be as exact as necessary, in this chapter all ideas are presented verbally without any mathematical pyrotechnics. The focus is on issues that have received particular attention by researchers in recent years.
The remainder of the book is divided into two parts. Part I avoids the problems of the incomplete contracts approach, since either the class of contracts is not restricted (Chapter 3), or since the first best is achieved (Chapters 2 and 4), so that there is no need to consider more general contracts. Chapter 2 shows that the first best solution to the hold up problem may be achieved even if renegotiation takes place under asymmetric information, provided that investments are selfish, i.e. influence only a party's own valuation. If investments are cooperative (i.e., the seller's investment influences the buyer's willingness-to-pay), there is in general no hope to achieve the first best in the presence of private information, even if renegotiation can be ruled out (Chapter 3). It is argued in Chapter 4 that an agent can be given incentives to both gather information and reveal the acquired information truthfully. Simple contracts that give agents a chance to be integer suffice. This contradicts Prendergast's (1993) theory of 'yes men' behavior in organizations and his explanation of low-powered incentives.
Part II consists of some applications of the theory of incomplete contracts. These applications demonstrate that the incomplete contracts approach indeed provides powerful tools to analyze various economic questions of practical importance. However, the models also throw some critical light on this approach. Chapters 5 and 6 show that some of the main findings reported by Hart and Moore (1990) and Hart (1995) do not seem to be very robust. In Chapter 5 it is argued that giving a non-investing party ownership can be optimal if the relationship specificity of the investments is determined endogenously. Chapter 6 shows that giving two parties veto power can be optimal if know-how disclosure by one party improves the bargaining position of the other party, providing a new rationale for the institution of research joint ventures. Finally, Chapter 7 raises the question of whether Grossman and Hart's (1986) idea to compare the implications of rational behavior under certain exogenously given rules is really marking a new epoch, or merely a relapse into old habits of the law and economics literature. As an illustration, the joint use of ex post liability and ex ante safety regulation is discussed.
Erschienen in der Reihe "Berichte aus der Volkswirtschaft" im Shaker Verlag, Aachen, 1999.
ISBN: 3-8265-5874-X