Costly contracting in a long-term relationship

Authors


  • We thank two anonymous referees for very useful comments and suggestions. We also thank Luca Anderlini, Mariagiovanna Baccara, Alvaro Bustos, Arnaud Costinot, Avinash Dixit, Kfir Eliaz, Leonardo Felli, Astrid Gamba, Edoardo Grillo, Bentley MacLeod, Eric Maskin, Fabio Michelucci, Fausto Panunzi, David Pearce, Ludovic Renou, Joel Watson, the participants in conferences at Siena, Venezia, Ischia, Gertzensee, and Lousanne, and the participants in seminars at Northwestern University, PUC Rio de Janeiro, European University Institute, Bocconi University, DELTA, INSEAD, University of Arizona, University of Helsinki, Hebrew University of Jerusalem, and Tel Aviv University for helpful comments and discussions. Battigalli thanks Bocconi University for financial support. Maggi received financial support from the National Science Foundation. Both authors thank the NYU Stern School of Business for its hospitality during part of this project.

Abstract

We examine a model of contracting where parties interact repeatedly and can contract at any point in time, but writing formal contracts is costly. A contract can describe the external environment and the parties' behavior in a more or less detailed way, and the cost of writing a contract is proportional to the amount of detail. We consider both formal (externally enforced) and informal (self-enforcing) contracts. The presence of writing costs has important implications both for the optimal structure of formal contracts, particularly the tradeoff between contingent and spot contracting, and for the interaction between formal and informal contracting. Our model sheds light on these implications and generates a rich set of predictions about the determinants of the optimal mode of contracting.

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