Contracts as Threats: On a Rationale for Rewarding A While Hoping for B

34 Pages Posted: 31 Jan 2011

See all articles by Elisabetta Iossa

Elisabetta Iossa

University of Rome Tor Vergata; IEFE Bocconi University; Centre for Economic Policy Research (CEPR)

Giancarlo Spagnolo

Stockholm School of Economics (SITE); Centre for Economic Policy Research (CEPR); University of Rome 'Tor Vergata'; EIEF

Multiple version iconThere are 3 versions of this paper

Date Written: January 2011

Abstract

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'.

Keywords: Governance, incomplete contracts, multi-tasking, relational contracts

JEL Classification: C73, D86, L14

Suggested Citation

Iossa, Elisabetta and Spagnolo, Giancarlo, Contracts as Threats: On a Rationale for Rewarding A While Hoping for B (January 2011). CEPR Discussion Paper No. DP8195, Available at SSRN: https://ssrn.com/abstract=1749816

Elisabetta Iossa (Contact Author)

University of Rome Tor Vergata ( email )

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Italy

IEFE Bocconi University ( email )

Via Roentgen 1
Milan, Milan 20136
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Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Giancarlo Spagnolo

Stockholm School of Economics (SITE) ( email )

P.O. Box 6501
Stockholm
Sweden

HOME PAGE: http://https://sites.google.com/site/giancarlospagnoloshomepage/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

University of Rome 'Tor Vergata' ( email )

Faculty of Economics - DEI
Via Columbia 2
Rome, RM 00133
Italy

EIEF ( email )

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Italy

HOME PAGE: http://WWW.EIEF.IT

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