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Prof. Thomas Kittsteiner

London School of Economics and RWTH (Rheinisch-Westfaelische Technische Hochschule) Aachen University, Germany

Authors: Pablo Casas-Arce and Thomas Kittsteiner
 

Abstract: This paper formalizes the idea that contracting partners can engage in post-contractual opportunistic behavior aimed at circumventing the original intention of their agreement. We show that anticipation and observability of such behavior are typically not enough to prevent its occurrence. This is true if message games are allowed and parties renegotiate any inefficient contractual outcome. Any contractually specified incentives unavoidably have conflicting effects: they increase the likelihood of welfare improving investments and at the same time they increase the likelihood of (welfare reducing) opportunistic behavior. Thus opportunism reduces the value of contracting by limiting the effectiveness of contractual incentives. We provide conditions for the optimality of incomplete contracts, a simple characterization of the second-best contract, and some comparative statics. We demonstrate the usefulness of our framework by relating it to the property rights and transaction costs theories of the firm.

Full Text: “Opportunism and Incomplete Contracts”