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What are the characteristics of contracts that lead them to be incomplete? Why, in a world...

What are the characteristics of contracts that lead them to be incomplete? Why, in a world of incomplete contracts are the outcomes of principal-agent interactions typically Pareto-inefficient, resulting in enforcement rents and non-market clearing competitive equilibrium? What are the results of these kinds of markets for interpersonal repeated interactions?

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Answer #1

The characteristics of an incomplete contract are the following:

  • The contract is ambiguous
  • The contract has some missing provisions
  • The contract is short-term
  • The contract may have renegotiations

Principal agent theory is usually concerned with the conflicts of interest. In this theory the incentive problem is taken on priority and so they are modeled explicitly and with detailed precision. Principal agent theory usually leads to a non-market clearing competitive equilibrium, as they do not consider any difference between an incentive contract within the firm and between two separate firms. This alike treatment leads to Pareto inefficiency.

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