The application of hardship and gain provisions in strategic contracting

Abstract

Strategic contracting is based on the fundamental condition of risk and gain sharing in the course of relational rent creation. The mutual application of hardship and gain provisions implies that if such an instance occurs after the conclusion of the contract, the parties have an obligation to renegotiate the contract in a fair manner. However, even though strategic contracting strives to ensure the alignment of incentives, there might still be a risk of hold-up and perhaps even efficient breach of contract. We apply the classical microeconomic risk-preference theory of expected utility and transaction cost theory in order to develop a form of strategic contracting that entails the use of a reciprocal hardship and gain provisions, which helps the contracting parties deal with such instances. We outline three necessary and cumulatively sufficient conditions under which hardship and gain provisions make economic sense.