The Structure of Contracts and Transaction Costs: Note

Abstract

It is the purpose of this note to consider the determinants of contract provisions, in particular those that stipulate possible actions in the event of the breach of the terms in a credit contract. This category of provisions is generally called remedies when used in credit contracts. The use of creditors' remedies, collateral in particular, to reduce the likelihood of loan default has been examined in earlier papers [1,2]. Robert Barro's paper [1, p. 455] in concluding, suggested that Useful extensions to the model would include generalizations to the form of the loan contract, introduction to other types of transactions, costs, and analysis of the loan period. Although we do not extend Barro's model, we do extend some of his concepts in the direction suggested. In particular we will show that a theory based on nonzero information costs is capable of explaining the observed variation in the form or structure of credit contracts and their use of explicit remedies.