Incomplete Contracts Research Articles

Renegotiations in the Presence of Supply Disruptions

We study the ability to renegotiate in a supply chain setting with the possibility of supply disruption. Disruptions are a real threat to supply chains, especially as the supply chains become longer and more complex. When buyers and sellers write a purchase contract, specifying every possible contingency related to disruptions may not be realistic. However, the ability to renegotiate once a disruption occurs can help buyers and suppliers find efficient solutions. We conducted a controlled laboratory experiment consisting of three studies, each exploring different conditions regarding relationship length, bargaining power, and communication. Our findings indicate that the ability to renegotiate increases buyer profit and decreases disruption inefficiency in short-term relationships but not in long-term ones. In free bargaining, where bargaining power is equal, the impact of renegotiation is greater than in ultimatum bargaining, where bargaining power is unequal. Additionally, when communication is not allowed in ultimatum bargaining, renegotiation significantly enhances buyer profit and reduces disruption inefficiency. These insights can assist managers in designing and negotiating incomplete contracts in environments prone to supply disruptions. The findings can aid managers in designing and negotiating incomplete contracts in environments with supply disruptions.

Commitment to the truth creates trust in market exchange: Experimental evidence

Under incomplete contracts, the mutual belief in reciprocity facilitates how traders create value through economic exchange. Creating such beliefs among strangers can be challenging even when they are allowed to communicate, because communication is cheap. In this paper, we first extend the literature showing that a truth-telling oath increases honesty to a sequential trust game with pre-play, fixed-form, and cheap-talk communication. Our results confirm that the oath creates more trust and cooperative behavior thanks to an improvement in communication; but we also show that the oath induces selection into communication — it makes people more wary of using communication, precisely because communication speaks louder under oath. We next designed additional treatments featuring mild and deterrent fines for deception to measure the monetary equivalent of the non-monetary incentives implemented by a truth-telling oath. We find that the oath is behaviorally equivalent to mild fines. The deterrent fine induces the highest level of cooperation. Altogether, these results confirm that allowing for interactions under oath within a trust game with communication creates significantly more economic value than the identical exchange institutions without the oath.

Contract Contingencies and Uncertainty: Evidence from Product Market Contracts

We study contingencies written in firms’ material product market contracts, focusing on the theoretical prediction of uncertainty as an important determinant. We identify contract contingencies from firms’ public regulatory filings and examine the effects of general business uncertainty and specific innovation-related uncertainty. To enhance causal inference, we utilize two major business shocks (i.e., the 2008 Financial Crisis and the COVID pandemic) and the diffusion of 29 disruptive innovation shocks (Bloom et al. 2021). We also explore the effects of re-negotiation costs and writing costs. Overall, our empirical results are consistent with predictions from dynamic models of incomplete contracting.

Does common institutional ownership mitigate hold‐up problems along the supply chain?

AbstractWe show that common institutional ownership (CIO) along the supply chain mitigates hold‐up problems faced by supplier–customer relationships resulting from incomplete contracts. Suppliers make more relationship‐specific investments (RSIs) measured by R&D and patent filings toward their customers that share common institutional investors. Such effect is stronger as the CIO network between a supplier and customer pair becomes wider and deeper. We establish causality by exploiting exogenous shocks to CIO using a broad sample of mergers between financial institutions and further find the CIO effects on suppliers’ innovation specificity are stronger for those who ex ante face severer hold‐up concerns. Lastly, we provide evidence that CIO involvement increases the combined valuations of supply chain pairs (mainly for customers). Our work sheds light on the hold‐up mitigation effect of CIO on firms’ decision to make RSIs along the supply chain.

State Formation and Bureaucratization: Evidence from Pre-Imperial China

This paper studies the relationship between military conflicts and state-building in pre-imperial China. I develop an incomplete contract model to examine rulers’ and local administrators’ incentives in conflict. Defensive wars drive decentralization: landowning local administrators have more to gain from a successful defense and are therefore more committed to it. Offensive wars drive centralization: the landowning ruler has personnel control over the non-land-owning local administrator and can therefore force the latter to participate in less lucrative attacks. Model predictions are corroborated with empirical evidence and historical case studies, and offer broader implications for the political divergence between China and Europe.

REPUTATION AND TRUST OF PRINCIPALS AND AGENTS IN INTERORGANISATIONAL RELATIONS — THE CASE OF INTERDISCIPLINARY RESEARCH COOPERATION

Trust is the most important prerequisite for the emergence and effectiveness of interorganisational innovation cooperation, due to uncertainty and contract incompleteness. Nevertheless, little attention has been paid to the question of whether the trust of principals in a cooperation depends on different preconditions than that of agents. Based on a sample of 364 scientists from 100 German publicly funded interdisciplinary cooperations in medical research, we find that the trust of principals mainly depends on their partners’ reputation of ability, whereas the trust of agents on their partners’ reputation of benevolence. Surprisingly, culture- and personality-related factors prove to be ineffective. These results are of major relevance for the trust generation in innovation cooperation.

Overcoming contract incompleteness: evidence from long-term supply relationships

This paper explains how firms address contract incompleteness in long-term supply relationships. For firms, it is practically impossible to assess all future eventualities, draft complete and fully contingent contracts, observe and verify the agreed performance. Based on an empirical investigation of long-term supply relationships between agribusiness and farms in India, we present evidence that under certain conditions overcoming contractual incompleteness is possible. We argue that firms are better able to deal with contract incompleteness when they specify contract clauses that regulate (1) recurrent interaction, (2) relational frame and (3) nonlegal enforceability. These three mechanisms of contract clauses enable firms to preserve the substance of how they wish to relate to each other and simultaneously allow them to remain sufficiently flexible to embrace new opportunities.

The link between organizational choice and global input sourcing under sequential production

AbstractThis article analyzes the ways heterogenous firms procure their inputs in the presence of relationship‐specific investments and incomplete contracts. We first consider a closed economy in which firms decide how to structure their organization. Production is sequential and inputs (upstream and downstream) are sourced in the same order as production. While our closed‐economy setup is analogous to Antràs and Chor (Econometrica, 2013), there are two distinct features: (1) The reward to each supplier is determined through bargaining over the full revenue of the firm (as opposed to marginal contribution of the supplier), and (2) The reward structure combined with our sequential bargaining protocol gives rise to linkages across suppliers. The analysis in Antràs and Chor (Econometrica, 2013) identifies a mechanism in which upstream organizational decisions have spillover effects on downstream suppliers' investment incentives. Thanks to our novel features, we identify another mechanism: the spillover effects of downstream organizational decisions on the investment incentive of upstream suppliers. Next, we consider an open economy in which firms not only make organizational decisions but also determine where to source their inputs. We show that these decisions are connected between sequential production stages such that the sourcing location of the upstream input may affect the organizational choice in the downstream stage. We then examine how within sectoral heterogeneity and variations in industry characteristics influence the relative prevalence of firms that choose to form different organizational structures.

Баланс интересов внешних и внутренних бенефициаров в условиях «неполных контрактов» ресурсной экономики

This article examines the uncertainties arising from agent interactions in interregional resource-intensive markets, particularly those prevalent in northern regions, and explores factors undermining their effectiveness Given these circumstances, the study aims to establish an optimal balance of interests between external and internal beneficiaries by taking into account interests, as well as reducing transaction uncertainty by considering their interests and mitigating transaction uncertainty through the optimization of market regulators in the context of interregional resource-intensive markets typical of northern regions. The analysis reveals that the condition of a single market equilibrium is compromised due to the influence of exogenous factors and the endogenous formation of institutional mechanisms that coordinate agent actions amid uncertain collaborations. Contrary to the neoclassical approach, which focuses on competitive pricing without altering the market structure, an alternative perspective posits that spatial externalities induce endogenous mechanisms characteristic of Chamberlin-type market structures. The study expands the understanding of uncertainty causes within the theory of incomplete contracts, incorporating social system costs into transaction costs in line with the neo-institutional concept. This conceptual framework enables the exploration of spatial entities as meso-economic systems, with a specific emphasis on the organizational and geographical characteristics of northern territories. The research evaluates four institutional zones governing economic management practices in northern regions. Through competence enhancement and optimization of market regulator design, the study demonstrates the feasibility of achieving a balance of interests between external and internal beneficiaries by strengthening institutional capital, thereby reducing social system costs. The proposed system of organizational and institutional measures enhances local institutional practices within the existing institutional matrix without violating antimonopoly legislation, as its focus is on restoring competitive conditions and reducing the costs of operating the social system.

URBAN LIVEABILITY AND CEO TURNOVER: EVIDENCE FROM CHINESE FIRMS

Using data from 2,744 listed non-financial firms located in 273 Chinese cities and municipalities during the period spanning 2003 to 2017, this paper examines the impact of changes in urban liveability on the voluntary turnover of CEOs. Employing the panel probit methodology, we find that enhancements in urban liveability result in a reduction in CEO turnover. Moreover, such enhancements also serve to partially mitigate the performance sensitivity of CEO turnover. In a disaggregated analysis, we find that improvements in urban liveability likewise decrease the likelihood of CEO turnover for foreign-owned firms, companies facing stronger external rivals, and those lacking government industrial policy support. Our work extends existing literature on the factors influencing CEO turnover within the framework of incomplete contract theory. Additionally, this paper offers a policy foundation for urban planners to effectively decrease the CEO turnover rate by enhancing urban liveability.

Social appropriateness with contractual incompleteness

ABSTRACT We conduct the Krupka – Weber norm-elicitation game in a setting with contractual incompleteness and find that the method is not robust to subjects in different roles and treatments. We disclose bystanders’ norm ratings to trading parties in an information treatment. The two parties in the information treatment differ in rating the appropriateness of choices, and these role differences are rooted in an egocentric focus on bystanders’ ratings. We also find that the mechanism enhances their normative standard and selection of more pro-social choices.

Research on Tax Compliance Incentive Effects of Platform Companies from the Perspective of Incomplete Contract – An Empirical Study Based on China

Research on Tax Compliance Incentive Effects of Platform Companies from the Perspective of Incomplete Contract – An Empirical Study Based on China

Why Wages Don't Fall in Jobs with Incomplete Contracts

Why Wages Don't Fall in Jobs with Incomplete Contracts

“Controlled Competition”: How Governments can induce Long-Term Competition

This paper builds a model of dynamic tournaments under incomplete contract situations to analyze how the government, as a national development strategy, induces incentives or forms of competition between multiple companies (between state-owned enterprises (SOEs), between private-owned enterprises (POEs), or between SOEs and POEs) in the long-run. This paper can be considered as a model analysis of “controlled competition” under “State Capitalism”, in which the government participates in the market as an active player, such as in China, Singapore, and in a broad sense, in Japanese Industrial Policy in the past. In addition to clarifying the incentive mechanism embedded in this model, we also examine the problems and areas for improvement from the perspective of incentive design. In particular, in the long-term competition between two heterogeneous companies, it would be a beneficial policy for the government if the feedback effect could be mitigated by handicapping the winner and favoring the loser, thereby restoring the competitive pressure that had decreased. At the same time, as excessive competition-inhibiting discriminatory prizes (“Cronyism”) greatly impede investment incentives for both companies, these can be viewed as a "government failure", and thus the institution should be redesigned to correct such obstacles, thereby maintaining appropriate competitive pressures.

Overconfidence and Endogenous Contract Incompleteness

Overconfidence and Endogenous Contract Incompleteness

The agency costs of investment opportunities and debt contracting: Evidence from exogenous shocks to government spending

AbstractThis study investigates the impact of macroeconomic shocks to firm investment opportunities on firm debt contracting policy. We find that adverse shocks to investment opportunities lead to a significant reduction in the use of debt covenants in syndicated bank loans. Consistent with incomplete contract theory, we show that firms mitigate debt–equity conflicts arising out of investment opportunities by employing accounting‐based financial covenants rather than non‐accounting‐based prepayment covenants. Adverse shocks to investment opportunities also lead to a concomitant decrease in the cost of borrowing. We find consistent evidence for corporate bond covenants and bond market borrowing costs as well. Overall, this study resolves prior mixed evidence concerning the impact of investment opportunities on debt contracting and connects macroeconomic theory with the accounting literature on debt contracting.

Corporate Social Responsibility along the global value chain

Locating substantial parts of the production process in developing and emerging economies, many firms face an increasing demand by stakeholders for Corporate Social Responsibility (CSR) along their value chains. Contractual incompleteness between firms and their suppliers at different stages of production can exacerbate the ability to meet these demands. We analyze a model of sequential production with incomplete contracts where CSR by independent suppliers differentiates the final product in the eyes of caring consumers. Progressing down the value chain, our model predicts an increasing CSR profile from upstream suppliers with low CSR to downstream suppliers with higher CSR. We confirm this prediction using Indian firm-level data – computing a firm’s value chain position by combining its product-level sales information with the World Input–Output Database. We find that more downstream firms report higher CSR expenditures as measured by a combination of staff welfare spending and social community spending.

Construction dispute and contract incompleteness in Nigeria construction industry

This study identifies that the underlying root cause of construction disputes is contract incompleteness caused by bounded rationality and uncertainty. Using the relative importance index (RII) and confirmatory factor analysis(CFA) from SEM AMOS, this study examines the occurrence likelihood and significant effect on dispute occurrence in the contract incompleteness minefield (ambiguity of contract document (AOD), deficiency of contract document (DOD), inconsistency of contract document (IOD), and defectiveness of contract document (CDD)), and the manifestation of opportunism (violation of commitment (VOC), forced renegotiation (FRC), evasion of obligations (EOB), and refusal to adapt to change (RAC)). A large-scale survey of 350 professionals from the Nigerian construction industry was conducted. The RII result of the highly ranked minefield of the manifestation of contract incompleteness shows the interrelationship between contract incompleteness and dispute occurrence. Likewise, the CFA result significantly affects contract incompleteness on dispute occurrence. Therefore, the need to minimise contract incompleteness in the Nigerian construction industry becomes a pertinent issue to reduce dispute occurrence.

Can Blockchain Technology Help Overcome Contractual Incompleteness? Evidence from State Laws

Real-world contractual agreements between firms are often incomplete, leading to suboptimal investment and loss of value in supply chain relationships. To what extent can blockchain technology help alleviate problems arising from contractual incompleteness? We examine this issue by exploiting a quasi-natural experiment based on the staggered adoption of U.S. state laws that increased firms’ in-state ability to develop, adopt, and use blockchain technology. We find that, after exposure to a pro-blockchain law, firms with greater asset specificity exhibit more positive changes to Tobin’s Q, research and development, and blockchain-related innovation. Also, such firms appear to rely less on vertical integration, form more strategic alliances, and shift their emphasis to less geographically proximate customers. Overall, our results suggest that blockchain technology can help firms remedy constraints and inefficiencies arising from contractual incompleteness. This paper was accepted by Will Cong, Special Section of Management Science: Blockchains and Crypto Economics. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2022.04139 .

Analysis of Signing Incomplete Contracts between Maker Space and Start-Ups

With the advancement of science and technology, innovation has become one of the main ways to promote social development. In such an environment, the concept of maker space emerged. Maker space provides entrepreneurs with the services they need, helps entrepreneurs save costs, and simplifies the entrepreneurial process. Maker space also uses the effect of scale to provide these services at a relatively low cost and make profits. However, the development of maker space has entered a bottleneck period, and it is difficult to break through the profitability and market size, so it is necessary to seek optimization in the business model. Incomplete contracts provide a potential possibility. Incomplete contracts have the characteristics of low cost and strong incentive ability, which meet the needs of the maker space. In this context, this paper studies how incomplete contracts can achieve benefits between the maker platform and start-ups. Using SWOT analysis, it is concluded that the use of incomplete contracts between the maker space and start-ups has positive advantages. A suggestion that incomplete contracts should be widely used in the future contract signing between the maker space and start-ups is drawn. This study believes that the application of incomplete contracts has broad prospects in the future.