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Incomplete Contracts and Strategic Ambiguity

B. Douglas Bernheim and Michael D. Whinston
The American Economic Review
Vol. 88, No. 4 (Sep., 1998), pp. 902-932
Stable URL: http://www.jstor.org/stable/117011
Page Count: 31
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Incomplete Contracts and Strategic Ambiguity
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Abstract

Why are observed contracts so often incomplete in the sense that they leave contracting parties' obligations vague or unspecified? Traditional answers to this question invoke transaction costs or bounded rationality. In contrast, we argue that such incompleteness is often an essential feature of a well-designed contract. Specifically, once some aspects of performance are unverifiable, it is often optimal to leave other verifiable aspects of performance unspecified. We explore the conditions under which this occurs, and investigate the structure of optimal contracts when these conditions are satisfied.

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