INCOMPLETE CONTRACT THEORY AND CONTRACTS BETWEEN FIRMS: A PRELIMINARY EMPIRICAL STUDY by

Abstract

The theory of incomplete contracts has been much developed over the last few years, but it has failed to generate any empirical work. In part, this is due to the way models have been developed with a view to foundational rigour, and with little effort to draw out the empirical implications. It is also due to the difficulty in gathering relevant data. In this paper, we draw out some of the testable assumptions and predictions of incomplete contract theory with respect to the design of contracts between firms. Drawing on an earlier questionnaire study of UK manufacturing procurement contracts, we are able to cast light on the empirical relevance of some of the distinctive ideas from ICT. The evidence suggests that firms do use contracts with the expectation of legal sanction, and they are willing to renegotiate under conditions assumed by the theory. However, there is no support for the strategic use of contracts to encourage specific investments or to frame renegotiation. We conclude that firms develop alternative modes of governance to achieve this. One implication is that it is misleading to use one-shot classical contracting ICT, as a foundation for the theory of the firm