Reputations, Relationships and the Enforcement of Incomplete Contracts

This paper discusses the literature on the enforcement of incomplete contracts. It compares legal enforcement to enforcement via relationships and reputations. A number of mechanisms, such as the repeat purchase mechanism (Klein and Leffler (1981)) and efficiency wages (Shapiro and Stiglitz (1984)), have been offered as solutions to the problem of enforcing an incomplete contract. It is shown that the efficiency of these solutions is very sensitive to the characteristics of the good or service exchanged. In general, neither the repeat purchase mechanism nor efficiency wages is the most efficient in the set of possible relational contracts. In many situations, total output may be increased through the use of performance pay and through increasing the quality of law.contract, law and economics, reputation, repeated games, incomplete contracts, transactions costs, institutional economics, contract enforcement

A Note on the Optimality of Bonus Pay

This note derives the optimal compensation contract with subjective evaluation when the principal and agent may not agree regarding performance. The optimal contract takes the form of a bonus payment whenever the principal believes performance is acceptable, but with the payment of a penalty by the principal whenever the agent disagrees with a negative evaluation of the principal. The efficiency of the relationship is increasing with the degree of correlation, a result that is consistent with the importance of trust for an efficient employment relationship.

Great Expectations: Law, Employment Contracts, and Labor Market Performance

This chapter reviews the literature on employment and labor law. The goal of the review is to understand why every jurisdiction in the world has extensive employment law, particularly employment protection law, while most economic analysis of the law suggests that less employment protection would enhance welfare. The review has three parts. The first part discusses the structure of the common law and the evolution of employment protection law. The second part discusses the economic theory of contract. Finally, the empirical literature on employment and labor law is reviewed. I conclude that many aspects of employment law are consistent with the economic theory of contract – namely, that contracts are written and enforced to enhance ex ante match efficiency in the presence of asymmetric information and relationship specific investments. In contrast, empirical labor market research focuses upon ex post match efficiency in the face of an exogenous productivity shock. Hence, in order to understand the form and structure of existing employment law we need better empirical tools to assess the ex ante benefits of employment contracts.employment law, labor law, employment contract, employment contract, law and economics

Les contrats auto-exécutoires et la théorie des institutions du marché du travail

L’étude reprend les éléments essentiels de la théorie des contrats auto-exécutoires (self-enforcing contracts) présentée dans MacLeod et Malcomson (1989, 1991). Nous montrons que l’existence de contrats incomplets peut nous aider à comprendre pourquoi les marchés du travail ne sont pas parfaitement compétitifs. Le modèle des contrats auto-exécutoires permet notamment d’apporter un nouvel éclairage sur la dualité des marchés du travail dans les pays en développement, de même que sur les différences salariales interindustries.In this paper, the theory of self-enforcing contracts developed in MacLeod and Malcomson (1989, 1991) is outlined. It is shown how the existence of incomplete contracts can help us understand why labour markets are not perfectly competitive. In particular, the model of self-enforcing contracts provides some new insights into the existence of dual labour markets in developing countries and inter-industry wage differences

Job Characteristics and the Form of Compensation

In this paper we introduce a way to systematically organize the choice between different forms of compensation based upon observable job characteristics. Secondly, we explore the determinants of compensation based upon questionnaire responses concerning job characteristics and methods of pay contained in the Quality of Employment Survey (QES), the National Longitudinal Survey of Youth (NLSY), the Panel Study of Income Dynamics (PSID), and the Current Population Survey. The0501n conclusion is that there is no single model of the employment relationship that can explain the variation in compensation form. We draw upon both agency and incomplete contract models to study the interplay between job characteristics and compensation. Specific results include a) the number of tasks seems to be associated with the use of incomplete contracts; b) Piece rate jobs tend to be associated with more worker autonomy and fewer tasks performed than hourly paid jobs; c) tight labor market conditions tend to be associated with the use of bonuses and promotions instead of efficiency wages. Cet article cherche à organiser de façon systématique le choix des différentes méthodes de rémunération selon les caractéristiques observables des emplois. Par après, nous examinons de façon empirique les facteurs influençant le choix de ces méthodes en utilisant l'information concernant les caractéristiques des emplois contenue dans le Quality of Employment Survey, le National Longitudinal Survey of Youth, le Panel Study of Income Dynamics et le Current Population Survey. La principale conclusion est qu'il n'existe aucun modèle de la relation d'emploi qui puisse expliquer de façon satisfaisante la variation observée dans les méthodes de compensation.Les résultats plus spécifiques sont les suivants : a) le nombre de tâches semble être associé à l'emploi de contrats incomplets; b) la rémunération à la pièce va de paire avec la parcimonie des tâches de même qu'avec l'autonomie accrue du travailleur; c) un marché du travail local serré tend à être associé avec l'utilisation de bonis et de promotions plutôt que des salaires d'efficience.Job characteristics, methods of pay, incomplete contracts, agency models, Caractéristiques des emplois, méthodes de rémunération, contrats incomplets, modèles d'agence

First Do No Harm?: Tort Reform and Birth Outcomes

We examine the impact of tort reforms using U.S. birth records for 1989-2001. We make four contributions: First, we develop a model that analyzes the incentives created by specific tort reforms. Second, we assemble new data on tort reform. Third, we examine a range of outcomes. Finally, we allow for differential effects by demographic/risk group. We find that reforms of the "deep pockets rule" reduce complications of labor and C-sections, while caps on noneconomic damages increase them. Our results demonstrate there are important interactions between incentives created by tort law and other incentives facing physicians.

Construction Contracts (or “How to Get the Right Building at the Right Price?”)

Most contracts that individuals enter into are not written from scratch; rather, they depend upon forms and terms that have been successful in the past. In this paper, we study the structure of form construction contracts published by the American Institute of Architects (AIA). We show that these contracts are an efficient solution to the problem of procuring large, complex projects when unforeseen contingencies are inevitable. This is achieved by carefully structuring the ex post bargaining game between the Principal and the Agent. The optimal mechanism corresponding to the AIA construction form is consistent with decisions of the courts in several prominent but controversial cases, and hence it provides an economic foundation for a number of the common-law excuses from performance. Finally, the case of form contracts for construction is an example of how markets, as opposed to private negotiations, can be used to determine efficient contract terms.

The Economics of Relational Contracts

The legal scholarship on relational contracts highlights the fact that commercial transactions rely upon a large number of institutions, including trade norms and the good reputation of industry participants. This complexity is in contrast to the simple models that are often used in economics analysis of the law, leading Macauley (2002) to suggest one can view “law and economics as a desert, and law and society as a swamp". The purpose of this paper is to show that the economic analysis of relational contracts touches upon several elements of modern micro-economics that can be distinguished by different meanings of the term “price” . The term “economic price” refers to the true resource cost of a commodity, and can explain the role of standards setting by trade organizations. “Trade price” refers to terms of trade, but can be distorted due to asymmetric information. This effect may be mitigate via reputational mechanisms. Finally, “contract price” refers to contingent prices such as warranties, as well as legally enforceable agreements for which courts can be asked to impose damages where there is con- tract breach

Patience Versus Decisiveness in Decision-Making

When rationality is bounded, a variety of factors may influence how far a choice is from optimal. We examine the willingness to search among alternatives. We find fixed individual differences in this temperament measure. People may be usefully typed according to how they obtain improved choices. More patient subjects obtain improvement by effectively using decision resources, performing better when the decision is more complex. More decisive subjects obtain improvement by conserving valuable decision resources, performing better when the decision problem is simple. We find that a bonus incentive frame encourages patience, while a penalty frame encourages decisiveness. These results suggest an organization can enhance its performance by matching individual temperaments and incentive frames to decision tasks at hand.framing, deliberation cost, bounded rationality, heuristics, incentives

The Empirical Implications of the Grossman-Hart Model: Comments on “Incomplete Contracts and the Internal Organization of Firms” by P. Aghion, N. Bloom and J. Van Reenen

This is a comment on “Incomplete Contracts and the Internal Organization of Firms” by P. Aghion, N. Bloom and J. Van Reenen, forthcoming in The Impact of Incomplete Contracts on Economics, edited by Philippe Aghion, Mathias Dewatripont, Patrick Legros, and Luigi Zingales, Oxford University Press, 2015