incomplete contracts


  • [30] However, as this uncertain state of nature or behavior cannot be written into an enforceable contract, when the contract is incomplete, not all uses of the asset can
    be specified in advance and any contract negotiated in advance must leave some discretion as to the use of the asset, with the ‘owner’ of the company being the party to whom residual control is allocated at the contract stage.

  • A complete contract in economic theory means a contract which provides for the rights, obligations and remedies of the parties in every possible state of the world.

  • [32] Incomplete contractual/property rights approach gives rise to theories of ownership and vertical integration, and it also directly addresses the question of what constitutes
    a firm.

  • Oliver Hart and his co-authors argue that the hold-up problem may be mitigated by choosing a suitable ownership structure ex-ante (according to the incomplete contracting
    paradigm, more complex contractual arrangements are ruled out).

  • [35] Terms implied by the Court[edit] Courts are often willing to imply a term in a settled contract to “fill in the gaps” as long as it is: • Reasonable and fair; • Necessary
    to make the contract workable ; • So obvious as to be “self-explanatory”; • Able to be expressed clearly and in line with clear terms.

  • Example: • The court will imply into the contract terms which the parties are deemed to have known by virtue of the previous transaction.

  • Hence, the property rights approach to the theory of the firm can explain the pros and cons of vertical integration, thus providing a formal answer to important questions
    regarding the boundaries of the firm that were first raised by Ronald Coase (1937).

  • In particular, some authors such as Maskin and Tirole (1999) argue that rational parties should be able to solve the hold-up problem with complex contracts, while Hart and
    Moore (1999) point out that these contractual solutions do not work if renegotiation cannot be ruled out.

  • [28] In economic theory In 1986, Grossman and Hart (1986) used incomplete contract theory in their seminal paper on the costs and benefits of vertical integration to answer
    the question “What is a firm and what determines its boundaries?”.

  • In a world of incomplete contracts, decision-making power plays a key role in determining the incentives of owners.

  • As for contractual incompleteness, the law is concerned with when and how a court should fill gaps in a contract when there are too many or too uncertain to be enforceable,
    and when it is obliged to negotiate to make an incomplete contract fully complete or to achieve the desired final contract.

  • [34] One of Hart-Moore’s key findings suggests an explanation for why firms, rather than workers, tend to own most of the non-human assets used to produce goods and services:
    complementary assets should be owned by one person.

  • [9] Since at least in some states of the world the parties will renegotiate their contractual arrangements later on, they have insufficient incentives to make relationship-specific
    investments (since a party’s investment returns will partially go to the other party in the renegotiations).

  • [16] The property rights approach has also been extended by Chiu (1998) and DeMeza and Lockwood (1998), who allow for different ways to model the renegotiations.

  • [36] Statutory implied terms[edit] Example: ACL’s (Australian Consumer Law) implied terms in consumer contracts are intended to protect the buyer, and there is an implied
    term in every contract for the sale of goods.

  • [19] The theory of incomplete contracts has been successfully applied in various contexts, including privatization,[20][21] international trade,[22][23] management of research
    & development,[24][25] allocation of formal and real authority,[26] advocacy,[27] and many others.

  • The Grossman-Hart theory of property rights is the first to explain[citation needed] in a straightforward manner why markets are so important in the context of organizational

  • Thus, an immediate consequence of the incomplete contracting approach is the so-called hold-up problem.

  • In contract law, an incomplete contract is one that is defective or uncertain in a material respect.

  • [15] It has been pointed out by Schmitz (2006) that the property rights approach can be extended to the case of asymmetric information, which may explain ex-post inefficiencies.

  • The terms and provisions of the contract still have influence and are binding on the parties to the contract.

  • [3] In 1990, Oliver Hart and John Moore published another article, “Property Rights and the Nature of the Firm”, which provided a framework for addressing when transactions
    should take place within the firm and when they should take place through the market.


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