Incomplete Contracting: A Laboratory Experimental Analysis

Incomplete contracts are motivated by difficulties in specifying contingent responses to unforeseen change in long-term trading relationships. The issues can be parsimoniously represented. in a two-period model. Parties first make transaction-specific investme nt that enhances value or reduces cost. Surplus is then realized, and bargaining divides the surplus and completes the contract. The testa ble hypothesis is that realized surplus shares are independent of sunk investments. This is strongly rejected using laboratory experimental methods. Failure of the prediction affects the expected profitabilit y of contracts. Copyright 1993 by Oxford University Press.

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