This website uses cookies.

By clicking the "Accept" button or continuing to browse our site, you agree to first-party and session-only cookies being stored on your device to enhance site navigation and analyze site performance and traffic. For more information on our use of cookies, please see our Privacy Policy.

  1. Home
  2. Journals
  3. American Economic Review
  4. December 2009
  5. Endogenous Verifiability and Relational Contracting

Endogenous Verifiability and Relational Contracting

Download Full Text PDF

Abstract

Principal-agent models usually invoke the strong assumption that the parties know for sure ex ante whether a variable is verifiable or not. This paper assumes that only the probability of verification is known, and that this probability is endogenously determined. We analyze a principal-agent relationship where the verifiability of the agent's output is determined by the principal's investment in drafting an explicit contract. The model is well suited for analyzing the relationship between explicit contracting, legal courts, trust, and relational contracting. In particular, we show how trust -- established through repeated interaction -- and legal courts may induce contractual incompleteness. (JEL D82, D86)

Citation

Kvaløy, Ola, and Trond E. Olsen. 2009. "Endogenous Verifiability and Relational Contracting." American Economic Review, 99 (5): 2193-2208. DOI: 10.1257/aer.99.5.2193

JEL Classification

  • D82 Asymmetric and Private Information
  • D86 Economics of Contract: Theory