Incomplete Contracts in Multi-period Procurement

We analyze the problem of a buyer who purchases a long-term project from one of several suppliers. A changing state of the world influences the costs of the suppliers. We distinguish between complete contracts conditioning on all future realizations of the state of the world and incomplete contracts renegotiated whenever the state of the world changes. We provide conditions such that incomplete contracting does not pose a problem. If the changing state of the world is publicly observable and the buyer cannot switch between suppliers during the lifetime of the project, the buyer achieves the same surplus irrespective of whether contracts are complete or incomplete. An English auction followed by renegotiation whenever the state of the world changes is optimal. To identify conditions when buyers should consider drafting complete contracts, we extend the analysis by considering private information about the changing state of the world and supplier switching. In both cases, incomplete contracting poses a problem. In a survey of procurement consultants, we confirm that publicly observable states of the world via price indexes play an important role in procurement. Moreover, the consultants confirm that supplier switching is infrequent in procurement practice. Thus, incomplete contracting is less of a problem in a considerable share of procurement projects. However, complete contracts are useful and could be used more often. This paper was accepted by Yan Chen, behavioral economics and decision analysis.

Negotiating incomplete contracts

When planning is possible, as in predictive environments, comprehensive contracting is not only desirable, but also useful. However, under conditions of fundamental uncertainty, as is the case in non-predictive environments, incomplete contracting approaches likely prevail. In this study, we explore how trust in such environments affects the way in which venturing professionals negotiate, and how the outcome subsequently manifests itself in the negotiated agreement. In particular, building upon a sample of Norwegian firms, we find that stewardship relationships are more prone to incomplete contracting approaches than agency relationships, paving the way for a relational approach to contracting when uncertainty is high. Implications for theory and practice are discussed.

Trust, Incomplete Contracting, and Corporate Innovation

Innovation is a contract-intensive economic activity in a world of incomplete contracts. We show that trust mitigates incomplete contracting and enhances innovation by acting as an informal contracting mechanism. Trust plays an especially important role when formal laws and regulations are lacking, and it promotes innovation by encouraging collaboration and fostering tolerance for failure. Further analyses show that trust also facilitates cross-border technological spillover and innovation collaboration. Overall, our evidence highlights innovation as a key conduit through which trust affects economic growth. This paper was accepted by Gustavo Manso, finance.

Rational Choice Perspectives on Bureaucracy

Formal models of bureaucracy have attracted significant attention as a systematic body of theory in the past decades. Scholars in this tradition examine institutions and organizations, uncovering incentives that can explain and help to design governance. Scholars in the rational choice tradition study the relationship between politicians and bureaucrats as an incomplete contracting problem between a political principal and a bureaucratic agent. When elected representatives delegate policymaking authority to an administrative agency, they face hidden action problems when the agency takes unobservable actions, and hidden information problems when there are things about agency policy preferences that representatives cannot easily learn. A wide variety of bureaucratic policymaking problems can be modeled as variations on these information problems. Formal theorists have considered resources and discretionary authority as variables that can be optimized to mitigate agency problems, and the models have both positive and normative implications.

Behavioral Constraints on the Design of Subgame-Perfect Implementation Mechanisms

We study subgame-perfect implementation (SPI) mechanisms that have been proposed as a solution to incomplete contracting problems. We show that these mechanisms, which are based on off-equilibrium arbitration clauses that impose large fines for lying and the inappropriate use of arbitration, have severe behavioral constraints because the fines induce retaliation against legitimate uses of arbitration. Incorporating reciprocity preferences into the theory explains the observed behavioral patterns and helps us develop a new mechanism that is more robust and achieves high rates of truth-telling and efficiency. Our results highlight the importance of tailoring implementation mechanisms to the underlying behavioral environment. (JEL C92, D44, D82, D86, D91)

Organizing Global Supply Chains: Input-Output Linkages and Vertical Integration

We study how the technological importance of inputs—measured by cost shares—is related to the decision to “make” or “buy” that input. Using detailed French international trade data and an instrumental variable approach based on self-constructed input–output tables, we show that multinationals vertically integrate technologically important inputs. A stylized incomplete contracting model with both ex-ante and ex-post inefficiencies explains why: Technologically more important inputs are “made” when transaction cost economics type forces overpower property rights type forces. However, additional results show that both types of forces are needed to explain the full patterns in the data.

Contracting Outcomes with Communication and Learning

We show that allowing communication can increase optimal choices and efficiency in a multitask, incomplete contracting, principal–agent setting. We study two simple communication protocols, one allowing for one or more requests on non-contractible choices, and the other allowing for a request, promise and ex post payment. The protocol where principals are asked to communicate requests to the agent regarding non-contractible choices promotes better learning of optimal strategies on the part of the principals, but shows no tendency for coordination to superior outcomes. The benefits accrue mainly due to changes in the choices of principals, who issue communication, rather than those of agents. Coordination is promoted, and learning subdued, when the protocol permits promises and ex post payments, in addition to allowing a request. This protocol also increases efficiency, with the efficiency gains equal across the protocols. JEL Codes: L14, C91

Negotiating a Better Future: How Interpersonal Skills Facilitate Intergenerational Investment*

Using a randomized controlled trial, we study whether a negotiation skills training can improve girls’ educational outcomes in a low-resource environment. We find that a negotiation training given to eighth-grade Zambian girls significantly improved educational outcomes over the next three years, and these effects did not fade out. To better understand mechanisms, we estimate the effects of two alternative treatments. Negotiation had much stronger effects than an informational treatment, which had no effect. A treatment designed to have more traditional girls’ empowerment effects had directionally positive but insignificant educational effects. Relative to this treatment, negotiation increased enrollment in higher-quality schooling and had larger effects for high-ability girls. These findings are consistent with a model in which negotiation allows girls to resolve incomplete contracting problems with their parents, yielding increased educational investment for those who experience sufficiently high returns. We provide evidence for this channel through a lab-in-the-field game and follow-up survey with girls and their guardians.

A Theory of International Organization

This book explains the design and development of international organization in the postwar period. It theorizes that the basic set up of an IO responds to two forces: the functional impetus to tackle problems that spill beyond national borders and a desire for self-rule that can dampen cooperation where transnational community is thin. The book reveals both the causal power of functionalist pressures and the extent to which nationalism constrains the willingness of member states to engage in incomplete contracting. The implications of postfunctionalist theory for an IO’s membership, policy portfolio, contractual specificity, and authoritative competences are tested using annual data for seventy-six IOs for 1950–2010.