Incomplete Contracts Modelling

Contractual incompleteness has been understood in the literature as the conditions under which contracts are insufficiently state contingent due to non-observable and/or non-verifiable states of the world. The term incomplete contracts has been used in different meanings: to denote both proper contractual incompleteness (in a complete contracts context) due to various types of information problems, which can be contractually solved through a suitably designed mechanism and a context (an incomplete contracting context) where ex ante states of nature that are too expensive to describe prevent a contractual mechanism being designed. We examine these significantly different interpretations in both methodological and formal terms. We argue that, as long as relationship-specific investment conditions occur, an incomplete contracting context is an innovative paradigm to the extent that it permits analysis of issues that in a complete contract context cannot even be broached, namely the recognition of non-contractible inefficiencies and the possibility of non-contractual solutions to such inefficiencies.