Bounded Rationality and Incomplete Contracts

Bounded rationality and incomplete contracts

This paper explores the link between boundedly rational behavior and incomplete contracts. The bounded rationality of the agents in our world is embodied in a constraint that the contracts they write must be algorithmic in nature. We start with a definition of contract incompleteness that seems both appealing and widely applicable. Our first task is then to show that, by itself, the algorithmic...

The efficiency of managed care "patient protection" laws: incomplete contracts, bounded rationality, and market failure.

Complexity, Flexibility, and the Make-or-Buy Decision

Sixty-five years ago, Ronald Coase (1937) asked what determines whether production will be organized in a firm or through the market, later coined the "make-or-buy" decision. This question was put center stage by Oliver Williamson (1975, 1985) who further developed transaction-costs economics (TCE), arguing that incomplete contracts and specific relationships overshadowed by opportunism, asymme...

From “Thin” to “Thick” Bounded Rationality in the Economics of Organization: An Explorative Discussion

Bounded rationality has often been invoked in the theory of economic organization, mainly to rationalize contractual incompleteness. I argue that one may distinguish between " thin " and " thick " notions of bounded rationality; that models that rely on thin notions are often effectively indistinguishable from models that rely on full rationality; and that the value-added in terms of economic c...

Incompleteness as a Constraint in Contract Design∗

We develop a model that encompasses both the incomplete contracts that are used in practice and the idealized complete contracts that address all contingencies. The objectives of the paper are to (i) examine the extent of the inefficiency caused by the constraint of contractual incompleteness; (ii) to identify properties of agents’ preferences that determine whether or not incompleteness causes...