Incomplete Contracts with Disparity, Uncertainty, Information and Incentives

Cooperation among firms is governed by contracts. An interesting phenomenon is that some contracts are comprehensive while some are limited. This study tries to explain different levels of incompleteness of contracts that firms choose to govern their cooperation with. We find that a limited contract is more efficient than a comprehensive contract if partners are highly disparate or product quality is largely uncertain, and vice versa. In contrast, if there are private information and incentives to invest in quality, a comprehensive contract is likely to be more efficient. These findings offer an understanding as to why incomplete contracts are so popular in practice