Incomplete Contracts and the Governance of Complex Contractual Relationships
Even the simplest of economic transactions can be so complex that it is practically impossible to list the entire range of outcomes and contingencies that might affect contractual performance. Scholars outside the formal economic field of contract theory have long recognized that this complexity implies that real-world contracts will almost never provide an exhaustive description of the rights and obligations of the contracting parties in every possible contingency. The central role of contractual incompleteness in transaction-cost economics, contract law, and the law and economics movement should be contrasted with the minor role it played in the formal theory of contracts developed by economic theorists over the past two decades. The starting point of most formal contracting models (e.g., the principal-agent model with moral hazard) is the feasibility of a complete description of the set of possible contingencies and the ability to write contracts that are sensitive to even the most minute details of the events arising in the course of the transaction. One reason that might help explain this neglect of the role of incomplete contracts is the lack of a well-developed theory of contract enforcement (governance). By focusing on explicit written contracts as the only available method of governance, many models abstract from the role of other instruments such as ownership rights, contract law as interpreted by courts, reputation in long-term relationships, and social conventions that define what constitutes acceptable
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