Overcoming Contractual Incompleteness: The Role of Guiding Principles
We consider a buyer and seller who contract over a service. The contract encourages investment and provides a reference point for the transaction. In normal times the contract works well. But with some probability an abnormal state occurs and the service must be modified. The parties expect each other to behave “reasonably”, but given self-serving biases their views of reasonableness may not coincide, leading to aggrievement and deadweight losses. The adoption by the parties of guiding principles such as loyalty and equity in their contract can help. We provide supporting evidence in the form of case studies and interviews.
Frydlinger: Managing Partner, Cirio law firm (email: David.Frydlinger@cirio.se); Hart: Department of Economics, Harvard University (email: email@example.com). We would like to thank Hal Bretan, Sylvain Chassang, Tim Cummins, Tore Ellingsen, Christoph Engel, Maija Halonen, Louis Kaplow, Henrik Lando, Klaus Schmidt, Andrei Shleifer, Kathy Spier, Jonathan Wight, and Christian Zehnder for helpful suggestions, and Angie Acquatella and Erica Moszkowski for research assistance. We have benefited from the comments of participants at the Mini-Conference on Relational Contact Management, Copenhagen Business School (2018), the research seminar in law, economics and organization at Harvard Law School (2019), the Symposium in Honor of Martin Hellwig (2019), the NBER working group in organizational economics (2019), the 13th International Conference, Challenges of Europe, Croatia (2019), the University of Bristol contract theory workshop (2019), and SIOE (2019). The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
David Frydlinger's firm advised on the deal by Telia Company referred to in this paper. He also advises firms in applying the Vested model, but did not advise on any of the other deals referred to herein.