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Department of Business and Management Science, Norwegian School of Economics (NHH) Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)

No 2010/10:
Incentive provision when contracting is costly

Ola Kval°y () and Trond E. Olsen ()

Abstract: We analyze optimal incentive contracts in a model where the probability of court enforcement is determined by the costs spent on contracting. We show that contract costs matter for incentive provision, both in static spot contracts and repeated game relational contracts. We find that social surplus may be higher under costly relational contracting than under costless verifiable contracting, and show that there is not a monotonic relationship between contracting costs and incentive intensity. In particular we show that an increase in contracting costs may lead to higher-powered incentives. Moreover we formulate hypotheses about the relationship between legal systems and incentive provision, specifically the model predicts higher-powered incentives in common law than in civil law systems.

Keywords: Contract costs; incentive provision; (follow links to similar papers)

JEL-Codes: J00; (follow links to similar papers)

34 pages, August 31, 2010

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