Contractual Choice
4100
CONTRACTUAL CHOICE
Scott E. Masten
Louis and Myrtle Research Professor of Business and Law, University of
Michigan Business School
© Copyright 1999 Scott E. Masten
Abstract
This chapter discusses alternative theories of contract choice and design with special emphasis on (i) the interaction between contract design and contract enforcement and (ii) the explanatory power of alternative theories. After discussing the primary functions of contract, the entry reviews the assumptions and implications for contract design of the three dominant approaches to contracting in economics. An overview of the empirical literature on contracting and contractual choice identifies the main empirical regularities and their relation to the theory. A final section addresses implications for contract law and enforcement and directions for future research.
JEL classification: D23, K12, D82
Keywords: Contracting, Contract Enforcement, Incentives, Transaction Costs
1. Introduction
A contract, at its most basic level, is a legally enforceable agreement. Although economists - and occasionally lawyers - have used the term more expansively to describe essentially any transaction, the termc o n t r a c t as used in this chapter is reserved for formal, legal commitments to which each party gives express (though not necessarily written) approval and to which a particular body of law applies. ‘Breaching a contract’ differs from ‘canceling an order’, to use Stewart Macaulay’s (1963, p. 61) dichotomy. Ultimately, what distinguishes a contract from a mere transaction is the opportunity contracts afford transactors to invoke the formal dispute resolution machinery and coercive power of the state to enforce promises.
Besides distinguishing true contracts from ‘implicit contracts’ or self-enforcing agreements, this definition of contract highlights the fundamental link between contract design, on the one hand, and contract enforcement, on the other: the choice of contract
CONTRACTUAL CHOICE
Scott E. Masten
Louis and Myrtle Research Professor of Business and Law, University of
Michigan Business School
© Copyright 1999 Scott E. Masten
Abstract
This chapter discusses alternative theories of contract choice and design with special emphasis on (i) the interaction between contract design and contract enforcement and (ii) the explanatory power of alternative theories. After discussing the primary functions of contract, the entry reviews the assumptions and implications for contract design of the three dominant approaches to contracting in economics. An overview of the empirical literature on contracting and contractual choice identifies the main empirical regularities and their relation to the theory. A final section addresses implications for contract law and enforcement and directions for future research.
JEL classification: D23, K12, D82
Keywords: Contracting, Contract Enforcement, Incentives, Transaction Costs
1. Introduction
A contract, at its most basic level, is a legally enforceable agreement. Although economists - and occasionally lawyers - have used the term more expansively to describe essentially any transaction, the termc o n t r a c t as used in this chapter is reserved for formal, legal commitments to which each party gives express (though not necessarily written) approval and to which a particular body of law applies. ‘Breaching a contract’ differs from ‘canceling an order’, to use Stewart Macaulay’s (1963, p. 61) dichotomy. Ultimately, what distinguishes a contract from a mere transaction is the opportunity contracts afford transactors to invoke the formal dispute resolution machinery and coercive power of the state to enforce promises.
Besides distinguishing true contracts from ‘implicit contracts’ or self-enforcing agreements, this definition of contract highlights the fundamental link between contract design, on the one hand, and contract enforcement, on the other: the choice of contract