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Incentive provision when contracting is costly

Author

Listed:
  • Kvaløy, Ola

    (Dept. of Economics and Business Administration, University of Stavanger)

  • Olsen, Trond E.

    (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

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.

Suggested Citation

  • Kvaløy, Ola & Olsen, Trond E., 2010. "Incentive provision when contracting is costly," Discussion Papers 2010/10, Norwegian School of Economics, Department of Business and Management Science.
    • Handle: RePEc:hhs:nhhfms:2010_010
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    File URL: http://hdl.handle.net/11250/164144
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    References listed on IDEAS

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    More about this item

    Keywords

    Contract costs; incentive provision;

    JEL classification:

    • J00 - Labor and Demographic Economics - - General - - - General

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