Perspectives from New Institutional Economics
Edited by Claude Ménard
Chapter 26: Incomplete contracts and governance structures: are incomplete contract theory and new institutional economics substitutes or complements?
Eric Brousseau and M’hand Fares* INTRODUCTION Since Coase’s contribution of 1937, economists have known that it is essential to grasp the nature of authoritarian coordination to be able to endogenize the genesis of various types of coexisting coordination mechanisms in a decentralized economic system. For a long time, however, scholars were not primarily concerned with this challenge, and we had to wait until Williamson’s contributions to beneﬁt from a systematic analysis of authoritarian coordination (Williamson 1975, 1985). This analysis relies on the insight that in certain circumstances it is either impossible or inefﬁcient to design a complete contract. It is therefore necessary to create a mechanism that will complete the contractual incompleteness by monitoring the contractors. The resulting transaction cost theory (TCT) relies on hypotheses that contrast with those of neoclassical economics, especially in the case of the agents’ rationality. This is why Grossman and Hart (1986) initiated a new theoretical branch – incomplete contract theory (ICT) – whose stated objective was to explain authoritarian coordination in an ‘enlarged’ neoclassical framework. The purpose of this chapter is to compare these two analytical frameworks. Indeed, although ICT draws its inspiration from Williamson’s analysis and its stated objective was to formulate a model from Williamson’s essential insights, especially on vertical integration, it relies on different assumptions. Moreover, it deviated progressively from TCT by becoming a theory of the renegotiation schemes to be implemented to complete incomplete contracts. On the other hand, Williamson’s TCT has been enriched by complementary analyses of transaction costs,...
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