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Contracting with reading costs and renegotiation costs

  • Author(s): Brennan, James R.
  • et al.
Abstract

In the economy, contract formation and recontracting are costly, and these costs have important implications for contractual outcomes and economic objectives like efficiency. In this dissertation, I characterize systematically how reading costs and renegotiation costs affect contracting behavior, and I describe how third- party enforcement, conducted by institutions such as courts, might ameliorate efficiency problems associated with both types of costly contracting. Chapter I contains analysis of contracting and costly renegotiation using mechanism-design. The Renegotiation-Proofness Principle (RPP) is formalized: any state-contingent payoff vector that is implementable with renegotiation is also implemented by a mechanism in which renegotiation does not occur in equilibrium. The RPP is not valid. However, our more general monotonicity result confirms the RPP's "renegotiation is bad" message, because it shows the set of implementable state-contingent payoffs becomes larger as the costs of renegotiation increase. In the model of Chapter II, a buyer must incur a reading cost to understand payoffs sellers' contracts promise. An equilibrium with reading with reading exists in which the buyer reads offers with positive probability. Further monotonicity results characterize how the equilibrium depends two enforcement features. Increasing the lowest enforceable payoff reduces the equilibrium reading investment and encourages acceptance. And, reducing reading costs increases the buyer's reading probability, though the total reading investment is kept low. I indicate several existing institutional rules that limit contract payoffs or reduce reading costs. The penalty doctrine restricts private damages not to exceed harm; substantive unconscionability effectively excuses performance for a low payoff; and procedural unconscionability and disclosure regulations reduce reading costs. In Chapter III, interaction between a seller who offers a standard form contract and a buyer who reads it--under two-sided asymmetric information--reveals reading costs are not incurred in equilibrium. Payoff- based limitations on enforceable contracts therefore play a vital role in agreement, since any accepted contract will not have been read. An example and general discussion relate expected surplus generated in a no-reading equilibrium to contract payoff boundaries defined by enforcement

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