The Economics of Contracts: Theories and Applications

By Eric Brousseau; Jean-Michel Glachant | Go to book overview

12
Allocating decision rights under
liquidity constraints
Philippe Aghion and Patrick Rey

1 Introduction

The debate on the foundations of incomplete contracts had focused essentially on the Grossman–Hart (1986) framework, in which actions (in that case, trade versus no-trade) are assumed to be exante non-describable but expost verifiable. This class of incomplete contracts models focuses on how ownership allocation affects exante investments through its impact on the expost bargaining between the contracting parties; since actions are verifiable, this bargaining is always expost efficient so that the main source of inefficiency lies in the non-verifiability of exante investments. In this framework, Maskin and Tirole (1999a) shows that message games played expost can often be used to circumvent the exante non-contractibility and even the non-describability of actions and states. A main response to this criticism (see Segal 1999, Hart and Moore 1999a, Maskin and Tirole 1999b) has been to add renegotiation and complexity considerations, in order to generate optimal mechanisms that can be easily interpreted as ownership and control allocations.

Another set of incomplete contracting models, starting with Aghion and Bolton (1992), focuses instead on expost inefficiencies resulting from the non-contractibility of actions, combined with additional limitations on the ability to induce expost efficient action choice through adequate transfers to the controlling party. In Aghion and Bolton (1992) (hereafter, AB), what limits the scope for expost efficiency is the wealth constraint faced by the entrepreneur whenever the outside investor is in control (which prevents the entrepreneur from inducing the first-best action choice from the investor), together with exante participation constraints which can make it non-feasible to allocate full control to the entrepreneur (and then let the unconstrained investor make the expost monetary transfers to induce efficient action choice). In Aghion and Tirole (1997) and the subsequent literature on authority, what prevents achieving expost efficiency is the non-responsiveness of the agent to monetary incentives. 1 Now, as Maskin and Tirole did for the Grossman–Hart

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