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Overconfidence and Endogenous Contract Incompleteness

Author

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  • Te Bao
  • Yun Dai
  • Yongqin Wang

Abstract

We set up a model on the hold-up problem with uncertain bargaining power and find that, when two agents are overconfident about their bargaining power ex ante, both of them may endogenously choose incomplete contract over complete contract even when complete contracting is feasible. The intuition behind the result is that ceteris paribus, overconfidence leads to a higher expected return to relationspecific investment and a higher investment level. Our model provides an additional behavioral explanation for the prevalence of contract incompleteness in addition to those existing in the literature.

Suggested Citation

  • Te Bao & Yun Dai & Yongqin Wang, 2024. "Overconfidence and Endogenous Contract Incompleteness," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 180(3), pages 463-484.
    • Handle: RePEc:mhr:jinste:urn:doi:10.1628/jite-2024-0025
    DOI: 10.1628/jite-2024-0025
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    More about this item

    Keywords

    endogenous contract incompleteness; overconfidence; control right; bargaining power;
    All these keywords.

    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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