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Incomplete Contracts: An Empirical Approach

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  • Sarath Sanga

Abstract

The strategic ambiguity hypothesis posits that when some aspects of performance are observable but not verifiable, the optimal contract is deliberately incomplete. I test this result for the first time. Because a direct test is infeasible, I derive an equivalent result: incompleteness is optimal when some terms are legally void. I test this using executive contracts from S&P 500 firms. I find that firms pay severance in discretionary installments to induce their executives to comply with noncompete agreements—but only in California, where noncompetes are void. Outside California, noncompetes are valid and these same firms pay non-discretionary severance upfront. I conclude that firms use strategic ambiguity to circumvent legal constraints.

Suggested Citation

  • Sarath Sanga, 2018. "Incomplete Contracts: An Empirical Approach," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 34(4), pages 650-679.
    • Handle: RePEc:oup:jleorg:v:34:y:2018:i:4:p:650-679.
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    File URL: http://hdl.handle.net/10.1093/jleo/ewy012
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    Citations

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    Cited by:

    1. Colleen Honigsberg & Sharon P. Katz & Sunay Mutlu & Gil Sadka, 2021. "State contract law and the use of accounting information in debt contracts," Review of Accounting Studies, Springer, vol. 26(1), pages 124-171, March.
    2. Michael Lipsitz & Evan Starr, 2022. "Low-Wage Workers and the Enforceability of Noncompete Agreements," Management Science, INFORMS, vol. 68(1), pages 143-170, January.

    More about this item

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts

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