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Incomplete contracts and corporate ethics: a game theoretical model under fuzzy information

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Abstract

Corporations allocate to they corporate governance structures authority over a large part of the transactions they carry out, both regulated by (incomplete) labour contracts or by (incomplete) arm's length contract. These contracts, as the eventuality of unforeseen contingencies is anticipated, are completed by residual rights of control allocating discretion upon ex ante non-contractible decisions to one party in the contract. Ownership and control structures respond to a need of minimising some transaction costs, but also admit the risk of abuse of authority. Both empirical investigation and theoretical deduction from the theory of firm suggest that corporations need systems of self-regulatory norms of behaviour like codes of ethics exactly because of the 'abuse of authority' problem. One requirement that a code of ethics must satisfy is to answer the question how who holds authority in the firm may undertake commitments over events and situations that cannot be ex ante contractible nor describable. This paper suggests a first modelling of unforeseen contingencies in terms of fuzzy sets theory. Incomplete knowledge about unforeseen contingencies is captured by defining some events as fuzzy sub-sets of the set of unforeseen states of the world. Such events correspond to terms of the ex ante language used to define the domain of general abstract principles. The cost of their all-encompassing nature is vagueness. This opens the route to define domains of abstract principles as fuzzy sets of unforeseen states of the world. Then a model is suggested of the reasoning the players perform, given this incomplete (vague) base of knowledge, in order to jump from vague premises to what it has to be done in any unforeseen contingency. Players' inferences are understood according to the logic of default reasoning. The intuition is that, given our limited knowledge, we extend our belief that the "normal course" does in fact hold also to the unforeseen situations. As a consequence are defined commitments that a player conforming to the code is expected to carry out. This allows replicating within the new context some well-known results in the theory of reputation games.

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  • Lorenzo Sacconi, 2001. "Incomplete contracts and corporate ethics: a game theoretical model under fuzzy information," LIUC Papers in Ethics, Law and Economics 91, Cattaneo University (LIUC).
    • Handle: RePEc:liu:liuced:91
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    1. Lorenzo Sacconi & Stefano Moretti, 2002. "Fuzzy norms, default reasoning and equilibrium selection in games under unforeseen contingencies and incomplete knowledge," LIUC Papers in Ethics, Law and Economics 104, Cattaneo University (LIUC).
    2. Hart, Oliver & Moore, John, 1990. "Property Rights and the Nature of the Firm," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1119-1158, December.
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    7. Drew Fudenberg & David K. Levine, 2008. "Maintaining a Reputation when Strategies are Imperfectly Observed," World Scientific Book Chapters, in: Drew Fudenberg & David K Levine (ed.), A Long-Run Collaboration On Long-Run Games, chapter 8, pages 143-161, World Scientific Publishing Co. Pte. Ltd..
    8. Luca Anderlini & Leonardo Felli, 1999. "Incomplete Contracts and Complexity Costs," Theory and Decision, Springer, vol. 46(1), pages 23-50, February.
    9. Anderlini, Luca & Felli, Leonardo, 2004. "Bounded rationality and incomplete contracts," Research in Economics, Elsevier, vol. 58(1), pages 3-30, March.
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    Cited by:

    1. Markus Beckmann & Ingo Pies, 2007. "Freiheit durch Bindung — Zur ökonomischen Logik von Verhaltenskodizes," Schmalenbach Journal of Business Research, Springer, vol. 59(5), pages 615-645, August.
    2. Gianluca Grimalda & Lorenzo Sacconi, 2002. "The Constitution of the Nonprofit Enterprise: Ideals, Conformism and Reciprocity," LIUC Papers in Ethics, Law and Economics 115, Cattaneo University (LIUC).
    3. Gianluca Grimalda & Lorenzo Sacconi, 2005. "The Constitution of the Not-For-Profit Organisation: Reciprocal Conformity to Morality," Constitutional Political Economy, Springer, vol. 16(3), pages 249-276, September.
    4. Lorenzo Sacconi, 2007. "A Social Contract Account for CSR as an Extended Model of Corporate Governance (II): Compliance, Reputation and Reciprocity," Journal of Business Ethics, Springer, vol. 75(1), pages 77-96, September.

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