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A Matter of Interpretation: Bargaining over Ambiguous Contracts

Author

Listed:
  • Simon Grant

    (Department of Economics, Rice University)

  • Jeff Kline

    (Department of Economics, University of Queensland)

  • John Quiggin

    (Department of Economics, University of Queensland)

Abstract

We present a formal treatment of contracting in the face of ambiguity. The central idea is that boundedly rational individuals will not always interpret the same situation in the same way. More specifically, even with well defined contracts, the precise actions to be taken by each party to the contract might be disputable. Taking this potential for dispute into account, we analyze the effects of ambiguity on contracting. We find that risk averse agents will engage in ambiguous contracts for risk sharing reasons. We provide an application where ambiguity motivates the use of a liquidated damages contract.

Suggested Citation

  • Simon Grant & Jeff Kline & John Quiggin, 2009. "A Matter of Interpretation: Bargaining over Ambiguous Contracts," Risk & Uncertainty Working Papers WPR09_3, Risk and Sustainable Management Group, University of Queensland.
    • Handle: RePEc:rsm:riskun:r09_3
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    File URL: http://www.uq.edu.au/rsmg/WP/WPR09_03.pdf
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    References listed on IDEAS

    as
    1. Oliver Hart & John Moore, 1999. "Foundations of Incomplete Contracts," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 66(1), pages 115-138.
    2. Sujoy Mukerji & Jean-Marc Tallon, 2001. "Ambiguity Aversion and Incompleteness of Financial Markets," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 68(4), pages 883-904.
    3. Oliver Board, 2008. "Object-Based Unawareness: Theory and Applications," Working Paper 378, Department of Economics, University of Pittsburgh, revised Mar 2009.
    4. Kathryn E. Spier, 1992. "Incomplete Contracts and Signalling," RAND Journal of Economics, The RAND Corporation, vol. 23(3), pages 432-443, Autumn.
    5. Kim-Sau Chung & Oliver Board, 2007. "Object-Based Unawareness," Working Papers 2007-2, University of Minnesota, Department of Economics, revised 24 Aug 2007.
    6. Heifetz, Aviad & Meier, Martin & Schipper, Burkhard C., 2006. "Interactive unawareness," Journal of Economic Theory, Elsevier, vol. 130(1), pages 78-94, September.
    7. Bernheim, B Douglas & Whinston, Michael D, 1998. "Incomplete Contracts and Strategic Ambiguity," American Economic Review, American Economic Association, vol. 88(4), pages 902-932, September.
    8. Eric Maskin & Jean Tirole, 1999. "Unforeseen Contingencies and Incomplete Contracts," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 66(1), pages 83-114.
    9. Chew Soo Hong & Jacob S. Sagi, 2006. "Event Exchangeability: Probabilistic Sophistication Without Continuity or Monotonicity," Econometrica, Econometric Society, vol. 74(3), pages 771-786, May.
    10. Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
    11. Grant, Simon & Kajii, Atsushi, 1995. "A Cardinal Characterization of the Rubinstein-Safra-Thomson Axiomatic Bargaining Theory," Econometrica, Econometric Society, vol. 63(5), pages 1241-1249, September.
    12. Mukerji, Sujoy, 1998. "Ambiguity Aversion and Incompleteness of Contractual Form," American Economic Review, American Economic Association, vol. 88(5), pages 1207-1231, December.
    13. Ilya Segal, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 66(1), pages 57-82.
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    Cited by:

    1. Halpern, Joseph Y. & Kets, Willemien, 2015. "Ambiguous language and common priors," Games and Economic Behavior, Elsevier, vol. 90(C), pages 171-180.

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    More about this item

    Keywords

    ambiguity; bounded rationality; expected uncertain utility; incomplete contracts; liquidated damages.;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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