‘Incomplete Contracts and the Theory of Contract Design,’ by Robert Scott and George Triantis
Economists and lawyers know that almost every contract is incomplete. Contracts routinely omit or leave undefined important terms, and they rarely anticipate every circumstance that might frustrate performance. The reason is simple: It makes little sense to spend $1,000 drafting a provision that has an expected value of only $100. Parties therefore leave lower-value contingencies unaddressed.
Yet economists who analyze contracts have focused on a related but distinct issue: the many events for which one might want to account in a contract which cannot be verified by external authorities (e.g., courts). If performance terms cannot be verified, it would appear meaningless to include them in a contract.
Enter Robert E. Scott and George G. Triantis’ 2005 article “Incomplete Contracts and the Theory of Contract Design.” Real-world contracts, they observe, often address contingencies that courts cannot verify. This fact suggests that much of the economic literature on contracts is incomplete at best and wrong at worst. Here, I outline the paper’s core arguments: its account of the economic literature on contract design, its critique of that literature, and its alternative theory of incomplete contracting.