Incomplete written contracts: endogenous agency problems

This paper suggests a reason, other than asymmetric formation, why agency contracts are not explicitly contingent on the contracting parties' performances or actions. This reason is the formal nature of contracts: the form, usually written, that contracts are required to take to be enforceable in a court of law by legal prescription, common practice or simply by the contracting parties' will. We model the formal nature of contracts as the requirement that the mapping from the domain of the contract into the corresponding remunerations must be of an algorithmic nature. We show that there exist situations in which the chosen contract cannot be explicitly contingent on the parties' performance although, in principle, such performances are contractible and observable to all parties to the contract, court included. This approach allows us to interpret agency contracts as incomplete contracts. We relate this incompleteness either to the form of the parties' preferences or to the shape of the technological relationship through which the parties' contractible performances are transformed into contractible outcomes.