A Theory of Contractual Incompleteness based on Judicial Agency

Ex ante contractual agreements between parties must necessarily be enforced by an enforcing authority ex post. If the enforcing authority turns out to be opportunistic, the initial contract de...nes an ex post rent dissipation game that the contracting parties will play in trying to bribe him. When parties foresee this possibility, they may rationally refrain from contracting in the ...rst place, and consequently contracts will be “incomplete”. It follows that contractual incompleteness is more likely to be observed when the value of contracting is low, when the incentives that the contract must supply are high, when the individuals involved have substantial wealth, and when the enforcing authority enjoys substantial discretion. Consistent with these predictions, (1) criminal law regularly employs ambiguous and hard-to-verify contingencies, and in general the “punishment ...ts the crime”, (2) laws requiring judicial interpretation appear to be less common in countries where judges enjoy more discretion, and (3) private commercial contracts make some but limited use of clauses that require judicial interpretation. ¤I thank Richard Brooks, Kim-Sau Chung, Mike Fishman, Kathleen Hagerty, Anna Paulson, Ashok Rai, Kathy Spier and especially Arvind Krishnamurthy for helpful comments, along with seminar audiences at Caltech, Northwestern University, the North American Summer Meeting of the Econometric Society (2001), the Southeast Theory and International Economics Meetings (2000), and Stanford Institute of Theoretical Economics (2000). Any errors are of course my own. yEmail: [email protected]. Mailing address: Kellogg Graduate School of Management, Northwestern University, Evanston IL 60208-2001.