Incomplete Contracts: An Empirical Approach

Sarath Sanga*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

5 Scopus citations

Abstract

The strategic ambiguity hypothesis posits that when some aspects of performance are observable but not verifiable, the optimal contract is deliberately incomplete. I test this result for the first time. Because a direct test is infeasible, I derive an equivalent result: incompleteness is optimal when some terms are legally void. I test this using executive contracts from S&P 500 firms. I find that firms pay severance in discretionary installments to induce their executives to comply with noncompete agreements-but only in California, where noncompetes are void. Outside California, noncompetes are valid and these same firms pay non-discretionary severance upfront. I conclude that firms use strategic ambiguity to circumvent legal constraints.

Original languageEnglish (US)
Pages (from-to)650-679
Number of pages30
JournalJournal of Law, Economics, and Organization
Volume34
Issue number4
DOIs
StatePublished - Nov 1 2018

ASJC Scopus subject areas

  • Economics and Econometrics
  • Organizational Behavior and Human Resource Management
  • Law

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