TY - JOUR
T1 - Incomplete Contracts
T2 - An Empirical Approach
AU - Sanga, Sarath
N1 - Funding Information:
doi:10.1093/jleo/ewy012 Advance Access published July 11, 2018 © The Author(s) 2018. Published by Oxford University Press on behalf of Yale University. All rights reserved. For permissions, please email: journals.permissions@oup.com *Email: sanga@northwestern.edu. I am grateful to the editor Raymond Fisman and two anonymous referees for comments that substantially improved this article. I also thank Patrick Bolton, Richard R. W. Brooks, Ezra Friedman, Geneviève Helleringer, Justin McCrary, Kerem Sanga, Max Schanzenbach, and participants from seminars at Oxford, Notre Dame, Duke, Northwestern, Hitotsubashi (Tokyo), Yale, University of Pennsylvania, and Université Panthéon-Assas (Paris II) for valuable comments. This research was supported by the Northwestern University Pritzker School of Law Faculty Research Program. 1. See, e.g., Hart and Moore (1988); Edlin and Reichelstein (1996).
Publisher Copyright:
© The Author(s) 2018. Published by Oxford University Press on behalf of Yale University. All rights reserved.
PY - 2018/11/1
Y1 - 2018/11/1
N2 - 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.
AB - 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.
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U2 - 10.1093/jleo/ewy012
DO - 10.1093/jleo/ewy012
M3 - Article
AN - SCOPUS:85056579196
VL - 34
SP - 650
EP - 679
JO - Journal of Law, Economics, and Organization
JF - Journal of Law, Economics, and Organization
SN - 8756-6222
IS - 4
ER -