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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