Introduction

Building upon the work of Simon (1957), Williamson (1975) observes that a fundamental reason for transaction costs is the impossibility of planning for all future contingencies in a relationship. The purpose of this chapter is to explore the conditions under which such complexity can constrain the set of feasible contracts, and help us better understand the contracts observed in practice. Specifically, a situation where agents are asked to make decisions when unforeseen events occur, but cannot renegotiate the contract is one I call ex post hold-up. In these cases, complexity can have an important impact upon the form of the optimal contract. The chapter begins by comparing the structure of the ex post hold-up problem to other contracting problems in the literature and suggests that a key ingredient in understanding the form of the optimal contract is the timing of information and actions in a relationship. Secondly, a way to measure contract complexity is suggested that has empirical implications. Finally, the optimal governance of contracts facing ex post hold-up when complexity is high depends upon the degree of correlation in subjective beliefs between the contracting parties.

Beginning with Simon (1951), there is a large literature that takes as given contract incompleteness due to transaction costs and then explores its implications for efficient governance.