Opportunism and the dynamics of the incomplete contracts

Abstract

This paper studies a buyer-seller relationship where "quality" is not contractible but is affected by effort and the seller's privately known innate value. The seller's cost of effort is also private knowledge. Assuming constant outside opportunities, we show that more than two contracts is redundant, the sequence of contracts exhibits increasing prices and durations, and commit- ments for prices beyond the actual contract invite opportunism, not effort. The seller uses effort during the screening process, which improves noncontract- ible quality. As a result, type-related information may have negative value when contracts are incomplete.