Incomplete Contracts and Complexity Costs

Abstract

This paper investigates, in a simple risk-sharing framework, the extent to which the incompleteness of contracts could be attributed to the complexity costs associated with the writing and the implementation of contracts. We show that, given any measure of complexity in a very general class, it is possible to find simple contracting problems such that, when complexity costs are explicitly taken into account, the contracting parties optimally choose an incomplete contract which coincides with the ‘default’ division of surplus. Optimal contracts with complexity costs are constrained efficient in our model. We therefore interpret our results as saying that, in the absence of a strategic role for complexity costs, their effect is entirely determined by their size relative to the size of payoffs.