We consider a buyer and seller who contract over a service. The contract encourages investment and provides a reference point for the transaction. In normal times the contract works well. But with some probability an abnormal state occurs and the service must be modified. The parties expect each other to behave ‘reasonably’, but given self-serving biases their views of reasonableness may not coincide, leading to aggrievement and deadweight losses. The adoption by the parties of guiding principles such as loyalty and equity in their contract can help. We provide supporting evidence in the form of case studies and interviews.
David Frydlinger and Oliver Hart, Overcoming Contractual Incompleteness: The Role of Guiding Principles (September 2020).