Real world contracts often contain incentive clauses that fail to fully specify conditions triggering payments, giving rise to legal disputes. When complete contract generate Pareto efficient allocations the L&E literature advocates that courts should fill in the missing clauses. This logic does not directly extend to environments with moral hazard, where complete contracts result in constrained efficient allocations. Despite this inefficiency we find that when agency and marginal agency costs are congruent, the legal system can do no better than guide its courts to complete contracts according to the parties’ intentions.
Benjamin Bental, Bruno Deffains and Dominique Demougin, Interpreting contracts: the purposive approach and non-comprehensive incentive contracts, European Journal of Law and Economics volume 50, pages 241–265 (2020). Published: 18 September 2020.