Resolving Contractual Disputes under Non-verifiability

Economics

Further details

(with Miltiadis Makris)

In this paper we look at contracting under conditions when the outcome is observed by both contracting parties but cannot be verified to a third party like a tribunal or a court. We first show that the contract always enters a dispute phase. We analyze two possible legal rules which the court can use to resolve the disputes. Under both rules the paper derives the optimal contract. An interesting feature of the optimal contract is that the agent is always rewarded unless there is failure. The other result is that under both legal rules used first best effort and more than first best effort level can be implemented.