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Working Papers Abstract

Costly Contracting in a Long-Term Relationship
by Pierpaolo Battigalli (Bocconi University, IEP and IGIER) and Giovanni Maggi (Princeton University)


We examine a model of contracting where parties interact repeatedly and can contract
at any point in time, but writing enforceable contracts is costly. A contract can
describe contingencies and actions at a more or less detailed level, and the cost of writing
a contract is proportional to the amount of detail. We consider both formal (externally
enforced) and informal (self-enforcing) contracts. The presence of writing costs has important
implications both for the optimal structure of formal contracts, particularly the
tradeo. between contingent and spot contracts, and for the interaction between formal
and informal contracting. Our model sheds light on these implications and generates a
rich set of predictions about the determinants of the optimal mode of contracting.

JEL classification: D23, C73.

KEYWORDS: writing costs, contingent vs spot contracting, formal vs informal contracts.

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Last updated November 19, 2003