Hart on Ex-Post Governance

13 June 2006 at 2:29 am Leave a comment

| Peter Klein |

Nicolai, Joe Mahoney, and I had the pleasure of lunching yesterday with Oliver Hart, who was in Copenhagen to attend our PhD course and learn something about the theory of the firm. (Ha ha, just checking to see if you're paying attention; actually he was in town for a workshop.)

Hart is writing a new paper (with John Moore), currently titled "Partial Contracts," responding to the charge that incomplete-contracting models of the firm ignore the temporal, sequential processes of coordination that characterize the firm. Robert Gibbons, characterizing the asset-specificity approaches of Williamson (1971, 1979, 1985) and Klein, Crawford, and Alchian (1978) as rent-seeking theories of the firm, calls the Grossman-Hart-Moore property-rights approach

the inverse of the rent-seeking theory. Specifically, where the rent-seeking theory envisions socially destructive haggling ex post, the property-rights theory assumes efficient bargaining, and where the rent-seeking theory is consistent with contractible specific investments ex ante, the property-rights theory requires non-contractible specific investments. These distinctions should already make it clear that the property-rights theory in no sense formalizes the rent-seeking theory (i.e., Grossman-Hart did not formalize Williamson….).

Williamson puts it thusly: "GHM vaporize ex post maladaptation by their assumptions of common knowledge and costless ex post bargaining."

In the new paper, Hart and Moore relax the assumption of costless bargaining, allowing contracting parties to be "unhappy" with the terms of trade terms ex post, and consequently to deliver less than full performance (what Hart and Moore call "perfunctory," rather than "consummate," performance) after the terms of trade have been established. This, they argue, provides a rationale for contracts: fixing the terms of trade ex ante, using competitive market prices, removes these feelings of unhappiness, even if the parties are locked into bilateral monopoly ex post. Hence, relatively simple (but unorthodox) behavioral assumptions explain the use of contracts even in the absence of relationship-specific investment and the threat of holdup.

Hart presented the model at a seminar today but has not yet written it up in a full paper (handout available here). Without a formal paper, it's a bit unfair to offer a critique. (I'm not sure I completely followed the argument anyway — must be jetlag.) Overall, the approach is intriguing, but still seems to hang on the assumption that particular actions — in this case, the level of consummate performance, rather than investment in specific assets — are observable but not verifiable, an assumption that not all theorists are comfortable with (1, 2, 3).

Entry filed under: - Klein -, Theory of the Firm.

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