Document Type

Article

Publication Date

1987

Center/Program

Center for Contract and Economic Organization

Center/Program

Program in the Law and Economics of Capital Markets

Abstract

This Article uses the techniques of modern decision analysis and game theory to analyze the decisionmaking strategies of parties to long-term commercial contracts. Most parties to long-term contracts initially allocate the risks of future contingencies and agree-either explicitly or implicitly-to adjust this initial risk-allocation scheme if unanticipated events occur. Once contract risks are initially distributed, however, each party's self-interest may compel them to evade their responsibility rather than adjust cooperatively as originally agreed. Visualizing the interactions between contracting parties as an iterated prisoner's dilemma, the Author attempts to clarify the dynamics of this adjustment process. Professor Scott employs a game theoretic model to demonstrate that two polar behavioral patterns-either conflict or cooperation-would dominate if parties were unable to bargain over adjustment. However, this choice may not occur, he suggests, because even parties that are precluded from negotiating each adjustment option, nevertheless can communicate their intentions to each other. Under these conditions, a cooperative equilibrium will emerge so long as one of the parties commits to a strategy of conditional cooperation before the first adjustment is necessary. Professor Scott notes that in more realistic contractual situations, some breakdowns in patterns of mutual cooperation are inevitable. In actual contract settings, substantial problems of information and enforcement may threaten the parties' efforts to realize a cooperative equilibrium. Nevertheless, he concludes that parties in continuing relationships can invoke various legal and extralegal mechanisms to reduce these information and enforcement deficits and strengthen the existing matrix of social and contractual norms.

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