Introduction

The notion of incomplete contract has received increasing attention in law and economics literature as it permeates all economic problems that entail a legal solution. The incomplete contract framework is now applied to a wide range of research fields in law and economics, which cover, among other issues, the theory of the firm and economic organizations, the study of corpor­ate governance and finance, the design of liberalization and privatization policies, the governance of intellectual property and international trade.

In perfect competitive markets the relevant action to be made by economic agents is that of a Pareto-relevant economic exchange (Bowles, 2003): given initial endowments, the mere existence of potential gains from trade gener­ates that trade automatically. Under that framework, there is no need for legal rules or institutions to facilitate economic exchange. As the Coase theorem reveals, this is the tautological¹ outcome of perfect competitive markets: when transaction costs are negligible and property rights are well-defined, economic resources will automatically end up in the hands of those agents who value them the most, independently of any initial assignment of property rights on those resources. However, as long as transaction costs grow, poten­tial Pareto-relevant exchanges could be inhibited, leading to an inefficient outcome. Since incompleteness raises relevant transaction costs, incomplete contracts are a potential source of market failure. In order to minimize trans­action costs, an appropriate institutional environment has to be designed so as to enforce parties’ obligations against opportunism and renegotiation. The law and economics of incomplete contracts thus refers to the compared analysis of transaction costs associated with the legal rules and private solu­tions designed to guarantee parties’ performance in an incomplete contract framework.