Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/28087
Authors: 
Bester, Helmut
Krähmer, Daniel
Year of Publication: 
2008
Series/Report no.: 
Diskussionsbeiträge des Fachbereichs Wirtschaftswissenschaft der Freien Universität Berlin 2008/23
Abstract: 
This paper analyzes bilateral contracting in an environment with contractual incompleteness and asymmetric information. One party (the seller) makes an unverifiable quality choice and the other party (the buyer) has private information about its valuation. A simple exit option contract, which allows the buyer to refuse trade, achieves the firstbest in the benchmark cases where either quality is verifiable or the buyer's valuation is public information. But, when unverifiable and asymmetric information are combined, exit options induce inefficient pooling and lead to a particularly simple contract. Inefficient pooling is unavoidable also under the most general form of contracts, which make trade conditional on the exchange of messages between the parties. Indeed, simple exit option contracts are optimal if random mechanisms are ruled out.
Subjects: 
Incomplete contracts
asymmetric information
exit options
JEL: 
D82
D86
L15
ISBN: 
3938369949
Document Type: 
Working Paper

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