contract

1. Contract theory
Contract theoryisthe studyof howpeople andorganizationsdeveloplegal agreementsinsituations
withuncertainconditions,unknownfactorsandinformationasymmetry.Contracttheoryappliestoboth
multi-partynegotiationsbetweenaprincipal andone ormore agentsandcontracts createdby a single
individualororganizationtospecifydetailsof multi-partyagreements,suchasemployee contracts.
Ideally,acontract specifiesthe responsibilitiesandrequirementsof bothpartiessometiculouslythat
there can be no room fordispute ormisunderstanding.However,thatideal mayneverbe achieved,for
variousreasons.Moral hazard, one model withincontracttheory,isthe riskthatone party to a
transactionisnot actingin goodfaith. For example,thatpartymayhave withheldimportant
informationorprovidedmisleadinginformationormayhave undisclosedmotivationdrivingelementsof
an agreementthatare beingnegotiated.Moral hazardofteninvolvesthe assumptionof risksthat
disadvantage the partywithlessinformation.Othermodelswithincontracttheoryinclude adverse
selection,inwhichthe principal partyisnotfullyinformedof the agent’sriskfactors,andsignaling,in
whichthe agentreliablyconveysinformationaboutitself tothe principal,forexample,ajobapplicant
listingqualificationsthatmatchthe hirer’slistof requirements.
Contract theoryisa special applicationof game theory,whichisthe studyof mathematical modelsof
negotiation,conflictandcooperationbetweenindividuals,organizationsandgovernments.Central
questionsof game/contracttheoryinclude whyanindividualmakesaparticulardecisionandhow the
decisionsmade byone individualaffectothers.
Contracts
A voluntary,deliberate,andlegallybindingagreementbetweentwoormore competentparties.
Contracts are usuallywrittenbutmaybe spokenorimplied,andgenerallyhave todowithemployment,
sale or lease,ortenancy.
A contractual relationshipisevidencedby:-
• An offer,
• Acceptance of the offer,anda
• Valid(legal andvaluable) consideration
Each party to a contract acquiresrightsanddutiesrelativetothe rightsanddutiesof the otherparties.
However,whileall partiesmayexpectafairbenefitfromthe contract(otherwise courtsmaysetitaside
as inequitable)itdoesnotfollowthateachpartywill benefittoanequal extent.
Existence of contractual-relationshipdoesnotnecessarilymeanthe contractisenforceable,orthatit is
not void(see voidcontract) orvoidable (seevoidable Contract).Contractsare normallyenforceable
whetherornot ina writtenform,althoughawrittencontract protectsall partiestoit.Some contracts,
(suchas for sale of real property,installmentplans,orinsurance policies)mustbe inwritingtobe legally
bindingandenforceable.Othercontracts(see impliedinfactcontractand impliedinlaw contract) are
assumedin,andenforcedby,lawwhetherornotthe involvedpartiesdesiredtoenterintoacontract