Incomplete Contracts and Renegotiation

When drawing up a contract, it is often impracticable to specify all the relevant contingencies, and so contracts are typically incomplete. This paper considers the extent to which these gaps might be filled by building into the contract a mechanism for revising the terms of trade. One conclusion is that because the par-ties can rescind the original contract and negotiate a new one, severe limitations are placed on the form the revisions can take. The authors characterize the optimal revision mechanism both when the contract is used t o encourage relationship-specific investments and when it is used for risk sharing. Copyright 1988 by The Econometric Society.