In 2016, Profs. Oliver Hart and Bengt Holmstrom won the Nobel Prize in Economics for theoretical models, whose predictions have received validation in experiences of economic agents in all spheres of economic activity.
In their theoretical models, Profs. Hart and Holmstrom predicted that attempts at arrival at ‘perfect contracts’ are, for lack of better terminology, a waste of time.
The intuition for this prediction is very straightforward. If none of the parties to a contract are able to perfectly predict the future, no matter how watertight a contract appears to be today, upon arrival, in future, of any unanticipated events, reasonableness of both agents can imply appropriateness of renegotiation of the contract.
Let us denote capacity for perfect anticipation of all that feasibly could transpire in future, the capacity for Perfect Foresight.
In presence of the normative that none of the parties to any contract have perfect foresight, there does not exist any such thing as a ‘perfect contract’.
In absence of feasibility of a perfect contract, the best that parties to any contract can target, is arrival at a contract, which, conditional on current and anticipated circumstances, is acceptable to both parties. The parties then either can attempt to prespecify conditions that trigger renegotiation, or can predicate renegotiation on future discussions that reveal necessity of renegotiation.
An application of prespecification of conditions, which trigger renegotiation, is indexing of dollar value of a government contract for building of infrastructure, a contract that can span as much as 5 to 10 years, to inflation. Within such a context, in presence of an increase to inflation, a contractor automatically receives larger payments in response to fulfillment of an infrastructure contract.
Whenever a soccer player outperforms his or her contract, and management of the soccer team chooses to renegotiate the preexisting contract — which may not expire for, say, another 18 months — renegotiation has been left open to discussions, and is voluntarily triggered by management of the soccer team in response to…